There are cynics, there are doomsayers, and then there's Albert Edwards, the Societe Generale economist who is in a league almost of his own.
Edwards' most recent call is that if the US economy plunges into a recession led by weak manufacturing output, stocks will be worth about a quarter of what they're priced at now.
It's a heavy-duty prediction.
On Tuesday the S&P 500 was at 1,938.68. Edwards sees it possibly passing the low of 666 it hit during the 2008 financial crisis and ending up at just 550.
The main thrust of the thesis is that central bankers inflated asset prices after the 2008 crisis and didn't let stocks hit the lows they should have done.
Central banks also caused a huge debt bubble to expand in the emerging markets and China, which is now pressuring emerging-market currencies to devalue, which could lead to a deflationary spiral and a US recession.
Now that central banks have used up their ammunition to prop up stocks, asset prices will fall dramatically if the recession does hit. Stocks will be valued at seven times earnings.
And Edwards thinks the US is on the brink. Weak manufacturing data is the canary in the coal mine.
When an economy is hurtling towards recession it is almost always the manufacturing sector that takes the less volatile services sector by the hand and leads it into a recessionary underworld.
Here's the chart:
Edwards carried on with the doom and gloom, adding:
If I am right and we have just seen a cyclical bull market within a secular bear market, then the next recession will spell real trouble for investors ill-prepared for equity valuations to fall to new lows. To bottom on a Shiller PE of 7x would see the S&P falling to around 550.
I will repeat that: If I am right, the S&P would fall to 550, a 75% decline from the recent 2100 peak. That obviously will be a catastrophe for the economy via the wealth effect and all the Feds QE hard work will turn dust.
That is why I believe the Fed will fight the next bear market with every weapon available including deeply negative Fed Funds rates in addition to more QE. Indeed, negative policy rates will become ubiquitous.
Most believe a 75% equity bear market to be impossible. But those same people said something similar prior to the 2008 Global Financial Crisis. They, including the Fed, failed to predict the vulnerability of the US economy that would fall into deep recession, well before Lehmans went bust in September 2008.
This story originally appeared in Business Insider by Ben Moshinsky on January 13, 2016. View article here.
