The cover story in this week’s MoneyWeek magazine focuses on whether the US bull market and economic expansion can continue. One person who has a strong opinion on this is Albert Edwards, head of global strategy at Societe Generale.
Many strategists like to play it safe, limiting themselves to safe predictions and minor portfolio tweaks, but Edwards is well known for his bold, contrarian calls. We recently talked to him about his outlook for the US economy and why he thinks that “we are in the late autumn of the economic cycle”.
“Nearly every Federal Reserve rate-hiking cycle has ended in recessions” says Edwards, and this time is unlikely to be any different: “When the good times are rolling, people tend to ignore risk, creating problems when the cycle turns”.
The build-up of credit is a dangerous levels
So it is not surprising that “excess levels of credit have been allowed to build up” in the US economy – by some measures, US firms are more indebted now that they were in 2008. The International Monetary Fund released a report in April 2017 suggesting that 20% of American firms were at risk of default and bankruptcy if interest rates were to increase significantly.
Of course, “using credit to elongate the business cycle inevitably makes the downturn worse”, so “when the collapse comes, it will be much deeper”.
Any recession “could be as bad as the one that took place in 2008” says Edwards, and could include “a huge amount of unemployment” as well as a collapse in US house prices, which have recovered and are making new highs. We shouldn’t expect a quick recovery, either: after all, “when the Japanese bubble burst in 1990 it took many business cycles to fix”.
Another thing that should worry investors are the high valuation levels, especially in the US, “which are currently detached from reality”. This means that equities could end up suffering from a double blow of both falling earnings and lower price/earnings ratios, which could fall into single digits. From discussions with his colleague Andrew Lapathorne, Edwards thinks that the stockmarket could crash by as much as 70%, rather than the 50%-60% fall that happened during the Great Financial Crisis.
A crash will spread far beyond US markets
Of course, it won’t just be the US that is affected since “entities around the entire world are likely to suffer”. A stockmarket crash could put the long-term future of the global financial system in danger.
Because of the rapid post-2009 recovery, policymakers and central bankers “largely got away with it”, and escaped blame for their actions in the run up to the crisis. But now, with populist politicians either in power or on the verge of office, this is unlikely to happen again, so we should expect to see central bankers bear the brunt of any criticism this time – it is even possible that we could see the end of independent central banking.
Certainly, low interest rates and high levels of money printing mean that the major central banks “have already lost a lot of their credibility”.
How to position your portfolio
If such a meltdown does take place, then the immediate beneficiaries are likely to be traditional safe havens such as gold, cash and government bonds. Indeed, bonds in particular could benefit from both their safe-haven status and also from any “race to the bottom” in terms of money printing.
If you don’t want to abandon shares, then Edwards recommends Japan as one of the few developed countries where companies have taken advantage of cheap money to get their house in order and reduce their level of the corporate debt. Japan’s investment in robotics has resulted in higher productivity, despite its unfavourable demographics.
It also might be worth taking a look at emerging markets. While they will inevitably get caught up in any global downturn, many of them have much lower levels of corporate debt. Thanks to recent price declines, they also “start from a much lower level”. Taking these factors into account it is possible that there could even be a few potential bargains, especially if prices fall further.
However, one country that you should definitely avoid is China. This is because it is suffering from “a massive credit bubble”, that is arguably far worse than the one in the United States.