Albert Edwards turned bearish on stocks back in 1996—well, not exactly bearish, but cautious. He recommended to clients that they overweight long-term, high-quality bonds and therefore underweight stocks in their portfolios. It turns out that clients who followed his advice fared not quite as well as those 100 percent invested in stocks but also took far less risk. Edwards believes that events that are currently unfolding will actually vindicate his approach.
Although Edwards never mentions energy as central to his thinking, I believe that energy and oil, in particular, are related to his views. I’ll develop this later, but first more on Edwards.
Edwards is a long-time financial strategist for the French investment bank and financial services giant Société Générale. He has an investment thesis that arose from the experience of Japan in the 1980s. He calls it the “Ice Age” thesis. It amounts to this: Gigantic debts that built up during Japan’s boom in the 1980s led to exceptionally sluggish economic growth after the Japanese stock market bust and finally to deflation and ultra-low interest rates.
Edwards expected the same thing to happen to Europe and the United States for the same reason. He got some of what he expected after the market crash of 2008/2009: ultra-low interest rates and sluggish growth. What didn’t show up was deflation.
But Edwards kept expecting his Ice Age thesis to play out in a subsequent recession that he felt couldn’t be more than four or five years away. At regular intervals he gloomily predicted a stock market crash resulting from a deflationary shock. But the recession and crash kept getting postponed—until now, he thinks.
Edwards was one of the very few who correctly predicted the drop in bond yields this year and he believes the world is about to enter the long-awaited terminal phase of the “Ice Age” he outlined back in 1996. In this terminal phase, he expects U.S. interest rates to turn decidedly negative and U.S. stocks to decline by more than 80 percent—that is, unless the Federal Reserve decides to interrupt the decline by buying stocks directly to bolster the market or to hand out free money to the populace in a sort of quantitative-easing-for-all strategy.
Edwards writes: “The key for me is whether QE2 [that is, another round of forced credit and money infusions into the economy by central banks] can revive the economic cycle, not equity prices temporarily.” He believes QE2 cannot revive economic activity at this point. And, that implies a bust that will rival if not exceed the crash of 2008, he says—and a prolonged malaise of slow or no growth afterward as part of a financial hangover from bingeing on too much credit.
Edwards hints that “unprecedented monetary measures” might be taken to forestall outright deflation which, of course, implies entirely different investment advice than he is giving now.
So, how does all this relate to energy and, in particular, oil. When reading Edwards’ latest pronouncements, I couldn’t help thinking about Gail Tverberg’s almost parallel thesis that what will doom oil supplies is prices that are too low for producers to make a profit. That is just what has been happening this decade along with the slowly creeping financial Ice Age described by Edwards. Could the two be related?
Tverberg answers the question indirectly in a second piece entitled “Why stimulus can’t fix our energy problems.” For Tverberg affordability is the problem. Widening wealth inequality leads to stagnant and even lower incomes for a greater and greater number of people who are then unable to afford not only direct energy purchases as easily as they have in the past, but are also faced with affordability issues for practically everything else. That’s because energy is embedded as a cost of production, distribution and sale in everything we buy.
So, a sluggish economy—made sluggish by excessive debt (Edwards)—combined with widening wealth inequality (Tverberg)—leads to generally lower employment and depressed wages than otherwise would have been the case—which leads to prices that are too low for energy producers, in particular, oil producers to make a profits sufficient to replace oil reserves that have been depleted or, in the case of oil exporting nations, pay for social welfare costs. According to Tverberg, this inability to make much profit among oil producers—shale producers have had negative free cash flow for years—feeds back into the economy, especially in the United States where the previously broadly booming oil and gas industry has been a major source of employment and business activity. (The boom now seems confined to the Permian Basin in Texas.)
A low oil price also leads to lower investment and social welfare payments in major oil exporting nations which reduces employment and incomes below what they otherwise would have been. The overall sluggishness of the world economy (compared to previous expansions) reinforces the effect of low oil prices.
The sweet spot in the oil industry is a price which insures healthy profits for the industry (with which they can invest in new wells) and at the same time does not tip the world into recession because the price is unaffordable to consumers. There is a supposition in Tverberg’s work that these two price bands no longer overlap. Prices low enough for the world’s consumers to afford are too low for producers. Prices high enough for producers to make a decent profit are too high for consumers to afford over the long term.
Now, here’s how Tverberg’s thinking hooks up most directly with Edwards’. Tverberg writes: “It looks as though growing debt at ever-lower interest rates is becoming a less effective workaround for the economy’s real need, which is a need for a rapidly growing supply of under $40 per barrel oil and other low-priced energy products.” Edwards sees debt creation as becoming a less and less potent way to create economic growth in a debt-saturated economy. Tverberg goes to what she believes is the heart of the matter claiming that added debt cannot seem to provide oil and other energy sources at cheap enough prices for the economy to flourish. The financial Ice Age seems central to the views of both.
And, both Edwards’ and Tverberg’s outlook lead to the same result, a crash in the world economy that will be difficult to turn around. For Edwards there is the possibility that after a long retrenchment period, economic conditions could return to what passes for normal. For Tverberg, however, her thesis suggests a permanent alteration of conditions for modern societies in which energy insufficiency becomes a feature that limits and even stops economic growth.
If either one is correct, look for an economic tsunami in the not-to-distant future.
Photo: Abandoned oil-distribution unit, in old oil fields of Azerbaijan (2016) AlixSaz. https://commons.wikimedia.org/wiki/File:Abandoned_oil-distribution_unit.jpg