Albert Edwards, Société Générale's (SocGen) famously bearish economic analyst, raises the spectre of a 1937-style recession in the US in his latest Global Strategy Weekly research note.
Edwards, picking up on comments from hedge fund heavy hitter Ray Dalio, says premature interest rate hikes following the Great Depression plunged the US economy back into the red and hammered the stock market.
Citing a note from Dalio’s hedge fund Bridgewater Associates Tightening at the End of the Supercycle, Edwards fears a repeat.
‘The note likens financial conditions today to those of 1937, eight years after the 1929 stock market crash and after four years of money printing had driven a surge in equity valuations’ writes Edwards.
‘That year, premature tightening by the Fed led to a one-third slump in the Dow Jones Industrial Average and the sell-off continued into the following year.’
The central bank is in a quandary, according to Edwards, because while real economic activity is fragile, financial markets are surging because of low rates.
Edwards says rates are too low for the financial economy but are arguably too high for the real economy.
To make this point, the SocGen analyst shows that household wealth in the US has been increasing, thanks to the growing value of financial assets and property.
But these households are still net savers in the economy, paying down debt or stockpiling assets and cash.
‘While asset prices have rocketed upwards consumers are unusually reluctant to borrow and spend.’
Most of the decline in the US savings rate since the financial crisis has come from the activities of US corporations in financial markets, which have been borrowing to fund share buybacks and mergers and acquisitions.
‘The problem with using asset bubbles to drive an economy is that when the bubble bursts, private sector borrowers realise they have been taken for a mug and correct their savings behaviour aggressively, causing a recession, writes Edwards.
‘That same barbarically naive policy remains in place today.’
In our general election coverage, Shares highlights how government deficits and changes in the current account can impact the private sector savings rate – and the implications for the UK economy.
Edwards maintains his target equities weighting at its lowest permitted level of 30%. He advocates a 50% weighting in bonds and 20% in cash.