Perma-bear Albert Edwards warns stocks have ‘drunk the Kool-Aid’ as recession looms

Perma-bear Albert Edwards warns stocks have ‘drunk the Kool-Aid’ as recession looms

Appetite for stocks tends to taper when 10-year Treasury yield moves above 3%

Albert Edwards, global strategist at Société Générale, this week cautioned that the moment of reckoning for stocks is near and investors should stop buying into the fantasy of a robust economy as a recession is lurking right around the corner.

The stock market, he said, “truly has drunk the strong economy Kool-Aid.”

That warning comes as the Federal Reserve is all but certain to raise the benchmark interest rate when the Federal Open Market Committee meets next week. And as the central bank maintains a hawkish stance, investors are wondering how high Treasury yields can go before the stock market’s red hot rally hits a wall.

Conventional wisdom suggests that once the 10-year note starts yielding more than 3%, appetite for stocks tends to taper.

But for Edwards, the market is already on precarious footing and it has only mere months to go before everything falls apart.

The strategist — who has doggedly warned that the central banks’ easy-money policies since the 2008 financial crisis have created a giant bubble that would eventually plunge the global markets into a financial ice age — believes 2018 is looking a lot like 2007.

“The economic data looked just as strong back in June 2007 and only a few mavericks had figured out a recession was on the way,” Edwards told MarketWatch.

If history repeats itself, which he seems to think it will, the selloff in stocks will be triggered by rising yields on the back of improving economic data even as expectations for inflation remains muted.

“Then, like now, enthusiasm on U.S. growth was reaching its heady climax,” he wrote in a note to clients.

And although the famed perma-bear himself declined to predict a specific number that could trigger a market collapse, he cited research from his colleague Stephanie Aymes who projected selling pressure to accelerate when the 10-year Treasury yield nears 3.05%, a level that was recently breached.

“The Citi Economic Surprise Index for the U.S. had slumped back towards zero. That convergence of expectations with the data normally means yields should have continued to paddle sideways around 2.8% — and yet we have seen this dramatic rise,” he said.

The yield on the 10-year note TMUBMUSD10Y, +0.64% moved above the closely watched 3% mark on Monday with upward pressure expected to steadily build as the Fed continues to tighten the monetary policy on a booming economy. The central bank is widely expected to hike the federal-funds rate, currently at 1.75% to 2%, by 25 basis points when the FOMC convenes its two-day meeting on Sept. 25.

Edwards’s bearish outlook rings hollow at a time when the U.S. economy is prospering and corporate earnings are growing by double digits. Yet, his references to a looming recession may not be as outlandish as it seems given concerns about an inverted yield curve where long-term yields such as the 10-year Treasury yield fall below their shorter-term peers. This inversion typically happens when confidence in the economy is weak and is viewed as a harbinger of doom as it has preceded every U.S. recession over the past six decades.

A number of strategists expect the 10-year/2-year yield curve to flip some time next year with Oliver Jones, a markets economist at Capital Economic, projecting an inversion in early 2019.

The 10-year yield traded at 3.06% and the 2-year hit 2.80% Friday, a mere spread of 26 basis points.

In contrast to Edwards, Tom Lee, managing partner at Fundstrat Global Advisor, said stocks should remain largely immune to the adverse impact of higher rates until the 10-year tests 4% which is where price to earnings ratio starts to feel pressure.

“A sustained rise in rates has the biggest effect on growth versus value [stocks], favoring value,” he said.

Meanwhile, most fund managers surveyed by Bank of America Merrill Lynch said that 3.6% is the “magic number” that would make them rotate away from stocks into bonds.

The central bank has telegraphed four interest-rate hikes this year or one each quarter, with the markets penciling in another increase in December after this month.

However, mounting friction between the U.S. and China could result in a more cautious message from the central bank, according to Bricklin Dwyer, U.S. senior economist at BNP Paribas.

“We expect a discussion of the ‘downside risks’ to growth and ‘upside risks’ to inflation posed by these trade policy changes in both Chair Powell’s press conference and the subsequent minutes of the meeting,” said Dwyer in a note.

President Donald Trump on Monday announced new tariffs on about $200 billion in Chinese goods and threatened additional penalties as part of his effort to force trading partners to offer more advantageous terms.

In response, China retaliated with tariffs of 5% to 10% on $60 billion worth of U.S. products that will take effect Sept. 24 and said it may introduce more measures if the U.S. goes ahead with higher tariffs.

Stocks, however, mostly shrugged off heightened tensions with the S&P 500 index SPX, -0.04% up 0.9% and the Dow Jones Industrial Average DJIA, +0.32% rallying 2.3% for the week. The Nasdaq COMP, -0.51% bucked the trend for a weekly loss of 0.3%.

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