A famed permabear says investors need to brace for a market 'shock' from a new wave of inflation

• The famed bear Albert Edwards sees another market 'shock' in the cards.
• The SocGen strategist said he believed investors were too complacent about inflation risks.
• That leaves markets vulnerable should inflation see a second post-COVID surge, he said.

Investors don't seem to be ready for what the future may hold for markets, according to one longtime permabear.

Albert Edwards, a global strategist at Société Générale who rose to fame for calling the dot-com crash, said he sees the conditions for another potential "shock" to hit markets. In a note to clients on Thursday, he pointed to what he believed was investor complacency about the risks of higher inflation, with investors barely pricing in any lasting impact despite the recent surge in oil prices.

Oil is retesting the $100-a-barrel mark as conflict in the Middle East drags on, but the 5-year 5-forward, a measure of five-year inflation expectations five years from now, has only ticked up slightly to 2.1% this week, according to Fed data.

However, there are signs that a more meaningful rise in inflation is coming, Edwards said, suggesting that the muted reaction among investors is leaving markets vulnerable.

"Investor complacency invites a market shock," Edwards wrote.

"It seems the market has gone all-in with the optimistic view of the war, ignoring at its peril the entirely plausible risks of a more prolonged rise in inflation and its consequences," he added.

The slight change in long-term inflation expectations suggests that most investors anticipate the inflationary impact of the oil shock to be short-lived, as they have been following conflicts in the past.

But there could be a reason to worry about another inflation surge, Edwards said. He pointed to the recent rise in bond yields, and the positive correlation between stock and bond prices in recent years. Higher inflation tends to raise bond yields due to the expectation of higher interest rates, which ends up hurting bond prices.

The 10-year US Treasury yield has climbed 29 basis points since the start of the US-Iran war.

"Higher inflation that pushes bond yields up will most likely push equity prices lower," Edwards said.

"There is now a risk that the second inflationary wave could hit sooner. I'm not sure of that, but I am sure that market seems strangely complacent, " he added, referring to the wave of inflation that first hit the US economy following the pandemic.

Edwards didn't have an exact target for how high inflation could rise, though consumer price growth peaked at around 9% year-over-year in 2022.

Edwards is known for his dire market prognostications. In the past, he warned that financial markets look mired in an "everything bubble" and that a crash could rival the drop in stocks on Black Monday in 1987.