‘I’m getting a sense of deja vu’: A prominent bear rips into the argument that the stock market’s ‘obscene’ valuation is justified — and lays out why a Great Depression-like collapse could strike at any moment

  • With stock market valuations at record highs, Societe Generale's Albert Edwards is predicting what he calls an "Ice Age" for investors: a long period of both stocks and bonds bearing no fruitful returns.
  • Rejecting economist Robert Shiller's opinion that low interest rates justify valuations, Edwards says factors like concentrated outperformance and the Federal Reserve's interventions will lead to a market crash and long period of weak performance.
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Winter will begin in just over a week. 

And, if only for investors, it will be here to stay for the foreseeable future, according to Société Générale Global Strategist Albert Edwards.

With stock market valuations at record highs, the prominent and bearish analyst is predicting what he calls an "Ice Age" for investors: a long period of both stocks and bonds bearing no fruitful returns.

It's certainly not a widely-shared opinion on Wall Street today, where many see the low interest rate environment leaving investors with no choice but to put their money in stocks, therefore driving up valuations. 

That's exactly what Nobel Prize-winning economist and Yale Professor Robert Shiller argued recently, which prompted Edwards to publish a December 10 note rebuffing the line of thought. 

In the note, he compared Shiller to economist Irving Fisher, who wrongly predicted the direction of the market in 1929.

"As the US equity market hits another record high, I'm getting a sense of déjà vu," Edwards wrote in the note. "The great Yale economist and market historian Robert Shiller has just published an article justifying high US equity valuations on the basis that bond yields are low." 

"This has echoes of economist Irving Fisher (who coincidentally was also a Yale University professor) who in early October 1929 proclaimed, 'stock prices have reached what looks like a permanently high plateau' just weeks before the stock-market collapse," he added.

Edwards' issue with Shiller's argument that equity valuations rise when interest rates are low is that he assumes all other variables are constant. Edwards says this is not the case in the current environment. 

The "Ice Age" thesis — and why Edwards says we're entering one

Edwards' "Ice Age" thesis is basically that in a low interest rate environment, while it's possible to see stock valuations surge as investors seek returns, it is also possible that stock valuations drop.

He said market conditions in Japan in the 1990s led him to this theory.

"When I developed the Ice Age thesis in late 1996 I had observed the unfolding Ice Age investment lessons from Japan – namely in a situation of very low inflation and bond yields, equity market PEs will fall to very low levels," Edwards said.

He said this is also possible in the US. 

"US history also confirms that very low equity market PEs are consistent with both very high AND very low bond yields…But current Ice Age conditions justify very low bond yields and very low equity market PEs," he said.

Edwards laid out a chart comparing the ratios of the cost of equities versus bonds in Japan — where equities' cost levels relative to government bonds peaked in 1990 — and in the US, where it peaked in 2000.

It shows a bleak picture for equity valuations in the US over the next decade.

But what are these conditions in the US? The first is that he is skeptical of the credibility of bullish earnings estimates being made by analysts on expensive stocks. He pointed to the dot-com bubble as an example of analysts overshooting longer-term estimates.

"As the late 1990s TMT (technology, Media and Telecom stocks) bubble collapsed, so too did analysts' long-term eps estimates. After all, the analysts no longer needed them to be so high to square their outlandish buy recommendations," Edwards said.

He added: "In a world of low inflation and low nominal GDP, analysts' long-term EPS growth forecasts must also eventually decline in tandem, offsetting the PE-expanding impact of lower bond yields."

Second, Edwards said that the Federal Reserve's role in inflating asset prices has pacified investors into believing that equities are low-risk.

"Given the temporary success policymakers have in manipulating and lengthening the economic cycle (e.g. the Great Moderation) investors are often blind to the explosive reality that lurks beneath the low vol surface," Edwards said.

"Indeed, with the Fed Put seemingly underpinning the equity market, investors mistakenly think (at least in the US) that equities are lower risk, and I can totally understand that," he continued. "It is only in the depths of recession when profits collapse that investors finally wake up from their dream-like state to face the nightmare reality. And so it is then that equity valuations quickly collapse."

He added: "Needless to say that in my Ice Age view of the world, Robert Shiller is dead wrong. In my view, US equity valuations are a QE- fueled bubble waiting to burst."

Edwards also points to the exceptional nature of high equity valuations in the US compared to other markets. 

In Europe, for example, stock prices have remained low over the last decade, while those in the US have climbed.

Finally, he highlights the concentration of market outperformance among the top six stocks in the S&P 500: Apple, Microsoft, Facebook, Netflix, Alphabet, and Amazon. 

He said unless these stocks can continue to justify their valuations with strong earnings, prices will climb so high that investors will eventually no longer be willing to pay up so much for them.

"The concentration and leadership of the overall US market by an increasingly small number of very expensive mega-cap stocks could soon be seen as a burden as much as a boon," Edwards said.

"What might trigger a collapse in US CAPE valuations in line with the Ice Age reality suffered by all other markets? It does really seem to hinge on when or if the FAAAMN bubble bursts."

He added: "And if investors are looking for signals, what better than Robert Shiller's justification of the nose- bleed high US equity valuations. This could just be an Irving Fisher October 1929 moment!"

A bear among bulls

Edwards isn't alone in his pessimistic assessment. There are other notorious bears, like John Hussman, also making epic market crash predictions. 

But by-and-large, Edwards' views are not mainstream on Wall Street right now. Virtually all of the major investment banks are estimating big gains for the S&P 500 for the year ahead. 

Read more:

Goldman doubles down on its call for 16% stock gains in 2021 with investors still sitting on mountains of cash

The S&P 500 will climb 8% in 2021 – and investors picking unloved stocks will profit the most, Morgan Stanley says

JPMorgan sees $1 trillion flowing into the stock market in 2021 amid 'one of the best environments' in years

Many have also argued that even as the economy recovers and investors start to favor more cyclical assets compared to the mega-cap tech stocks leading the market, these large stocks will still not see an extreme sell-off despite perhaps smaller pullbacks.

"It's certainly not going to be a death knell. They're very good companies, and we do still expect to see good performance out of those companies," Morningstar's Chief US Market Strategist Dave Sekera said in an interview with Business Insider on November 12, referencing how large-cap tech firms would perform when a COVID-19 vaccine comes to market. 

"It's just that generally we think that on several of them the market has just run too far, too fast on the stock price itself," he said.

Though certainly on the fringes of market forecasts, Edwards at the very least presents an interesting argument. 

Time will tell if his "Ice Age" thesis comes to pass.

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