This is a Vulcan death grip:

And according to SocGen’s über-bear Albert Edwards, that’s exactly the state in which equity investors find themselves in now.

Or as he puts it (our emphasis):

The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious.

You see, according to Edwards, the notion that equity markets predict economic trends or events in any shape or form is largely incorrect. After following markets for 25 years, he says he believes it’s actually the case that equity markets react to events, if anything.

Which is why it’s better to look to leading indicators. And these, it seems, are pointing to a hard landing, or at best, a decisive slowdown.

Hence:

In my view we are poised to slide back into another global recession: the data is slowing sharply but, just like Japan in its Ice Age, most still touchingly believe we are soft-landing. But before driving off a cliff to a hard (crash?) landing we might feel reassured when we pass a sign that reads Soft Landing and we can kid ourselves all is well.

I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can’t remember where I read this, otherwise I would reference it). We have not quite reached this point. But with margins so high, any cyclical slowdown will crush productivity growth. Already in Q2, US productivity growth fell 1.8%  the steepest fall since Q3 2006. Hence, inevitably, unit labour costs have begun to rise QoQ. This trend will be exacerbated by recent more buoyant average hourly earnings seen in the last employment report. Whole economy profits are set for a 2007-like squeeze. And a sharp slide in analysts’ optimism confirms we are right on the cusp of falling forward earnings (see chart below).

De Nile, it seems, is not just a river in Egypt in Edwards’ eyes.

For example, Edwards wonders why markets are suddenly kidding themselves by looking to private payrolls rather than government jobs. As he states:

Last Friday saw the equity market rally as August’s 67k rise in private payrolls and an upwardly revised July rise of 107k beat expectations. But did I miss something? When did we switch from looking at headline payrolls to private jobs? Does the fact that government is shedding jobs not matter? Admittedly temporary census workers do mess up the data, but hey, why not look at nonfarm payroll data ex census? Why not indeed? Because the last 4 months run of data looks notably weaker on payrolls ex census basis than looking only at the private payroll data (ie Aug 60k vs 67k, July 89k vs 107k, June 50k vs 61k and May 21k vs 51k). But these data, on either definition, look dreadful compared to the 265k rise in April and 160k in March (ex census definition). If someone as pathologically lazy as me can find the relevant BLS webpage after a quick call to the BLS (link), why can’t the market? Because it is bad news, that’s why.

Meanwhile, the sort of indicators markets are haplessly ignoring are some of the regional subcomponents like the Philadelphia Fed workweek, which in his opinion are SCREAMING that recession is imminent.

Of course, with Fed policy focused on boosting asset and equity prices via QE2 — comparable to interest rate cuts in their effects — the revival of the actual economic cycle may be being put on a back burner.

And the trouble with that is, we’ve now come to a point when equity prices are sliding regardless, and we still don’t have any signs of an imminent cyclical recovery coming our way.

As Edwards concludes:

In the absence of a cyclical recovery I cannot see how QE is any different in its ability to revive asset prices than lower rates in anything other than a temporary fashion. (Interestingly many of our clients think QE2 might give a temporary fillip to the risk assets but that the subsequent failure to produce any cyclical impact will cause an extremely violent reaction as investors lose faith in QE as a policy tool and Central Banks in general.)

Which we guess is what happens when you boldly go, where no central banking policy has really gone before.

Related links:
Everyone’s an Albert these days – FT Alphaville
The loneliness of the long-distance inflationista – FT Alphaville
For Edwards, the Japanese lesson still holds… – FT Alphaville
Notes from the deflationary quicksand – FT Alphaville
On the edge of a deflationary precipice… – FT Alphaville

This entry was posted by Izabella Kaminska on Tuesday, September 7th, 2010 at 11:15 and is filed under Uncategorised. Tagged with albert edwards, Deflation, Equities, payrolls, SocGen. Edit this entry.