Markets face Freddie Kruger-like nightmare

Shake It Baby

Albert Edwards, Societe Generale's strategist, predicts a global recession with equity valuations dropping to their lowest levels in a generation.

The recent emerging market sell-off was the final tweet of the canary in the coal mine, according to Albert Edwards, Societe Generale's uber-bearish strategist, who now predicts a global recession with equity valuations dropping to their lowest levels in a generation.

"The ongoing EM (emerging market) debacle will be less contained than sub-prime ultimately proved to be," he said in a research note released on Thursday, warning that the markets face being trapped in "a Freddie Kruger-like nightmare."

"The market has at last awoken from the dream it hoped would last forever."

(Read More: US recession is nigh...and the Fed can't stop it: SocGen's Edwards )

Edwards believes his "Ice Age" thesis - a series of economic cycles that deteriorate in ever decreasing circles - is drawing ever closer to its final stages. He believes that the current "tapering" of Federal Reserve stimulus is indeed a "tightening" of monetary policy - despite calls from bank officials for the contrary.

This tightening has played a key role in triggering the next financial crisis, he said, with a very weak yen also undermining current account deficits in the emerging world - as it did in the Asian currency crisis of 1997.

A weaker yen is in the process of causing a correction in emerging market currencies as they try to rebalance to achieve competitiveness again and boost their exports.

This devaluation and renewed exporting will stunt corporate profit growth in developed markets as waves of deflation flow from Asia to overwhelm the fragile situation in the U.S. and Europe, Edwards said.

(Read More: Albert Edwards: Bernanke, Osborne blowing bubbles )

Corporate profits have already been lackluster in the last two years, according to the datasets that Societe Generale include in their research.

"Most profit growth is the result of astute financial engineering rather than improving cash flow - yet another sign of a tired, long in the tooth, profit cycle," SocGen's Andrew Lapthorne said in a research note back in January.

The recent selloff in emerging markets has already also caused a "risk-off" move in equities. Japan's Nikkei has lost 8.45 percent since the start of the year, the S&P 500 has declined 5 percent and the Euro Stoxx 600 Index has slipped over 3 percent.

(Read More: Albert Edwards: Emerging market rout to trigger global recession )

Edwards believes this is just the "pungent smell of coffee" that has now overwhelmed the "hallucinatory vapors" contained in the Fed's quantitative easing (QE) bond-buying program that it started shortly after the financial crash of 2008.

"Commodities snapped out of their trance some two years ago and could not find their way back into that same dream-like state. Now it is equities turn," he said.

"And even if the Fed resumes massive QE at some point as the world melts down, and markets desperately attempt their return to the dream trance, they will instead find themselves locked into a Freddie Kruger-like nightmare."

It's not the first time that Edwards has made bearish predictions on stocks. In September 2012, Edwards said the U.S. had already entered a recession and it wouldn't be long before the equity market reacts. He also warned about the "ultimate" death cross for the S&P 500 - where the 50-month moving average falls below the 200-month moving average. Since that call the S&P 500 has risen around 26 percent.

By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81

image: © Tambako the Jaguar

Bank Workers CharityBank Workers Charity - Supporting bank workers

Register for Financial Markets News Alerts