Writing in a note on Wednesday, Edwards, says the coming carnage is “an indirect result of the failure of the Fed’s QE”.
While it may not have done a great deal to boost US growth, he says, it has certainly inflated global asset prices, especially in emerging markets.
“Surplus money poured into these supposedly superior investment opportunities, leading to massive EM foreign exchange intervention to hold their currencies down. This turned ineffective US QE into very effective EM QE in terms of boosting EM economic growth.
“A commodity bubble and the resultant US shale investment boom were all consequences of the Fed’s QE,” he adds.
A key part of this thesis, Edwards, believes is that “the US equity market remains in a valuation bear market that did not fully play itself out in March 2009, when the S&P touched the 666 level, and we will see new lows.”
As he explains, valuation booms are followed by busts and can take place in either a high or a low inflation environment. But, he points out: “What is true for all of them is that the take many economic cycles to play out.
Indeed, he adds, “The three previous valuation bear markets have taken between 4 to 6 recessions to fully play out… If I am right and we have just seen a cyclical bull market within a secular bear market, then the next recession will spell real trouble for investors ill-prepared for equity valuations to fall to new lows.”
Edwards then looks at what has happened in previous cycles through the lens of the cyclically adjusted price earnings ratio or Shiller PE.
According to Edwards, these valuation bear markets take the Shiller PE back down to 7x or below.
“To bottom on a Shiller PE of 7x would see the S&P falling to around 550. I will repeat that: If I am right, the S&P would fall to 550, a 75% decline from the recent 2100 peak. That obviously will be a catastrophe for the economy via the wealth effect and all the Feds QE hard work will turn dust. That is why I believe the Fed will fight the next bear market with every weapon available including deeply negative Fed Funds rates in addition to more QE. Indeed, negative policy rates will become ubiquitous.”
