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A Brief History of Financial Entropy

May 17, 2019

The global economy began an experiment with fiscal and monetary alchemy when it exited the gold standard almost 50 years ago.

In 1971 the USD completely separated from the last vestiges of its tether to gold. In effect, it released the worldwide monetary system from any limitations of base money growth, as it was no longer pegged to the increase in the mine supply of gold. This is because the USD was once linked to gold and the rest of the developed world linked their currencies to the dollar. This was the case ever since The Bretton Woods agreement of 1944.

Therefore, when the U.S. severed the link to gold, the world entered into its doomed experiment with global fiat currencies and began its journey down the road to financial entropy.

A Bit of History

Paul Volcker (Fed Chair from August 1979 thru August 1987) had vanquished the inflation caused by the loose monetary policies of the Johnson and Carter Administrations by the early ’80s. But once again, the recidivism of the Fed led to rising inflation by the middle of the decade. By the first half of 1987 stock markets had been soaring, rising an astonishing 44% by late August. But by mid-October, the federal government disclosed a larger-than-expected trade deficit leading the dollar to fall further in value and markets to unravel.  By the end of trading on Friday, October 16th the Dow Jones Industrial Average (DJIA) sank 4.6%.  On the following Monday morning, investors in the US awoke to stock markets in and around Asia in free fall. This led the DJIA to crash at the opening bell, eventually plunging 508 points, which amounted to a brutal 22.6% one-day decline. Fed Chairman Alan Greenspan was quick to assure markets his Fed would serve as a source of liquidity and that he would print enough money to support the financial system. He thus encouraged financial institutions not just to remain calm but buy shares with abandon with the full sanction of the central bank.

For the first time since its inception in 1913, the Fed wasn’t just coming to the rescue of an individual bank, or even trying to tinker around the edges of stimulating economic growth; Alan Greenspan made it clear that the Fed was now in the business of directly supporting the stock market. The DJIA gained back 288 points in just two trading sessions. Back in 1987, the entire market value of equities made up just 66% of the economy. And Household Net Worth as a percent of GDP was 370%

The late 1990s ushered in new market worries such as the “Asian Contagion.” From 1985 to 1996, Thailand’s economy grew at over 9% per year. But by 1997, it became clear that much of that growth had been predicated on years of rampant credit growth that yielded an abundance of bad loans. There was also a tremendous amount of foreign borrowing of dollar-based loans and other foreign currencies that exposed the Thai economy to exchange rate risks that had been masked by longstanding currency pegs. When those pegs proved unsustainable and were forced to be broken, firms were unable to pay their foreign-denominated debt–leading many into insolvency. This collapse spread like wildfire throughout Asia and caused the IMF to offer a bailout of over $20 billion.

On the heels of the Asian crisis, Russia becomes an issue. Its weak economy, deficits, and reliance on short-term financing caused the outbreak of a severe sovereign debt crisis. In August of 1998, the Russian government shocked markets when it announced it would devalue the ruble and no longer honor its debts; financial chaos ensued. Many governments and financial institutions found themselves on the wrong side of this trade, but none more so than the highly leveraged hedge fund called Long Term Capital Management, which lost $4.6 billion in short order. Fearing a systemic financial meltdown, the Fed once again came to the rescue of markets organizing a bailout by a consortium of 14 financial firms. Of course, all underwritten by the international fiat printing press.

All of that government-sanctioned counterfeiting exacerbated the NASDAQ bubble of 2000, which soon after burst causing tech stocks to lose 78% of their value by the fall of 2002. At the peak of this bubble, the total market cap of equities as a percentage of the economy was no longer 66%, but had grown to 148% of GDP! And, Household Net Worth surged to 450% of GDP.

In the wake of the dot-com collapse, the Fed took interest rates to one percent and left them there for one year—between June 2003 June thru 2004. This engendered the real estate bubble and Great Recession of 2007 thru 2009. Just before the collapse, Household New Worth climbed to a then-record of nearly 490% of GDP.

The Fed’s response to that worst crisis since the Great Depression was to cut interest rates from 5.25% in 2007, to virtually 0% by the end of 2008; and kept them pegged there for nearly nine years. It also purchased $3.7 trillion worth of banks’ assets to push those same assets back into another bubble. This latest iteration of central bank mania has placed the economy in the position of enduring three great bubbles concurrently for the first time in history (real estate, equities, and bonds). Consequently, not only are stocks valuations back towards 1.5 times the economy but home prices are overvalued by about 35%; along with bond prices that are so distorted that governments are getting paid to borrow money. This current bubble has caused Household Net Worth as a percent of GDP to skyrocket to a record 535%!

From Order to Chaos

The salient issue is that each crisis was ameliorated by printing more money and pushing borrowing costs significantly lower than where the free market would have demanded. Rising rates would normally have cut off access to the cheap credit that keeps non-viable businesses afloat. Recessions are healthy in that they purge the economy of its malinvestments. However, by its systemic practice of artificially suppressing interest rates with increasing distortions, central banks have created massive misallocations of capital that have produced unprecedented levels of debt and asset bubbles.

As a result of this, Household Net Worth as a percentage of GDP is now 50% higher than its historical average.

A significant component of Household Net Worth is stock valuations. As you can see from the chart below, we are now at altitudes only once before ascended during the thin air of the tech bubble.

Another important component of Household Net Worth is real estate values. Here we find that US home prices have far exceeded their bubble-highs set 13 years ago at the peak of the real estate bubble.

 

Add to this calculation the price of bonds, which includes $10 trillion worth of sovereign debt with a negative yield, and you get the trifecta of the everything bubble. It was previously unfathomable to have even one dollar’s worth of negative yielding debt prior to the Great Recession.

The major consequence of all this is that the valuation of assets has now become far bigger than the underlying economy and therefore can very easily bring the whole charade crashing down.

The amount of subprime mortgage debt before the Real Estate bubble collapsed was just shy of $1.5 trillion–its demise brought down the entire global economy. Compare that figure to the amount of “sub-prime” corporate debt, and you can understand the scope of just one of these asset price distortions. When you add the total of junk bonds and leveraged loans together, you come up with a figure of $2.8 trillion. Then, if you count the surging $2.6 trillion level of BBB debt, which is just one notch above junk, you come up with a figure of $5.4 trillion worth of extremely economically sensitive business debt. By the way, this does not imply that over leveraging can only be found in business debt; as of Q1 2019 there is a record $13.6 trillion of household debt outstanding, which is nearly one trillion dollars more than the previous peak in Q3 2008. Therefore, even a small contraction in GDP could quickly snowball into an avalanche of defaults and economic chaos.

The key point here is that when the total value of equities was roughly half of GDP like it was from the mid-’70s thru the mid-’90s; the economy was able to lead the stock market. But, when money printing pushes stocks to become 1.5x the value of the economy, it is stocks that then lead GDP. Likewise, when Household Net Worth was 370% of GDP, asset prices were more a function of economic growth. But with asset prices now at 535% of GDP, it is asset prices that pull the economy. Hence, keeping equities in a bubble is now mandatory because a fall in the market can easily bring down the economy and also any political leader that happens to be in charge. Donald Trump is keenly aware of this fact. But in truth, all those in power are cognizant to this fact as well. We saw an example of this in Q4 2018 when the junk bond market froze for 41 days without any new issuance, and stock prices entered into a bear market. The Fed quickly abandoned its rate hiking plans and promised to truncate its QT program.

But, of course, this bubble just doesn’t belong to the U.S. According to Kyle Bass, the banking system of Hong Kong has now exploded to become 8.5x the island nation’s GDP. Its neighbor, China, has a massive and unproductive $40 trillion worth of debt that has quadrupled since 2007. Japan’s economy would crash in epoch fashion if the Bank of Japan (BOJ) ever began to step away from its asset bubble support. The quadrillion yen Japanese government bond market (JGBs) would become insolvent without its primary buyer the BOJ—it now owns over 50% of the entire JGB market. The BOJ also already has possession of nearly 80% of the ETF market. Therefore, at the first hint that the Japanese government was to begin removing its bid for stocks it would most likely cause the NIKKEI Dow to plunge in a manner that makes its spectacular crash of 1989 look like a bull market.

In other words, the power that once existed within free markets has now been completely usurped by governments and central banks.  These abrogators of freedom have gone all-in with their price manipulations and are now forced to perpetually engage in debt monetization, or risk a global asset price meltdown that would almost certainly engender a depression worldwide. This is the truth as to why Wall Street cares very little about earnings and the economy and instead has become completely focused upon every word that proceedeth out of the mouth of a central banker.

The linking of money to gold was a spark of human genius, but it was also the avarice nature of mankind that eventually destroyed it. The inevitable and dire consequences of which are high.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

When Overvalued and Dangerous Markets Meet Stagflation

April 29, 2019

To put into perspective how overvalued and dangerous the US market has become; I often cite the figure of total market cap to GDP—currently 145% of the economy. How high is 145% of GDP? It is a full 30% higher than it was before the start of the Great Recession. The twin sister to this metric is the Household Net Worth to GDP Ratio. Household net worth as a percent of GDP is calculated by dividing the current bubbles in home prices and equities by the underlying economy, which has been artificially inflated by interest rates that have been pushed into the sub-basement of history. This metric is now an incredible 535% of GDP, which is a record high and 19% higher than the NASDAQ bubble of 2000. To put that figure in perspective, the good folks at Daily Reckoning have calculated that the historical average is 384%.

These valuation measurements are much more accurate than Wall Street’s favorite PE ratio valuation barometer because they cannot be easily manipulated by corporate share buybacks that have been facilitated by record-low borrowing costs. And, as hinted at already, the GDP denominator of today is much more tenuous because it has become more than ever predicated on the record amount of fiscal and monetary stimulus from the government.

This begs the question: why are asset prices at an all-time high when Japan and Europe are stuck at zero percent GDP growth, U.S. growth has been cut in half, and the growth rate of China is decelerating.  What caused these bubbles is no mystery: a decade’s worth of Zero Interest Rate Policy and Negative Interest Rate Policy worldwide that led to a massive pulling forward of consumption through a record level of new debt, which in turn was primarily used to purchase (a.k.a. inflate) asset prices.

Global Central Banks have become the captains on this heavily overcrowded and doomed ship that has a woefully insufficient number of lifeboats; where investors have been forced onboard chasing risk because traditional bank deposits offer little no return.

However, this daunting game can continue skipping along until one of two daggers present themselves to annihilate these bubbles. The two catalysts are; intractable inflation or a recession/depression. I include depression as a likely outcome in the next economic contraction because the level of economic distortions has never been more manifest.

So how will inflation prick this bubble and what level will most likely accomplish this? First, it is crucial to understand that central banks cannot accurately create a certain level of inflation. Central banks are undergoing a process of trying to inflate asset prices by eroding the confidence in fiat currencies, which is ultimately what inflation is all about. They do this by printing enough money to ensure nominal bond yields are below inflation.

Therefore, it is impossible for a handful of academics that sit on the Fed Open Market Committee to accurately pinpoint where the rate of inflation will end up, much less be able to maintain it at a certain level. This is especially true given their professed knowledge of inflation matches that of an amoeba with a low IQ. One possible outcome is that inflation eventually brings the Fed back into tightening mode. This would most assuredly occur if the core level of its preferred metric, core PCE price index, reaches above 2.5% in a sustainable fashion and then continues higher from there. And, even if the Fed did not react to this inflation by increasing the Fed Funds Rate, longer-duration yields would surely begin to spike to offset the increasing loss of purchasing power over time. The already-embattled auto and real estate markets would then crater just as the consumer is crushed under rising debt service payments on the record amount of household debt. In addition, the junk bond market would implode just as equity prices crash due to the increasing competition for cash–in other words, a replay of Q4 2018 that can’t be so easily cut short and mollified just by another Fed pause. It would take rate cuts and a return to QE to have a chance at arresting the next economic and market downturn.

The other dagger is an economic contraction; which, given how far asset values have grown above the underlying economy, is virtually guaranteed to be a long and brutal one. Surging government expenditures along with falling revenue will send trillion-dollar deficits soaring above $2 trillion in short order. Annual deficits will be accretive to the $22 trillion National Debt just as the GDP denominator in the Debt to GDP Ratio heads sharply lower—causing the already dangerous 105% National Debt to GDP Ratio to surge.

The bottom line is the bubbles will break just as they have in the past. But investors must first become afraid of not only losing their profits but their ability to retire. Falling GDP, and/or spiking interest rates will accomplish this. And, given the fact that both equities and bonds are in a bubble, there is a chance that bonds and equities will collapse in price together.

Today’s market is trading at a nominal record high and record high valuations. But these prices exist in the context of unprecedented economic distortions. To be specific; there is $10 trillion worth of sovereign debt with a negative yield, global debt has surged by $70 trillion—to $250 trillion–since 2008, central banks are stuck at the zero-bound interest rate range and have already permanently monetized $14 trillion worth of debt and have destroyed the free market and the middle class in the process.

Hence, the only prudent strategy at this time is to have a robust and proven model that will identify when the inflation or the growth slowdown has reached critical mass so you can protect and profit from the next air-pocket in equity prices. As a reminder, during the last two recessions, investors lost half of their wealth. February and October of last year proved beyond a doubt how fragile this market is, and that tenuous state is the direct consequence of its artificial construction.

Wise investors will think about these facts and use this strategy to avoid getting sucked into the markets biggest black hole in history.

Global Bond Bubble’s Ultimate Culmination

April 22, 2019

Historically speaking, a normal Fed tightening cycles consist of raising the Fed Funds Rate (FFR) by 350-425bps. It is at that point that the yield curve usually inverts–thus, disincentivizing future lending and closing down the credit conduit. At that point the Fed backs off from future rate hikes. Then, about a year later, a stock market meltdown begins; and six months after that a recession ensues. During this current cycle, the Fed Open Market Committee (FOMC) has raised rates by just 250bps before turning dovish. Therefore, Wall Street takes solace in the view that this time around the Fed stopped in time before it killed the business cycle.

However, that 250bps of hiking is before you factor in the end of Quantitative Easing (QE) and the current Quantitative Tightening Program (QT), which is still an ongoing process and won’t end until September. When you factor in the tightening that occurred when the Fed ended QE in October of 2014, which amounted to $85b per month of newly printed money at its peak and added a total of $3.7 trillion to the Fed’s balance sheet, the actual amount of tightening from ending QE is probably close to 300bps. And, the QT from the Fed will end up draining nearly $1 trillion from its balance sheet and reached $40-$50 billion per month at its peak. A reduction in the Fed’s balance sheet of anything close to $1 trillion is completely unprecedented and amounted to a tremendous drain on liquidity. Nobody knows exactly the amount of rate hikes this equates to, but it most likely added another 75bps of monetary tightening.

Société Générale calculates that the Shadow Fed’s Fund Rate dropped to three percent and, therefore, the amount of rate hikes to date have been 525-550bps. 300bps more than the stated FFR of 2.25-2.5%. But that is before you add in the Fed’s QT program. Therefore, when you add it all up, you get the equivalent of 600-625bps of rate hikes in this current tightening cycle—well above the high-end of the historical range where the business cycle turns towards recession.

My friend and Director of the National Economic Council, Larry Kudlow, recently stated that interest rates might not rise again in his lifetime. He is 71 years old, and I hope he lives for a very long time, but you get the point. Larry believes interest rates won’t rise for decades to come. Vice President Mike Pence said in an interview with CNBC that the Fed should cut interest rates by 50bps and agrees with President Trump about ending the QT program immediately. Pence also said this, “There’s no evidence of inflation in this economy.” Ok, Mr. VP, you don’t have to be Sherlock Holmes to discover the evidence. Home prices have jumped 48% in the past six years, all forms of insurance coverage have skyrocketed, and college tuition has been rising 8x faster than wages. But even if he took the time to view the manipulated government data on CPI and PPI, he’d see Consumer Prices are up 1.9% year/year, and Producer Prices have risen 2.2% year/year.

Nevertheless, President Trump is pushing for a return to QE, and he may find out that he has more friends on the Fed than he currently believes. Chicago Fed President, Charles Evans, had this pithy bit of wisdom regarding how he views his responsibility to protect the purchasing power of the dollar, “Inflation is weaker than I would like,” he said recently on a TV interview. As to why more inflation would help grow the economy, these lovers of counterfeiting can never clearly articulate.

With the FFR hovering at less than half its historical level, and the Fed’s balance sheet at $4 trillion, one would hope the government would think the last thing this economy needs is to cast more doubt on the faith in the US dollar’s purchasing power.  Inflation pushes the middle class further and faster along its inexorable path towards extinction. To add to this distorted view, our President recently tweeted that the Dow would be 5-10k points higher if the Fed had not engaged in QT. One also has to wonder how much more unhinged the President wants the stock market to become in relation to the underlying economy. After all, the total market cap of equities now stands at an incredible and dangerous 1.5 times GDP. The danger to the entire economy emanating from the inevitable crash from such lofty heights is growing exponentially.

Meanwhile, the debt dung pile in Chinese debt just got a whole lot deeper. Again, I don’t blame the great people of China but rather its government for this. The March total debt number was 80% higher than the year-ago figure, and the YTD debt increase was 40% higher than the year-ago period. Aggregate financing in the first quarter amounted to 8.18 trillion yuan (US$1.2 trillion), which was an increase of 2.34 trillion-yuan year/year. As to how Wall Street believes adding to China’s debt at this point can be a viable and sustainable plan is inconceivable. After all, China’s debt has already quadrupled in the past seven years. So, it is not as if Beijing has not tried this stimulus trick before. The government has indeed levered-up many times before in a big way and has produced a more unstable and unhealthy economy with each iteration.

Turning to the US, our March fiscal year to date deficit came in at $691 billion–that is for just the 1st half or the fiscal year. So, governments around the world have unbelievably and inconceivably taken fiscal and monetary madness a giant leap further and deeper into the depths of inescapable insolvency.

Is it any wonder why stock prices are rallying? There has been an absolute deluge of promises from global governments since the market collapse of Q4 2018 that there will be more free money on offer, even though they are fully aware that taking on more debt at this point guarantees the future will be beyond bleak.

For now, the economy walks a very thin line along the cliff’s edge. Unless you believe central banks can stay at the 0 bound interest rate range forever and never cause a reduction in a currency’s purchasing power, intractable inflation is inevitable. Once achieved, it will produce an interest rate surge from all-time lows that will engender an equally disastrous plunge in asset prices. Any fixed income instrument and equity that the government is not actively purchasing will crash in price. This is exactly what occurred in October of 1987, where the Dow lost 23% of its value in one day. But unfortunately, the carnage should be much worse than 1987 given the relative level of debt and overvaluation of equities that exists today.

The number and dollar amount of business defaults occurring as a result of such a meltdown should be unprecedented. There is a real danger the economy will contract into a depression given the record level of debt it is lugging along. The US carries total debt that is worth 350% of GDP, which is the same Pre-Great Recession level. This figure was 160% of GDP in 1980 and just over 200% in 1987. But this time around central banks have little, to no room, left to reduce borrowing costs and spur on new lending.

On the other hand, a recession could begin even before inflation runs intractable. The global economy is already slowing, and earnings growth has slowed to a negative level. If the amount of Fed tightening I estimated earlier is anywhere near correct, the business cycle should soon turn south following a stock market peak and crash that is only a few quarters away. The massive re-leveraging in China has served to hold off the carnage a bit longer, but Beijing now risks a crash in the yuan.

If you are investing in this market, it is necessary to try and eke out any gains left and do so using a data and math-driven model that is built to identify when to head for the nearest emergency exit well ahead of time to ensure you find one of the few lifeboats available. Then, you can sit back and use your cash to finally pick up the pieces of good companies with solid cash flow and dividends at a fair price. It’s the only sound plan around.

LYFT Mania is Wall Street’s Dead Canary

April 8, 2019

Recently, Wall Street has been myopically focused on the IPO of a ride-sharing company called Lyft, which by the way, is hemorrhaging money. Since investors have become much less concerned about profits and valuations, this offering was an incredible 20 times oversubscribed. Meaning, the underwriters received $47 billion of orders for Lyft shares but raised $2.3 billion. The company generated $2 billion in revenue last year and lost an incredible $911 million! Investors rewarded this profligate business model with a market cap of $27 billion.

This is a great example that Wall Street has gone nuts. The Lyft IPO price was $72 per share and shot up to $88.60 on its first day of trading. But the following trading day those shares were down 24% from the high. Indeed, this is emblematic of the dead canary in Wall Street’s coal mine.

Wall Street’s mispricing of this IPO is a perfect illustration of how the yield suppression from central banks has caused another stock market mania. The LYFT IPO should provide prudent investors with a stark warning: It is crucial to ignore the lure of lemmings and groupthink. Rather, they should concentrate on the fundamentals and the data—both of which point to a massive equity bubble.

Recent data points prove that the US and the global economy are weak, at best and cannot support the stock market at this level.

The Commerce Department said recently that retail sales fell 0.2 percent in February. Over the past year, retail sales increased by a slight 2.2%. Hence, after adjusting for inflation, growth in retail sales was not evident at all. Durable goods orders for February fell 1.6%. A key measure of business investment, known as core capital goods orders, fell for the fifth time in the last seven, dropping 0.1%.

You can forget about the capital spending boom, and productivity gains hoped for from the tax cut. Ex-autos and gas the number was -0.6% vs. +0.3% expectations. Spiking prices at the pump boosted the headline retail sales number but didn’t help most consumers’ wallets. The Chicago PMI in March slowed to a reading of 58.7 from 64.7. Order backlogs fell into contraction territory, while production and new orders fell from the previous month’s level. Remember, March data is hugely important because those readings occurred after the government reopened at should show a strong rebound–if not, the economy is in deep trouble. The March ISM Services Sector PMI, which fell to 56.1, was the weakest print since August 2017 and down from 59.7 in February.

The US automotive sector is giving us another warning sign about consumers’ health. Fiat Chrysler reported a 3% decrease in U.S. Auto sales for the first quarter of 2019, while General Motors sales fell 7% in the first quarter as all four of its brands recorded losses. Toyota Motor Corp reported a 3.5% fall in U.S. sales in March and a 5% drop for the first quarter. Nissan Motor Co. posted a 5.3% drop in sales in March, and its first-quarter sales were down a significant 11.6%.

The economic slowdown is even worse in Europe. Factories in the Eurozone had their worst month for almost six years in March. The EU’s IHS Markit’s March final manufacturing Purchasing Managers’ Index declined for an eighth month, coming in at 47.5 from February’s 49.3. China’s March PMI improved to 50.8, which is barely in expansion mode. However, Wall Street ignored the horrific EU data in favor of the hopes that China can bounce back. But the truth is Red China is a debt-disabled nation with a shrinking labor force and falling productivity. China’s household debt increased by 716%, Non-financial corporate debt jumped by 400%, and total government debt climbed by 416%, all since 2008. This was the product of its past stimulus packages. It is extremely doubtful that robust and viable growth can be produced from yet another round of government stimulus.

Turning back to the US, the data does not indicate the real estate sector will be aiding to the hopes of a second-half rebound in the economy.

February made it 14 straight months of year over year declines in pending home sales. The drop in pending sales was down 4.9% from January.  The takeaway is clear: home prices have shot up well above incomes each year since 2012 due to Fed’s ZIRP. Now, home prices have become unaffordable for the first-time buyer for the most part, even though mortgage rates are coming down. Perhaps that is why we are starting to see the inexorable rise in home prices begin to reverse. The median sales price of a new home in February fell 3.6% to $315,300. The Home price/income ratio now stands at 4.4. It ranged from 3-3.5 from 1969-2001 and hit an all-time of 5.1 in 2005. Manhattan real estate sales fell for the 6th quarter in a row. That is the longest losing streak in the past 30 years.

Interest rates are falling commensurately with decelerating economic growth. Demand is down for homeownership due to affordability issues, and at the same time, banks are less incentivized to lend due to shrinking margins on new loans. The yield curve inverted recently and that inversion has led to a recession seven out of the last seven times it has occurred.

The most salient question is whether or not China’s massive stimulus efforts combined with the Fed’s abeyance with rate hikes and promise to end QT come October, will be enough to provide for viable global growth.

With all this, there are some small signs of stable data in the US, for example, the March ISM Manufacturing Index registering 55.3 in from 54.2 in February, which was a small increase. But that slight blip higher in the ISM was offset by the IHS Markit manufacturing PMI, which fell to 52.4 vs. 53 in February, which the lowest reading since June 2017.

The plain truth is the overwhelming majority of global data still points towards contraction and an anemic debt-disabled world. There is a contraction in global trade; the Baltic dry index has crashed; tax receipts are falling and, according to FactSet, there was the largest cut to Q1 S&P 500 EPS estimates since Q1 2016. EPS was cut by 7.2% to $37.33. The interesting part is that for all of last year the earnings for the S&P 500 was $161.57 & the projection for 2019 EPS is $168.19, or 4% growth. However, with Q1 projected to post just $37.33, it will take an absolute surge in global GDP and EPS to achieve anything close to that 2019 estimate. The current run-rate 2019 for full-year EPS on the S&P is below $150!

Therefore, the global equity market has priced in the environment that a return to a globally synchronized recovery is indeed already an established fact. Nearly every economist and market strategist is bullish; predicting a favorable outcome to Brexit, the trade wars, the slowdown in global GDP, the current recession in parts of Europe, the zero growth in Japan, US GDP growth slowing from 4.2% last year to 1.3% in Q1, which is projected by the NY Fed. They see no issues at all with record global debt levels and the $10 trillion worth of negative-yielding sovereign bonds; there is no fear over the threat from Donald Trump to close the southern border, or Trump imposing tariffs on autos from the EU. The level of complacency is astonishing. Only the tech bubble of 1999 can compare with the lunacy that Wall Street exhibits today.

Therefore, the only logical outcome is that disappointment lies ahead for the perma-bulls

A big drop in the stock market is inevitable. That collapse in asset prices will set the Fed up for a massive move back to ZIRP and QE along with fiscal spending that would make even Alexandria Ocasio Cortez blush, which will render the economy into a deep battle with stagflation. That stagflation will lead to some great opportunities on the long side but will also eventually set us up for a huge plunge in asset prices that will make Q4 of 2018 and 2008 look like a bull market. Such are the consequences derived from abrogating the free market in favor of the hubris of central planners.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

China Can’t Save the Global Economy Again

March 25, 2019

China has acted as part of the life support system for the global economy during the past two decades. The other part being comprised of central banks. When the Tech Bubble burst back in 2000, China began printing and borrowing an incredible amount of money to create demand for fixed assets. After the Great Recession struck in 2008, Beijing again reacted with a massive government stimulus package that helped further inflate its real estate bubble and placed a pervasive bid under global markets. It was much the same in the wake of the global slowdown and earnings recession in the U.S. in 2016. In fact, China has been a humongous tailwind for growth since 2000; taking on about $38 trillion in new debt, which amounted to an incredible 150-percentage point increase in its debt to GDP ratio.

Because of this untenable debt load, China recently began a much-needed policy of deleveraging, leaving many to speculate how long the global economy can sustain itself without its main growth engine. After all, the Red Nation had been responsible for roughly a third of global growth since 2008. However, and regrettably, China’s flirtation with austerity did not last very long. Authorities have now begun to reset priorities away from reigning in the nation’s $40 trillion worth of debt and are instead seeking to prop up the economy with yet more debt.

Some of the debt ratios in China not only exceed that of the U.S. but are also estimated to be twice as high as that of the average emerging market economy. Total debt has more than quadrupled since 2007. Total debt including household, corporate and government increased from 160% of GDP in 2008 to over 304% of GDP in 2018, according to the Institute of International Finance.

And all this begs the question: With its massive debt load, does China have the gas left to fuel the global economy, or has Wall Street misplaced its faith in an ersatz economic savior and a resolution to the trade war?

For the past three decades, China has been the global growth darling of the world and Wall Street. The communist nation has averaged GDP growth of 9.9%  from 1979 to 2010, according to the World Bank

Under its unique combination of communism and capitalism, China’s growth seemingly defied the laws of economics and the business cycle. But a cursory look beneath the surface exposes China’s economic miracle was continuously levitated by a dangerous mountain of debt.

While the central government in China holds little debt and enjoys healthy foreign currency reserves, regional government debt, household debt, and corporate debt have exploded. Regional governments in China provide schools, hospitals, and transportation services. However, they have almost no power to raise taxes and receive very little of the taxes levied in their territory. These localities balance their budget by issuing Local Government Financial Vehicles (LGFV). This type of debt is extremely opaque, making it difficult to accurately calculate the actual level of indebtedness, but it ranges between $5 trillion to $7 trillion, according to CHEN, Z. China’s Dangerous Debt: Foreign Affairs.

State Owned Enterprises or SOEs accounted for more than half of total corporate debt, or 72% of GDP in 2017 according to the International Monetary Fund (IMF). Most of these enterprises are Zombie corporations meaning they have an unsustainable business model. They exist mainly to employ people and must constantly take on new debt to pay off interest on existing debt. This type of state-directed debt is nonproductive in nature and is a primary contributor to the plunge in labor productivity.

The Private Sector Corporate debt consists of bank loans, bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock exchange.  offerings, and shadow banking activities. These debt-laden companies are even more vulnerable to a drop in asset -values and/or a rise in borrowing costs. Slowing growth and tighter regulations have recently triggered many bankruptcies in this space.

Finally, we have Chinese household debt, which has been dramatically outpacing household income for the past decade.

But debt is not the only overhang on the Chinese economy. China has a shrinking labor force and a population that is rapidly aging. In 2010, 13% of the population was 60 years old or older; but by 2030 that figure skyrockets to 25%. According to Statista, the labor force in China is shrinking by 0.2% between 2016-2026 and then it drops further from there.

All these factors prove that China’s recent economic problems have little to do with a trade war. The Shanghai Composite Index peaked two years before the first direct tariffs on China’s exports were put into effect.

Wall Street believes that resolving the trade war will become a panacea growth. But the Chinese economy has been fueled by a powerful credit bubble over the past few decades. And its credit-driven economy has become a significant growth engine for the global economy whose “recovery” is predicated on debt. Indeed, Global debt has increased by $150 trillion since 2003 and $70 trillion since 2008:

In the vanguard for this global re-leveraging process was, and is China. According to S&P Global Ratings, China’s household debt increased by 716%, Non-financial corporate debt jumped by 400%, and total government debt climbed by 416%; all since 2008. And now that immense pile of debt dung is exploding, and it just can’t be easily remedied by yet another stimulus package from Beijing.

Proof of China’s debt-disabled condition can be found in the current data. Mobile phone shipments in China totaled 14.51 million in February, a nearly 20% plunge year-on-year, according to data recently released by the China Academy of Information and Communications Technology. In addition, China Auto sales plummeted 14% year over year in February.  But last month was no aberration. Car sales were down for the 8th month in a row and have crashed by 16% in January and 13% in December. In addition, China’s Industrial Production in the first two months of this year fell to a 17-year low.

Similar to Japan in the late-1980s, China’s economic growth once appeared to be unstoppable. This mistakenly led most on Wall Street to believe that the communist nation would eventually leave the U.S. economy far behind in the dust. However, students of history know that Japan’s growth phenomenon came to a sudden halt in 1989; at the same time of its epoch market crash. Likewise, China’s economy and equity market peaked in 2015 and the Shanghai Index has fallen by 43% from that point.

By accumulating debt at such an aggressive rate, China is following in the same footsteps as its historical enemy to the east. All indications are that it will soon experience a similar fate, as the government’s debt scam implodes.

The joke here is that equity markets are banking on yet another global growth slingshot to occur very soon. But as to why the supposedly bastion of capitalism that exists on Wall Street has misplaced its faith in a communist nation’s ability to magically produce a targeted rate of growth on demand should be a mystery. Sadly, the truth can be found in that carnival barkers are always in search of a good story to tell; no matter how much fiction is involved.

Investors would be wise to use extreme caution given the fact that this global earnings and growth recession is occurring while equities are at all-time high valuations and at the same time debt levels are off the charts. Especially when central banks have either very little or in most cases, zero room left to lower the cost of debt and boost economic growth.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

 

 

Asset Bubbles and the Economy are Now One

March 11, 2019

 After this latest round of a deflationary recession/depression consummates, global central banks and governments will engage in an epic battle to re-inflate asset prices such as never before contemplated. Indeed, they are laying the framework for that assault right now.

Global central banks took interest rates to the zero percent range a decade ago and, for the most part, they remain there today. These confetti pushers printed $15 trillion dollars in order to push rates into history’s basement. Such an enterprise in counterfeiting has never been attempted before outside of a banana republic.

This process sent the total market cap of equities in the U.S. to 150% of GDP in the fall of last year, which was an all-time record high. Today, this most-accurate metric of equity valuations stands about 80 percentage points higher than its long-term average prior to the NASDAQ bubble of 2000. In other words, because of the unwarranted bounce in stocks at the start of this year, equity valuations have traded back to an extremely dangerous level once again.

The current bubbles in stocks, bonds, and real estate began to concern the Fed a few years back. The FOMC ended QE in October 2014 and began raising rates in December of 2015. This process of first ending QE, then raising rates 9 times, then selling $500 billion of its assets; was an honest attempt to roll back the massive and unprecedented stimulus programs deployed during the Great Recession. In fact, the new Fed Head, Jerome Powell, avowed on October 3rd of last year that his Quantitative Tightening (QT) program would remain on autopilot and that he intended to raise interest rates by another 100 basis points over the course of the next 1-2 years.

However, the cumulative effects of ending QE, draining half trillion dollars of liquidity from the economy, and raising the Funds Rate by 225 basis points eventually hit asset prices hard only a few days after his now infamous pledges. The major averages plunged by 20% and small-cap stocks cratered by nearly 30% by Christmas. It was at that point the Fed reached an epiphany. Mr. Powell and the rest of his merry band of money printers realized that asset prices and the economy had become one and the same. Whatever economic growth was experienced by the economy was completely beholden to the asset bubbles central banks created.

After all, the watershed change from hawkish to dovish was not due to the Fed’s two mandates comprised of stable prices and full employment. The December data on Consumer Inflation increased by 1.9% year over year and the January Non-farm payroll report showed a net 304k jobs were created. Therefore, it was the collapse in stock prices and the seizing up of the high-yield bond market that cowered the Fed into mush.  So now, in reality, the Fed has only one true mandate and that is a to ensure there exists a perpetual bull market in junk bonds and equities.

The sad truth is that central bankers are a group of flawed humans who have the hubris to believe they can play God with economies. Need more proof? Remember when former Fed Chair Janet Yellen promised that QT would be “like watching paint dry” and that there would not be another financial crisis in our lifetimes. Then, 16 months later the global economy began to crumble along with equity prices. Proving once again that central bankers aren’t even demi-gods—much less gods–they are just foolish and feckless individuals that have given themselves way too much power.

Therefore, the Fed is unaware what turning dovish at this juncture really means. With an effective overnight lending rate of 2.4%, Powell wasn’t even able to get the Fed Funds Rate at half the level it was at the peak of the last cycle. And, most importantly, leaving the balance sheet at a level of $3.5-$4 trillion when it ends Quantitative Tightening will mean the Fed has permanently monetized around $3 trillion worth of government debt and mortgage bonds.

The salient danger in stopping its normalization process at such levels is tantamount to admitting that asset prices and the economy are one in the same. And, the Fed is now powerless to stop their ascent without engendering an absolute and complete economic collapse. Also, the markets will soon be put on notice that real interest rates will become progressively more negative over time and that nominal rates are stuck near zero percent. Being a slave to the markets also denotes that there will never be a good time to normalize monetary policy and this condition will only grow worse over time.

As this current deflationary cycle intensifies, expect central banks to go full throttle back into QE and global interest rates to fall even further into the cellar of history. We should also expect massive fiscal stimulus programs worldwide that will add significantly to the global leverage ratio. For example, we already see China’s government force a record 4.64 trillion yuan ($685 billion) in the month of January alone into their economy! Hence, not long after this complete capitulation on the part of governments to go full-throttle with inflation, look for asset prices to grow further detached from the underlying economy and for the wealth gap to surge from its already crippling level.

In the end, it will be a brutal battle with global stagflation that eventually craters GDP, which has been artificially constructed using the printing press. The plunging faith in the fiat currency regime that underwrites a record $250 trillion of global debt will be the result.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

The Cavalry may not Arrive on Time

February 28, 2019

A vast amount of economic data had been delayed due to the government shutdown that lasted 35 days from December 22nd to January 25th. But now, unfortunately for the Wall Street shills, it is all coming out—and, for the most part, it is downright ugly. At the end of the day, you are going to invest either by using data and math or by feelings and misguided momentum chart chasing. I prefer the former to the latter.

So, what does the data say? Core capital goods dropped 0.7% in December, Housing starts plunged 11.2% in December month/month and tumbled 10.2% year/year. Leading Economic Indicators for January are declining; The Philly Fed Index dropped into negative territory for the 1st time in 3 years at–4.1% in February. Again, please note this was a February reading after the shutdown ended. Existing home sales in January fell to their lowest level since November of 2015. Pending Home Sales for January were reported to be 2.3% lower than a year ago, making the January reading the 13th straight month of year-over-year declines in future home purchases. Finally, US GDP for Q4 came in at a 2.6% annual rate, which was lower than the Q3 growth of 3.4% and significantly less than the Q2 growth rate of 4.2%. Yet, still better than the 1.2% growth rate for Q1 of this year predicted by the NY Fed.

Meanwhile, the data outside the US is even worse: German and Italian Purchasing Manager’s Indexes’ (PMI) both indicate that the European Union (EU) is heading into a recession, if not already in one. If you want to know how bad the core of Europe is doing, German PMI manufacturing index hit a 74-month low in February at 47.6. And it is the same story for Japan. And so much for China’s ability to boost growth by re-leveraging its already massively overleveraged economy. The communist nation’s official manufacturing purchasing managers’ index in February decreased to 49.2, data from the National Bureau of Statistics showed. It was the lowest reading in three years.

So, the question is how bullish do you want to get at this time now that the major averages have climbed all the way back to being close to all-time highs? Especially while GDP growth is slowing sharply, earnings growth has turned negative, and margins have peaked. And, especially when you consider that central banks have mostly run out of bullets to fight the falling business cycle.

Quantitative Easing (QE) works with a lag and is not a panacea for economic growth by any stretch of the imagination. But it does boost asset prices if it is both massive and protracted. Neither one of those conditions are prevalent today as they were from 2009 thru the start of 2018. And there is zero room left in Europe and Japan to reduce interest rates to relieve debt service payments and spur more borrowing to boost consumption.

Global economic data is crashing, and there is a pervasive and errant belief in investors’ minds that global central banks have now gone all-in on easing monetary policy and that it will very soon produce a synchronized global economic recovery once again. That notion, the carnival barkers in the Main Street Financial Media would have you believe, is highly unlikely to occur anytime soon. First, the European Central Bank (ECB) and the Bank of Japan (BOJ) already have negative interest rates. And the Fed only has less than 250 bps to lower rates. However, it usually takes at least 500 bps to pull an economy out of a recession.

QE not only does little to nothing in the way of improving growth it also is not any guarantee of perpetually higher stock prices. The Nikkei Dow is just about 3% higher today than it was back in August 2015, even after pouring in trillions of yen starting in 2013 that is continuing to be poured in today. The ECB just ended QE in December of 2018 after printing trillions of euros since 2015. But the German DAX is at the same value today as February 2015. It is the same with Italian and French exchanges. The truth is that stocks have gone nowhere in Europe for the past few years.

And despite all that QE there still is a recession in Italy, 0% GDP growth in Germany and 0% growth in Japan.

In the US, QE ran from the start of 2009 thru October 2014. However, real GDP averaged a pitiful 1.36% throughout this period.  The ECB QE program ran from 2015 thru the end of 2018. But despite negative interest rates along with a massive QE program, German growth was just 1.5% in 2018 the weakest in five years and was 0% in Q4 of last year. All that central bank money printing didn’t help Italian GDP; it was negative in the previous two quarters of 2018. And in Japan, its Qualitative and Quantitative unprecedented counterfeiting spree was only able to produce 0.0% GDP growth in Q4 of last year over the year-ago period.

QE does nothing to help the real economy in a viable manner and can only help push stocks artificially higher if it is both massive and infinite in nature. But neither of those conditions have become manifest in Europe and especially in the US at this time. In fact, the Fed is still in the process of selling around $40 billion of its asset each month off its balance sheet.

Therefore, there should soon be a significant selloff in the global averages as investors slowly realize the conveyor belt of bad data continues but global central banks have yet to commit to permanent money printing.

Remember, all of this central bank intervention was supposed to be temporary due to a worldwide economic emergency. Hence, going back into QE now would be an admission that QE can never end, and asset bubbles along with inflation will be allowed to run intractable. This is because nominal rates will forever be stuck at around 0% and real interest rates and will sink further and further into negative territory for as far as the eye can see.

Therefore, our central bank will be loathed to admit this and should be reluctant to put itself in such a position. This is because such an absurd monetary policy stance will put a death sentence out on the American middle class and set the economy firmly down the path of perdition. Again, I do not doubt that major global central banks will end up in that dreadful position. However, the Powell Put probably won’t become fully in effect in time to save the stock market from another massive selloff.

So, you might ask, what was the primary outcome of all this money printing? The 400 wealthiest Americans own more of the country’s riches than 150 million adults in the bottom 60%. That unbalanced condition will grow massively worse if the Fed goes back into QE from this point. The Fed is now even contemplating making up for the years following the Great Recession when inflation was below that magical official government measure of 2% CPI. In other words, the Fed will most likely seek to push inflation above 2% for at least seven years. Not only this, but the new economic fad is to push for something called the Modern Monetary Theory. Basically, a belief that governments should be allowed to spend unlimited amounts of money and have central banks print it all. God help us all!

What this all means is that if you are not investing with the inflation, deflation and economic cycle dynamic in full view you are virtually assured to either lose a massive amount of your principal; and/or risk even more losses in terms of your purchasing power through inflation. The goal of PPS is to ensure that in the long-term the exact opposite of that outcome is realized.

Repo Man’s Valentine’s Day Present

February 25, 2019

 The New York Federal Reserve recently sent out an early Valentine’s Day present to a certain group of individuals. However, this gift wasn’t to overleveraged American consumers; but rather to those who are employed repossessing one of those goodies they can’t afford.  On February 12th the NY Fed made the announcement that a record number of consumers are falling behind on their car payments.

There are now over 7 million car loans past due by at least 90 days as of Q4 2018, along with a record 89 million loans that are outstanding. For Subprime Auto borrowers with credit scores below 620, the delinquency rate spiked to over 16% and the number of subprime borrowers jumped to 20% of loans outstanding. The amount of overdue loans has spiked by 1.3 million since its previous high set in 2011 when the unemployment rate was at 9%.

 The total market for auto loans now stands at $1.2 trillion. Some may take solace in the fact this level is much smaller than the $9 trillion home mortgage market that brought down the global economy in 2008. However, when you combine car loans with all the other debt consumers have accumulated due to the Fed’s nearly decade-long zero interest rate policy, the numbers become daunting. Household Debt is now at an all-time record high of $13.5 trillion; this number includes a record $1 trillion in C.C. loans and $1.5 trillion of student loan debt.

And while that $9 trillion mortgage market isn’t in as bad shape as it was a decade ago, home prices have climbed back into an echo bubble and have become extremely susceptible to rising interest rates and the credit cycle. In addition, when you add in the boom in corporate credit–rising from $6 trillion in ’08 to $9.6 trillion today, along with the $22 trillion National Debt, you can clearly see the state of the US consumer has never been more precarious. In fact, these debt holders are desperately clinging to their jobs and hoping the economy avoids even a mild contraction in growth or any further advance in debt service payment costs. Considering all of these mindboggling obligations owed by consumers and taxpayers, is it really much of a mystery as to why the Fed is so panicked about even the slightest hint of a recession?

A recent Federal Reserve survey also reported that 40% of American adults say they couldn’t produce $400 in an emergency without sliding into debt or selling some assets. That is if they have any to sell in the first place.

The state of the US economy—and indeed that of the entire globe—now depends upon the conditions of ZIRP and asset bubbles that are made permanent. This shouldn’t be a shocking conclusion. After all, central banks wanted to re-leverage the economy after the Great Recession hit in 2008; and concluded the only way to accomplish this was to make money virtually free for the past 10 years.

Of course, one of the consequences of manipulating the cost of money in such an unprecedented manner was to force buyers into new vehicles at record numbers. This, in turn, drove the price of new vehicles to record highs, while it also significantly raised the residual values of new auto leases; and thus made monthly payments much more affordable. As long as zero percent financing was available to those with lower and lower credit ratings, the bull market in car sales and prices continued.

However, much like what occurred at the apex of the real estate bubble circa 2006, all bubbles inevitably pop; auto prices eventually increased to a level that became unaffordable to most buyers, dealers ran out of subprime borrowers, and the central bank began to normalize monetary policy. And then the car market goes into reverse as the economy slows due to the inevitable turn in the business cycle. What follows is a huge number of cars start heading back to the dealership (think jingle mail 2.0 but with car keys instead of front door keys) causing the price of used vehicles to drop sharply. This, in turn, causes residual lease values to plummet, and as a consequence, the cost of new leases begins to surge.

The collapse of the auto bubble happens to be just one small example of the “unintended consequences” and massive distortions created by central banks gone rogue.

Economic growth has slowed from 4.2% in Q2 of last year to just 1.5% in Q4, estimated by the Atlanta Fed. As the U.S. economy continues to slow and the global economy waxes towards recession, what is happening in the auto sector should also occur with student loans, credit card debt, mortgage-backed securities, leveraged loans, CLO’s, and so on. Of course, banks are the primary holders of all this debt and their balance sheets will once again become an issue in 2019-2020.

The next recession will cause tax receipts to plunge and push annual deficits to spike above $2 trillion, or an incredible 10% of GDP. Adding another two trillion dollars per year to an already unmanageable $22 trillion National Debt is not something our bond market or world’s reserve currency can easily withstand.  In other words, the US taxpayer will be required to perform yet another bailout of the banking system.

Inflation is the primary tool governments use to accomplish its economic rescue plans. And that means investors will need to flock into the economic freedom that can only be found in the ownership of gold.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

 

 

Wall Street is Chasing Ghosts

February 19, 2019

Wall Street’s absolute obsession with the soon to be announced most wonderful trade deal with China is mind-boggling. The cheerleaders that haunt mainstream financial media don’t even care what kind of deal gets done. They don’t care if it hurts the already faltering condition of China’s economy or even if it does little to improve the chronically massive US trade deficits—just as long as both sides can spin it as a victory and return to the status quo all will be fine.

But let’s look at some facts that contradict this assumption. The problems with China are structural and have very little if anything to do with a trade war. To prove this let’s first look at the main stock market in China called the Shanghai Composite Index. This index peaked at over 5,100 in the summer of 2015. It began last year at 3,550. But today is trading at just 2,720. From its peak in 2015 to the day the trade war began on July 6th of 2018, the index fell by 47%. Therefore, it is silly to blame China’s issues on trade alone. The real issue with China is debt. In 2007 its debt was $7 trillion, and it has skyrocketed to $40 trillion today. It is the most unbalanced and unproductive pile of debt dung the world has ever seen, and it was built in record time by an edict from the communist state.

Next, while it is true that in the long run, tariffs are bad for growth – and history proves this beyond a doubt — in the short term, this trade war between the US and China has actually helped boost global trade and GDP. A prolonged period of tariffs is bad for global growth because it stunts global trade—that is what’s bad about a trade war. But that is not what happened in this case; trade has actually increased. This is probably because president Trump first put on a relatively small level of tariffs in July of last year and then threatened to significantly increase the import duties at the start of 2019. This caused a surge in trade from both countries in an attempt to front run the deadline. Hence, China actually had a record trade surplus with the US in 2018 of $323.3 billion. US imports from China surged by 11.3% year over year to $478.4 billion. And, exports from the US to China actually increased as well—however, by a much smaller 0.7%. This trend continued in January, as China’s January dollar-denominated exports rose 9.1% from the year-ago period—most likely due to Trump’s can kick with raising tariffs until March 1st.

The point here is that global trade actually increased in the year the trade war began. So, if China’s exports actually increased strongly during the trade war and China doesn’t pay US tariffs, it is paid by US importers, how is it reasonable to contend that China’s growth will surge once a trade war truce is declared? Of course, if tariffs increased to 25% on all of China’s exports to the US it would stunt global growth. But that has not happened yet and investors are pricing almost no chance of it ever occurring.

Again, China is a debt disabled economy—much like Europe—that has been responsible for one-third of global growth coming out of the Great Recession of 2007-2009. However, it just can’t re-stimulate growth yet again by building another empty, unproductive city or port. Stimulating growth now by issuing more debt may be enough to levitate the economy from crashing, but it just can’t produce robust growth any longer. In fact, bond defaults have begun to surge, quadrupling from last year, as the communist nation struggles to handle its mountain of obligations.

Wall Street will soon have a day of reckoning when it realizes the trade war was not at all the primary driver behind the dramatic slowdown in global growth. And global growth is slowing dramatically—with a conveyor belt of bad news to continue well after the announcement of a deal.  US Retail Sales in December crashing by the most in nearly a decade is just one example.

In the developed world we have the Italian economy, which is in an official recession and it is the third largest bond market on earth. Putting global banks that own this debt in high danger. Eurozone Industrial Production plunged -4.2% year-over-year in December after falling 3.3% in November. The headline German (IFO), business climate index, slid to a two-year low of 99.1 in January, from 101.0 in December, dragged down by a crash in the expectations index to 94.2. And Q4 German GDP was exactly 0.0%. Japan’s economy is a perpetual state of malaise, as growth for the full year 2018 was a sad 0.7%. And on an annual basis, its industrial output declined 1.9% in December.

Of course, the world is full of emerging market economic basket cases like; Argentina, Venezuela, Turkey, and South Africa as well. This condition is the opposite of the recently enjoyed globally synchronized recovery, and it is putting extreme downward pressure on US multinational earnings.

Which brings us to the other ghost Wall Street is chasing…the Fed. Along with a handshake between Trump and XI, those Carnival Barkers are also cheering on the Fed’s move towards a dovish stance on monetary policy. But it is ignoring with alacrity the reasons why the Fed has paused with its rate hikes. The Fed inverted the yield curve on the 2-5 year spread late last year and, at least for now, it is still destroying $40 billion worth of assets each month. How is it that investors are so sure the Fed hasn’t already gone too far; just like it always has done in the past?

US GDP growth has dropped from 4.2% in Q2 last year to display a 1% handle in Q4 2018, according to the Atlanta Fed. Earnings growth has plunged from 20% in 2018 to a negative number at the start of this year. Real estate is in a recession, and equity prices lost 7% last year. It is highly likely the Fed turned dovish too late. Remember, the Fed stopped raising rates in 2006 and began to cut rates aggressively in 2007. But that didn’t stop the global economy from imploding a year later. The Fed also began cutting rates in January 2001. But the S&P 500 still fell another 37% by March 2003. And keep in mind, the Fed is still tightening rates by selling off its balance sheet.

As the global economy waxes towards recession investors are jumping into the relative safety of sovereign bonds. The Japan, 10-year bond, went negative once again and pushed the number of global bonds with a negative yield back up to $9 trillion. Yields are falling here in the US too, despite the fact that the National debt just hit $22 trillion and total global debt hit $250 trillion.

This begs the question: if global economic growth was about to turn around sharply to the upside based upon dovish central banks and an end to the trade war, then why do global bond yields continue to fall?

No, things are not normal, and the world has gone insane. And that is why heading to the safety of the gold market at this juncture is becoming more crucial by the day.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Powell’s Rate Pause Won’t Save Stocks

February 11, 2019

Jerome Powell threw Wall Street a lifeline recently when he decided to temporarily take a pause with the Fed’s rate hiking campaign. The Fed Head also indicated that the process of credit destruction, known as Quantitative Tightening, may soon be brought to an end.  This move towards donning a dovish plume caused the total value of equities to soar back to a level that is now 137% of GDP. For some context, that valuation is over 30 percentage points higher than it was at the start of Great Recession and over 90 percentage points greater than 1985. So, the salient question for investors is: will a slightly dovish FOMC be enough to support the massively overvalued market?

The S&P 500 is now trading at over 16x forward earnings. But the growth rate of that earnings will plunge from over 20% last year to a minus 0.8% in Q1 of this year, according to FACTSET. It might have made sense to pay 19x earnings back in 2018 because it was justified by a commensurate rate of earnings growth. But only a fool would pay 16x or 17x earnings if growth is actually negative?

The only reason why that would make sense is if investors were convinced EPS growth was about to soar back towards the unusually-strong rate of growth enjoyed last year. And for that to be the case several stars have to align perfectly.

The structural problems that are leading to sharp slowdowns in Europe, China and Japan all have to be resolved favorably and in a very short period of time. And, of course, global central banks begin another round of massive and coordinated of QE.

In addition, the trade war must also be resolved quickly and in a way that does not inflict any further damage to the ailing economy in China. Not only does China have to agree on a myriad of concessions; including eliminating its trade surplus with the U.S. and renouncing its practice of intellectual property theft. But the communist nation must also agree to subject itself to rigorous monitoring and enforcement mechanisms. Not only this, but any eventual deal must be constructed in a way that ensures increasing China’s dependence on imports does not negatively affect domestic production.

Additionally, China’s government must be able to re-stimulate its growth by forcing yet more debt upon its economy, which is already so overleveraged that it has begun to crash.

In addition, the chaos that surrounds Washington must abate quickly. This means future government shutdowns must be averted and that there will not be Presidential indictments from the soon to be released Mueller probe. Also, the upcoming conflagrations and brinksmanship over funding the government and increasing the debt ceiling must not adversely affect consumer sentiment.

But by far the most important of all these factors is the Fed. It must turn out to be the case that the previous 9 rate hikes and $500 billion worth of currency destruction through QT haven’t already been enough to push the economy and stock market over the edge–especially in view of the fact that the balance sheet reduction process is still ongoing.

It is prudent to point out that the Fed last stopped raising rates in the summer of 2006. But that certainly didn’t turn out to be the all-clear sign for the economy. A mere twelve months later the stock market began to crash, and 18 months after the Fed’s last hike the real estate crisis and Great Recession began.

Back in 2006, the global economy was booming with growth of over 4%. In sharp contrast, today we have parts of Europe in a recession, while Japan’s GDP is contracting. There is now a sharp slowdown in China from well over 10% growth in 2006, to the 6% range today.  Also, the U.S. economy has slowed from 4.2% in Q2 of last year to around 1% at the start of this year. The point here, is the world isn’t growing like it was 13 years ago, or even where it was a year ago–it is now teetering on recession.

This means there is a huge difference between the point in which the Fed is going dovish this time around–if you can indeed categorize a dovish Fed as one that is still in the process of destroying 10’s of billions of dollars each month through its reverse QE program.

It is true that the Fed stopped hiking the Funds Rate at 5.25% back in 2006; while today it is just below 2.5%. Therefore, Wall Street shills take solace in the fact that rates are at a lower point now than they were in the last hiking cycle. So, they conclude with an alacrity that today’s level of interest rates will turn out to be innocuous.

However, as already mentioned, stock prices are much higher relative to GDP today than in 2006. And, debt levels today dwarf what was evident at the start of The Great Recession. The fact is that total non-financial debt in the U.S. has surged from $33.3T (231% of GDP) at the start of the Great Recession in December of 2007, to $51.3T (249% of GDP) as of Q3 2018. The bottom line is the economy is lugging around an extra $18 trillion of debt that it has to service on top of what it could not bear a decade ago.

Therefore, it is logical to conclude after raising the Fed Funds Rate 9 times since December 2015 and also for the first time in history destroying $500 billion from its Quantitative Tightening program, that the Fed has already tightened enough to send earnings and GDP into a recession.

Despite the sharp slowdown in the global economy, the perma-bulls dismiss the idea of an earnings recession that lasts more than one quarter. This is primarily because the Fed has gone on hold with its monetary policy. However, this ignores the earnings recession that occurred only a few years back.

The S&P 500 EPS for the calendar year 2014 was $119.06, for 2015 it was $118.76, and for 2016 it was $119.31. It should be noted that the earnings recession of 2014-2016 occurred in a much more favorable macroeconomic environment. The ECB was still in the throes of its QE program, the Fed Funds Rate was 200 basis points lower, the trade war had not yet begun, the Fed’s reverse QE program was still another year off, and the Fed’s balance sheet was a half-trillion dollars larger. Yet, the earnings recession still happened; and the stock market went absolutely nowhere for two full years with a couple of steep double-digit percentage point drops mixed in.

The earnings recession was only bailed out by Trump’s massive corporate tax cut, an unprecedented stimulus package from China, and global QE that was spitting out around $100 billion of monetary confetti each month. But those conditions are not likely to be repeated, and that means that the global economy must stand on its own debt-disabled legs for the first time in over a decade.

Sadly, it should end up taking much more than an abeyance with rate hikes to levitate stock prices. After this next plunge in asset prices, the Fed will be quickly cutting interest rates back to zero percent and all global central banks will be forced to re-engage with a massive, protracted and record-breaking round of QE. This will also be combined with a humongous global fiscal stimulus package that will serve to push bankrupt nations further into insolvency.

It may be possible to rescue the stock market in nominal terms using this type of fiscal and monetary madness. However, it also means the already endangered middle class will take a giant step towards extinction. And this is why the timing of precious metals ownership will be more crucial than ever.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”