Recession fears have eased significantly since the summer, driving renewed investor confidence in a surging stock market. However, Albert Edwards, the bearish strategist at Société Générale renowned for calling the dot-com bubble, warns that historically high equity valuations don't require an economic downturn to experience a pullback.
In a note to clients on November 21, Edwards cautioned that the relentless market rally might be on the brink of reversal—recession or not. His thesis is rooted in two critical factors: valuation levels and tightening liquidity.
Overstretched Valuations
Valuations are soaring, and Edwards highlighted several unconventional metrics to underscore this. For example, U.S. equities now account for three-quarters of the MSCI World Index—a dominance signaling potential imbalance.
He also pointed to the S&P 500’s 12-month forward price-to-earnings (P/E) ratio compared to its trailing P/E ratio, an indicator of market optimism potentially getting ahead of fundamentals. Another red flag comes from the widely followed Shiller CAPE ratio, which reveals that current market levels rival historical peaks seen during past bubbles. Notably, the CAPE ratio indicates U.S. stocks are significantly more expensive than their European counterparts, which traditionally trade at similar valuation levels.
Liquidity Concerns
Edwards emphasized that market liquidity is drying up as the Federal Reserve continues shrinking its balance sheet. He referenced CrossBorder Capital's Global Liquidity Index, which recently dipped on a six-week basis. This contraction in liquidity, he argued, creates headwinds for speculative assets like Bitcoin and raises concerns for equity markets.
Another challenge stems from rising 10-year Treasury yields. Higher yields reduce bond prices, creating losses for investors who sell them and diverting capital away from equities toward risk-free assets. Edwards asserted that as bond yields rise, they will eventually exert downward pressure on the stock market, especially when coupled with lofty valuations.
“To be fair, full-blown equity bear markets—defined as a 20% or greater decline—typically occur during recessions when profits and valuations collapse,” Edwards wrote. “But sharply rising bond yields can also disrupt equities in a high P/E environment like today. It’s a case of an elastic band stretched to its breaking point—the 1987 equity crash is a prime example.”
Historical Comparisons
Edwards drew parallels with past market behavior. For instance, the equity euphoria of 2018 initially brushed off rising bond yields—until it didn’t. A similar scenario unfolded in 2022 when climbing yields eventually began to weigh on stocks. Edwards argued that history suggests it’s only a matter of time before rising yields take their toll again.
A Cautious Perspective
While Edwards’ recent track record has been mixed—his bearish outlook on stocks and the economy has clashed with a resilient market and economic strength—his warnings shouldn’t be dismissed outright. He acknowledged his missteps in the November 21 note, advising readers to take his predictions with a grain of salt.
Nevertheless, Edwards’ long-term credibility remains intact. He accurately forecast the 2000-2002 bear market and continues to provide thought-provoking insights. His arguments remind investors that rallies and economic expansions are finite.
As Marcus Ashworth, a Bloomberg Opinion columnist and former strategist, observed last year: “The SocGen strategist’s doomster scribblings are a must-read for fund managers—even if he’s often wrong.”
