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FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Stock Market Could Fall 70%

Stock-Markets / Financial Crash Jun 05, 2011 - 10:40 AM GMT

By: Justice_Litle

Stock-Markets

Best Financial Markets Analysis ArticleAlbert Edwards predicts the S&P will go back to 400 as a result of his "first deflation, then inflation" thesis.

Meet Albert Edwards, an investment strategist for Societe Generale (or "SocGen" for short).


Though SocGen is a French bank, Mr. Edwards is based in Britain. It is there he has developed a reputation as "the City of London's best-known permabear" (via The New York Times).

Also via the NYT, Mr. Edwards has called for "a stock market collapse of at least 60 percent, followed by years of inflation of 20 to 30 percent as the persistent printing of money by central banks desperate to improve the situation sends prices soaring."

Lately, though, the 60% target has been modified. Now Mr. Edwards, a friendly fellow known for his "sandals and chuckling demeanor," is calling for an even larger drop.

The new downside target? A toe-curling 400 on the S&P, or roughly a 70% fall from recent levels.

Wild predictions aren't meaningful in themselves, of course. With all the analysts out there hunting for press recognition, it isn't hard to cherry-pick the extremes. Sometimes a big target is thrown out, bullish or bearish, simply for the sake of headlines. (Perhaps the most infamous call in history was "Dow 36,000," in a book of the same name.)

The Albert Edwards case is intriguing, though, because of the logic behind his argument. The price target is not so important as getting the drivers right. If, for example, the S&P fell a mere 40% for the same reasons it was expected to fall 70%, would anyone quibble?

Mr. Edwards' thesis could perhaps be summarized as "first deflation, then inflation." That turn of events would be consistent with many elements pointed out in these pages.

For example, we have talked at length about how government "stimulus" does not really work, and in many instances makes the problem worse. If the economy stumbles again, we could find that all the previous money-printing has only resulted in an even bigger deflationary hangover than before (the side effect of trying to drink ourselves sober).

(Don't forget, you can Sign up for Taipan Daily to receive all of my and fellow editor Joseph McBrennan's investment commentary.)

For another example, we have talked about the loud and clear warning message of the bond market. U.S. Treasuries have been going UP, not down, even as Washington fights over the debt ceiling. This is a counterintuitive turn of events for those who think Uncle Sam is a deadbeat. Investors have been buying bonds, not selling them, which in turn has driven interest rates lower.

Albert Edwards has been expecting this phenomenon of lower bond yields (and higher bond prices), because falling interest rates (bond yields) are a hallmark of deflation taking hold. As Edwards writes to clients:

Clearly the S&P falling to 400 destroys household balance sheets and consumption anew. And EM liquidity tightening could cause hard landings. (In China, for example, a recent calculation showed FX intervention accounted for around one-half of the country's runaway money supply which has helped propel the boom.) My own view would be that despite the cessation of the EMs need to buy US Treasury debt as they curtail liquidity, weak economic fundamentals will drive US Treasury yields still lower in the near term. The printing presses being turned off will hit risk assets hard and that should boost Treasuries. So in my world, 400 on the S&P goes hand-in-hand with lower, not higher US bond yields. Ultimately I would concur that there is also going to be "The Great Reset" on US yields as well, but that will come after a frenzied orgy of balance sheet debauchment (both Fed and Federal) which will make events over the last three years look like an afternoon tea party with the Vestal Virgins.

In plainer terms, Edwards thinks that bond yields, already just below 3% on the 10-year note, could fall all the way down to 2%.

A move from 3% to 2% does not sound like a whole lot. But in the mammoth government bond market, that would be gigantic . Think of it like this: Going from "3.0" to "2.0" on the 10-year would mean cutting interest rates by a full third (thirty-three percent) from already depressed levels.

If that happened, we would be mimicking the experience of Japan. That is another unsettling thing: Via Japan, we can say that the Albert Edwards scenario is not unprecedented. In Japan, they saw a similar decline in interest rates from already depressed levels... and the Japanese Nikkei index lost more than 75% (three-quarters) of its value in result.

Ultimately, though, Edwards thinks out-of-control inflation still comes in the end. That is because the long-term costs of a deflationary downward spiral are too painful for any democracy to bear. Eventually the hurt gets so bad that furious voters become ready to sign on to ANY solution... anything to stop the torturous contraction.

It is at that point, when deflation pressures have become so strong that the populace is up in arms, that you get the risk of a "Weimar Germany" type scenario. Under these conditions, the economy gets worse and worse until a new crop of leaders strides forth with radical new ideas. (These ideas will not actually be "new," of course, they will just feel new at the time.)

These "new" ideas will be seen as risky, but worth trying against a desperate backdrop as all other options are seen as failures. And that is when you get the truly "nuclear" all-in policy responses that turn the currency into confetti and send bonds crashing through the floor.

Want to know the simplest way to keep tabs on the Edwards "first deflation, then inflation" prediction? Keep an eye on bond yields.

Just this past week, the yield on the 10-Year U.S. Treasury fell below 3.0% for the first time this year. If that yield keeps falling (alongside falling stock prices), then deflationary slowdown fears are tightening their grip... and the Albert Edwards prediction may be coming true.

Editor's Note: Inflation is rising rapidly, no matter what the government says. The result could spell doom for your bonds. But if you make one simple move right now, you could inflation-proof your portfolio and thrive as inflation continues to grow.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

Source :http://www.taipanpublishinggroup.com/tpg/taipan-daily/taipan-daily-060311.html

By Justice Litle
http://www.taipanpublishinggroup.com/

Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor to the free investing and trading e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.

Aside from his career in the financial industry, Justice enjoys playing chess and poker; he enjoys scuba diving, snowboarding, hiking and traveling. The Cliffs of Moher in Ireland and Fox Glacier in New Zealand are two of his favorite places in the world, especially for hiking. What he loves most about traveling is the scenery and the friendly locals.

Copyright © 2011, Taipan Publishing Group

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