In the aftermath of the Fed's first rate hike, SocGen's famous skeptic and "Ice Age" deflationista, Albert Edwards, who formerly called Alan Greenspan an "economic war criminal", unloads on Yellen and says that not only is the Fed's hike too late, but that the "Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis."
Cutting right to the chase, Edwards thinks the "Yellen Fed will go down in infamy as deliberately stoking up yet another massive financial bubble. But unlike the start of the last tightening cycle in 2004, this time the corporate bond market is already severely stressed and it may take just a tiny pin-prick to burst open the putrid excess."
To prove his point, Edwards shows the following chart which demonstrates the rampant bank credit growth unleashed by ZIRP, most of which has gone to fund stock buybacks as we showed in the past…
… and says that "in the wake of the 2001 recession, an extended period of corporate de-leveraging to unwind the excess of the tech bubble led the Fed to maintain loose monetary policy for far too long. By the time it eventually began to tighten, in June 2004, household debt growth rampant and eventually blew up the economy. This time around it will be no different, credit growth has already reached peak historical rates. In short Janet ?- It?s too late!"
He then attempts to answer what is perhaps the most important question: where in the business cycle is the US economy, for which he uses several charts, chief among which is the following which "nicely sums up the failure of the Fed?s strategy: the household savings ratio has stubbornly remained above 5% despite the Fed pumping household net wealth (which includes housing wealth) back up to all time highs (see chart below). The Fed would have hoped for a far larger decline in the ratio to boost GDP (savings ratio below is inverted).
He then shows a chart we have used on numerous occasions, perhaps the only chart which matters, this time in an iteration created by SocGen's Andrew Lapthorne, which "compares the quoted sector net debt (net of cash) explosion to profits. This is 100% attributable to the Fed's excessively loose monetary policy. Bernanke et al still blame excess global, and especially Chinese, savings for fueling the 2004-8 boom and bust cycle, claiming there was nothing they could have done to stop it. Let's see who Yellen blames this time around!"
Edwards then focuses on a chart which we first showed one month ago, which very clearly shows that virtually every raised through debt has been used, over the past two decades to buyback socks.
But it's not just the use of debt-funds. The problem is that as debt built up, it did not create incremental cash flow, and as Edwards observes, key metrics such as EV/EBITDA show stock market valuations back to all time highs "and well in excess of PE measures." The take home: "it is very difficult to find any cheap stocks."
Edwards then goes on a tangent to explain the recent cardiac arrest of the junk bond market:
For those of us who have been warning for some time of the ever expanding bubble of US corporate debt, the recent problems in the corporate bond markets come as no surprise. There is a limit to how much degradation of corporate balance sheets bond investors are prepared to tolerate. Hence the rapid widening out of junk bond spreads in the second half of last year was ultimately the result of the Fed's free money policies. Widening spreads were not just as many claimed merely due to problems within the energy sector. Spreads were also widening noticeably even if the energy sector was excluded.
Edwards, therefore, thinks the bond market is saying two things: "the party's over and bond investors who always tend to be more sober types, realize this and have headed for the exits whereas equity investors are so intoxicated they haven't realized that the music has stopped. Equity investors are still gyrating around the dance floor – just as in 1999 and 2007.
And the second thing the bond market is telling, is that "there is excess leverage in the US corporate sector, it doesn't help that both corporate profits and revenues are now falling."
The most visible way to see this, is by looking at nominal business sales and inventories which have been contracting all year as we have shown previously, however with sales sliding far worse than GDP-building inventories. And while Edwards amusingly notes that while the weakness was initially attributed to "cold weather", the "chilly data has not gone away, as a combination of rising unit labor costs and weak pricing power have led to a typical late cycle decline in profit margins." And what is scariest for US GDP is that as we predicted over the summer, with sales continuing to decline, the fragile US recovery now runs the risk of an end-cycle inventory liquidation.
But where the SocGen strategist is most damning is when discussing the problem at the core of the Fed, namely that in addition to its explicit employment and stable price mandates, "there has been some debate whether to make "financial stability" an explicit mandate. Some Fed governors such as Kocherlakota believe the Fed should only be concerned about financial stability to the extent that it impact the Fed's ability to reach its existing inflation and employment goals. And that is indeed the problem."
For rather than presiding over a sustainable recovery, as the myopic Fed would have us believe, we are unfortunately sitting on yet another recession-inducing, debt time bomb waiting to blow. This comes at a time when the Fed's own favoured measure of core inflation, the core PCE deflator, remains close to 1% (in contrast with the core CPI which has been driven up to 2% by rapid rental inflation).
The conclusion is pure poetry.
Outright deflation beckons in the next recession as a direct result of the Fed's negligently loose money policies and hence it will fail to meet their explicit dual mandate, let alone its "unwritten" financial stability target. I believe the Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis. And they will deserve it.
Yes… but as long as the market goes up – helped in no small part from buying by all the central banks including the Fed- nobody cares, and anyone who dares to warn about the hopium content of the Koolaid is branded a nut. The only time anyone does care is when the Fed can no longer prop up the object of its overt and covert manipulation, asset prices. By then, however, it is by definition too late as it means control has been lost.
