THE RISE OF THE PERMABEARS / THE NEW YORK TIMES ( RECOMMENDED READING )

August 9, 2010

The Rise of the Permabears

By LANDON THOMAS Jr.

LONDON — The central question dividing economists these days is whether Western governments should spend more to ward off a potential second recession or retrench to hold down their ballooning debts in a bid to restore confidence among investors.

But Albert Edwards, an investment strategist in London for the French bank Société Générale, says the debate is a waste of time. To be specific, he forecasts a “bloody, deep recession” that produces a stock market collapse of at least 60 percent, followed by years of inflation of 20 percent to 30 percent as persistent money printing by central banks desperate to improve the situation ultimately sends prices soaring.

Mr. Edwards’ leather sandals and chuckling demeanor belie his reputation as perhaps the City of London’s best-known permabear — a species that has long flourished on the outer margins of the financial industry but rarely inside mainstream banks.

That is no longer true.

With the shocking financial crisis of 2008 still fresh in people’s minds, and gloom-spinning economists like Nouriel Roubini having achieved pop-icon status, even long-standing pessimists like Mr. Edwards — who has been forecasting a Japanese-style stock market slump in the United States since 1997 — are being treated with newfound respect.

In many smart-money circles, listening to bears has become stylish, especially now that doubts remain about the sustainability of the euro zone, concerns grow that the United States may slip back into recession and that even the Chinese growth engine may seize up. But to some, the popularization of extremely dire forecasts suggests that the pendulum may have swung too far.

“Nothing is ridiculous anymore,” said Philippe Jabre, a hedge fund executive in Geneva. “There is no doubt that these days extremely negative research is being tolerated more.”

Mr. Jabre says that most of the research that comes his way has a distinctly negative bias and that finding actionable ideas with a positive spin is becoming far more difficult. “These guys are reinforcing a conviction among many who invest in hedge funds that they should remain scared,” he said.

Mr. Edwards’ newfound popularity reflects the trend. Once frequently shown the door by disbelieving clients, Mr. Edwards recently drew 600 investors to a conference in London.

Similarly, Bob Janjuah, the one strategist in London whose prognostications some see as even more dire than Mr. Edwards’ — “even I get depressed reading his stuff,” Mr. Edwards said — said he was courted by half a dozen investment banks this summer before deciding to leave his post at Royal Bank of Scotland to join Nomura. (He starts officially in October.)

“Clients are more receptive to hearing polar ends of an investment view,” said Mr. Janjuah, who expects economic growth for the major developed economies to average little better than 1 percent a year over the next five years.

Further afield, Raoul Pal, a former Goldman Sachs derivatives expert and hedge fund manager, has attracted a growing following with his monthly research note that, most recently, predicted a depression in the United States similar to the 1930s and eventual bankruptcy for Britain.

Mr. Pal writes The Global Macro Investor from a holiday village in the Spanish province of Valencia, and says that demand is so high now that he has the luxury of doling out his high-priced annual subscriptions only to clients he considers sophisticated enough to pass muster or who come recommended by people he trusts. Others must join a waiting list, Mr. Pal said, although he declined to say how large the group is. He says that 30 percent of his clientele — which includes pension and hedge funds, governments and proprietary traders at banks — consists of wealthy family offices with assets of more than $200 million.

“They are easily the most bearish of my subscribers because they invest in the longer term,” he said, “and in the longer run they see more uncertainty than ever before.”

According to TrimTabs, a funds researcher, hedge funds withdrew $3.5 billion in April and industry consultants say that many funds — positioned in July for a continuum of bad market news — were caught by surprise when the market rallied. “Where is the research telling me how good Intel’s earnings were going to be?” Mr. Jabre said. “I just have not seen it.”

In fact, if you had been following the advice of Mr. Edwards or Mr. Pal over the past month as stocks have bounced, you would have lost money, as both men readily acknowledge. Mr. Edwards has advised investors to be heavily underinvested in all equities and Mr. Pal, in addition to being short, or betting against, the U.S. stock market, is also shorting the euro in his model portfolio.

Mr. Pal’s bad run began in 2009 when, after becoming bearish in 2007 and reaping the fruits in 2008, he was caught short by the powerful recovery that began in March that year. To date in his model portfolio, he has lost 96 percent on a short bet of the Indian stock exchange, 68 percent betting against the Chinese H share stock market and 68 percent on the U.S. mutual fund company Franklin Templeton. (Until 2009, he says his model portfolio was up 700 percent).

In the tradition of the great macro hedge fund investors like George Soros and Julian H. Robertson Jr., Mr. Pal, whose last job was as a portfolio manager at GLG, a hedge fund based in London, likes to pick a theme that may take years to pan out and run with it.

His big bet is that the U.S. economy is not just about to enter a double-dip recession, but that it will be far worse than anything experienced in the lifetime of anyone under 70 years old.

He points to a weak rebound in consumer and industrial spending from the 2008 plunge, suggesting that companies and people will remain loath to borrow and spend. “Never before have we entered a recession with 10 percent unemployment,” he wrote in his August report. “And if you take into account that on average a recession increases unemployment by 3 to 5 percent, we could see 15 percent unemployment in the U.S. — that is staggering.”

As for whether central banks can rescue their economies through a fresh round of money injection, both Mr. Pal and Mr. Edwards are skeptical.

Both contend that there is no evidence that the huge injections of liquidity already engineered by the U.S. Federal Reserve, the European Central Bank and the Bank of England have led to a pickup in demand for loans.

That may be so. But Ed Yardeni, an independent strategist in the United States recognized for his consistently optimistic views, says it would be a mistake to bet against the evidence from strong corporate profits, which he believes are already driving a global rebound.

“Despite all this negative spin, we have seen one of the best corporate recoveries ever,” he said. Major company executives “are being fed this same diet of pessimism but instead of shutting down they are growing their profits and expanding their operations.”