SocGen's big short: A simple explanation for last week's market crash

When it comes to the reasons behind last week's "Black Monday," the mainstream view is nothing more than concerns about the U.S. economic recession, unwinding of the yen carry trade, bursting of the overvalued tech stock bubble, internal market dynamics, and strategic shifts...

However, according to Albert Edwards, the most pessimistic analyst on Wall Street, for the major market turmoil last week, there is a more straightforward explanation: the market's optimism towards tech stocks has peaked. Albert Edwards is the chief global strategist of the famous short-selling French bank Societe Generale, who successfully predicted the bursting of the dot-com bubble in 2000.

In his latest research report, Edwards believes that the recent market turbulence is related to analysts' peak optimism about the earnings of tech companies. Data shows that in the stock market rally driven by artificial intelligence, the upward trend of earnings per share (EPS) of the Nasdaq 100 index has turned downwards.

The analyst warned that when the optimism towards earnings per share (EPS) starts to decline, tech stocks will lose momentum, breaking below the 200-day moving average, with the extent of the decline likely to be equivalent to the excessive rise before.

Similar situations can also be observed when using the MSCI Tech Stock Index instead of the Nasdaq. Once optimism peaks, it often trends downward for a considerable period, dragging down the market and causing a decline.

Edwards believes that concerns about the U.S. economic recession were the direct trigger for the recent market crash, with the unwinding of the yen carry trade and the other three factors combining to form the cruel culprit of "beating the market." And the peak of optimism is a simpler explanation for the recent market crash.

As one of the most pessimistic analysts on Wall Street, Edwards is also not optimistic about U.S. economic data. He believes that many U.S. economic data points are worrying, especially the weakness in the labor market. Recently, the U.S. unemployment rate data also triggered the famous "Sam rule," indicating an economic recession. However, Claudia Sahm, the proponent of the "Sam rule," stated that considering the changes in the U.S. job market today, the rule is somewhat ineffective and cannot prove that the U.S. economy is already in recession.

But in Edwards' view, it is only a matter of time before the S&P index catches up with the labor market (collapse). A chart in Societe Generale's research report shows that historically, the fluctuations of the U.S. stock market and the labor market conditions index are usually positively correlated, and a divergence between the two is extremely unusualSince the AI ​​boom that began with the launch of ChatGPT in November 2022, the US stock market has been diverging from the labor market conditions. According to Edwards, this situation will eventually end, and the S&P index will collapse along with the labor market.

At the end of the research report, Edwards returned to his key point. He wrote, "Since the optimistic sentiment per share earnings has peaked and is rapidly fading, 'we will soon find out who is swimming naked.'"

Renowned Bear: US Stocks Are in a Bubble

Over the past few months, Edwards has been warning of the risk of a bubble burst in the US stock market. On July 19, he reiterated that the frenzy in US tech stocks may be coming to an end.

Historical data shows that extreme concentration of trading (such as concentrated trading in tech stocks) often occurs before a market crash, similar to the market conditions before the global financial crisis of 2007-2008 and the bear market in 2022. Edwards believes there is no reason to believe this time will be different.

At that time, Edwards believed that the plight of the Nasdaq may have only just begun and questioned the arguments supporting the AI ​​prosperity that fueled the historic highs of major US stock indices.

Many analysts have emphasized that the "AI revolution" will bring significant profit growth to companies. For example, the high valuations of large tech companies like Nvidia seem to be justified. However, Edwards holds a different view. He points out that massive investments in networking equipment in the past briefly made Cisco Systems the world's most valuable company at the peak of the internet bubble, but its stock price then plummeted rapidly.

In fact, except for a few companies like Nvidia, AI has not brought the expected profit growth. According to media reports, in Edwards' view, the real driving force behind the recent rise in US stocks seems to be not corporate profit growth, but the ample liquidity introduced by the Federal Reserve.

Edwards believes that viewing the Fed's quantitative tightening as a tightening of monetary policy is inaccurate. Although the Fed has reduced its bond holdings through quantitative tightening, its monetary market operations, especially the continuous injection of liquidity through the Fed's reverse repo mechanism, have actually injected more funds into the financial system, offsetting the loss of liquidity. He further points out that this has led to a continuous expansion of the US monetary base over the past year, which is inconsistent with the Fed's claim of draining liquidity from the financial system.

In April of this year, Edwards warned that the AI ​​boom had gotten out of control, and the five-month rise in the US stock market was showing all the characteristics of a bubble. He believes that the AI ​​boom, coupled with the Fed's "accommodative" monetary policy, has fueled another bubble in the US stock market.