The Japanese yen goes into freefall. China’s fragile economy tips over the edge. A wave of profit-crushing deflation comes washing over the U.S. and Europe. Investors panic.
That’s the view of perennial pessimist Albert Edwards. The London-based analyst and his team at investment bank Societe Generale SA have been ranked No. 1 for global strategy in surveys by Thomson Reuters Extel every year since 2007, even with a history of saying unpleasant things that few want to hear.
“My role is to step back from the excessive enthusiasm that builds up in the market, and to just say, ‘This is wrong. This is going to go horribly wrong,’” the 53-year-old said by phone last week.
The cliche is that when the U.S. sneezes, Japan catches a cold. Edwards says Japan is just as apt to lead the way. When the Internet bubble burst in 2000, Japan’s tech-heavy Jasdaq index started to slide weeks before the Nasdaq. Japan also pioneered the deflation that now threatens the West. In 1997, it was a plunging yen that helped trigger Asia’s currency crisis.
With the yen’s drop this week to a six-year low of 110 versus the dollar, Japan’s currency may once again be the first domino to fall in a chain of events that could be bad for everyone, according to Edwards.
The U.S. stock market rally has been going for 66 months since the financial crisis bottomed in March 2009, a streak that’s already a year longer than average. A disconnect between buoyant equity prices and corporate profit growth in the low single-digits makes the situation especially precarious.
“Almost 100 percent of investors think we’re at the start of a long recovery,” Edwards said. “It’s already a long recovery. Forget about starting from here.”
In an hour-long interview, during which he made the global economy sound like a game of Mousetrap, Edwards explained why investors should be watching Japan for clues about what may happen in the next big trouble-spot: China, whose economy is already headed for its slowest full-year growth since 1990.
The argument was this: if the yen falls, it will take other Asian currencies down with it. Eventually China will be forced to weaken the yuan, by adjusting its trading range and expanding its money supply, to keep its exports competitive. That will squeeze developed economies that have yet to fully recover from the financial crisis.
“What I’ve been saying for a couple of years — and I’ve been a voice in the wilderness — is China will ultimately have to devalue its currency,” Edwards said last week. “The yen will accelerate that.”
“Given China has so much surplus capacity and given, as well, how close the U.S. and Europe are to outright deflation, this could tip the West over the edge and cause a market panic.”
A divergence in U.S. and Japanese monetary policy — with the Fed slowing stimulus and the Bank of Japan expanding the money supply by record amounts — may have started the exchange rate moving. Now that the yen is past a tipping point, Edwards says the psychology of traders is likely to take over and turn the currency into a runaway train.
“Now we’re heading to 120, which is the 30-year support,” he said. “You break through that, and you can see it moving to 140, 150 very, very quickly indeed.”
Edwards found the yen’s price graph so compelling, he devoted an entire client note to it last week. He called it: “Presenting the most important chart for investors.”
He followed that up with a report yesterday, offering “the second most important” chart. That showed a drop in inflation expectations as measured by Treasury yields. The picture, he said, suggests investors are losing faith in the ability of policy makers to keep the U.S. economy from sliding into deflation.
Full article: Albert Edwards Says Watch Japanese Yen and Be Very Afraid (Bloomberg)