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2010-04-27 SocGen Albert Edwards Global Strategy Weekly

2010-04-27 SocGen Albert Edwards Global Strategy Weekly

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Published by Edward Harrison
Downturn in key lead indicator suggests recovery set to lose momentum.
Downturn in key lead indicator suggests recovery set to lose momentum.

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Published by: Edward Harrison on Apr 27, 2010
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Macro Commodities Forex Rates Equity Credit DerivativesPlease see important disclaimer and disclosures at the end of the document
26 April 2010
Global Strategy
 Alternative view
Global Strategy
Downturn in key lead indicator suggests recovery set to lose momentum
Albert Edwards
(44) 20 7762 5890albert.edwards@sgcib.com
Global asset allocation
Equities 30-806035Bonds 20-503550Cash 0-30515
Source: SG Cross Asset Research
Global Strategy Team
Albert Edwards
(44) 20 7762 5890albert.edwards@sgcib.com
Dylan Grice
(44) 20 7762 5872dylan.grice@sgcib.com
One of the key leading indicators we monitor has dipped sharply enough to provide a warning.We have always used the
in analysts’ optimism (i.e. the rate at which they upgradeEPS estimates) as an adjunct to other, more traditional leading indicators. Its decisive toppingout may be a prelude to a Japanese-style Ice Age growth slowdown that has arrived unusuallysoon after the recent cyclical revival. In the Ice Age, cyclical recoveries do not last very long.
When I first went underweight equities some 13 years ago, the Ice Age vision I had forsecular equity underperformance was seen by most readers as nonsense. Then as equitiessurged during the late 1990s, I had doubts as to my own sanity. How could almost all thesell-side be wrong and my apocalyptic vision be right? The same self-doubt hit me againduring the credit bubble. I was told
The Great Moderation
was now a permanent feature ofthe investment world and that high debt loads were wholly appropriate! Unlike thecharacters in Michael Lewis
The Big Short 
, I was never gifted with the certainty these shortsellers had that they were right and that it was the rest of the world that was wrong.
Now some13 years on from first turning bearish on equities much has changed. My sonis 21 this year and my daughter is 18. And I have begun arranging my 50
birthday partywell in advance of the event exactly one year from now. I am also worrying increasinglyabout my
senior moments
. Only this week when filling in an on-line form at home, I had togo to the front door and remind myself of the number of the house I have lived in for thepast two years. By the time this equity rally collapses below the March 2009 lows, I hope Ihave enough of my faculties still intact to call the bottom of this secular bear market.
The downturn in key leading indicators suggests I might not have to wait until my 50
s tosee new lows. The vulnerability of the recovery in a post-bubble world is a key lesson fromJapan. The unfolding downswing in key leading indicators (see chart below) is a warningsign that the end of this cyclical upswing could come far sooner than many believe.
in analysts’ global EPS optimism (upgrades as a % of EPS changes, 6m pp change) isleading the OECD US lead indicator downwards
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-8-6-4-20246810-30-20-10010203040
OECD lead indicatorch in analyst optimism (rhscale)
Source: Datastream
Global Strategy Weekly 
26 April 20102
I have had a few e-mails recently about some of the key leading indicators reaching newcyclical highs last week, and what this means for our view. To be sure, the latest weeklyreading for the Economic Cycle Research Institute (ECRI) key lead indicator reached a 99week high. That, at first sight, looks very bullish for the continuation of this cyclical upturn.However, as with all of these lead indicators, it is
the rate of change
that is important. TheECRI also report a smoothed annual change in their index. Last week that slipped to +12.5%yoy, which is
a 37-week low
(see chart below). Now one doesn
t want to be tooarmageddonish at this stage, but this is clear evidence that in 6-9 months time there will be adiscernible slowdown in the economic recovery from its recent moderate pace.
US Economic Cycle Research Institute leading indicator (yoy %)
-30.0-20.0- 01/01/2001 01/01/2003 01/01/2005 01/01/2007 01/01/2009
It was also pointed out to me that the Conference Board
s US leading indicator rose a steep1.4% in March to its highest level
 link. Again, although one might be tempted to believethis suggests the economy is accelerating, in fact the Conference Board itself reports in itsofficial announcement that the six-month rate of change
the way they themselves prefer tointerpret their index
has been stable over recent months, and that this is consistent with acontinued
recovery. It is clear to me however that both this and the OECD US leadingindicator have topped out rather than having just stabilised (see chart below).
Conference Board and OECD US leading indicators (both six-month % ch)
Source: Datastream, SG Cross Asset Research
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09-4-3-2-101234567-10-8-6-4-20246810
conference boardOECD
Global Strategy Weekly 
26 April 20103
Now clearly, although all of the indicators shown above are suggesting that the cycle may bepeaking out some 6-9 months from now, none of them are warning yet of a recession ahead.They say
the trend is your friend until it hits a bend 
and the leading indicators are telling usthat bend has most definitely been reached. Therein lies the rub. For the lesson from a post-bubble Japan was that relatively stable and lengthy economic cycles were replaced by violentand unpredictable higher frequency cycles. Hence investors who continue to anchor on theeconomic and market stability of
The Great Moderation
will be wrong-footed if, as I expect,the global economy enters another wholly unanticipated downturn. As we showed on the front cover, the
in analyst optimism also acts as a good leadingindicator. To be sure, the
rate of analyst EPS upgrades remains high (65% for the USand 60% for the world index
see chart below), but a turn has definitely been reached. On theway to renewed recession we pass a signpost looking exactly like this.
Analyst optimism (EPS upgrades as a % of all estimate changes, 3-mth MAV, seasonally adj)
Source: Datastream, SG Cross Asset Research
We can clearly see that it is in the acceleration phase of the recovery that equities do best (seechart below). That phase is now past. We are not yet in bear market territory. Analyst optimismwill have to subside further for that to occur, along with traditional lead indicators. But if
thetrend is your friend until it meets a bend 
, that trend is now the investor
s enemy.
Change in analyst optimism (6m pp ch) and S&P 6mth change
2001 2002 2003 2004 2005 2006 2007 2008 2009-50-40-30-20-1001020304050-40-30-20-10010203040
S&P % ch 6mthch in analyst optimism (rhscale)
Source: Datastream, SG Cross Asset Research
95 96 97 98 99 00 01 02 03 04 05 06 07 08 0910203040506070801020304050607080

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