Pentonomics

What the World Doesn’t Need Now is Lower Rates

July 22, 2019

The Q2 earnings season is upon us and the risks to the rally that started after the worst December on record at the close of last year is in serious jeopardy. We received a glimpse of this with some of the current companies that have reported. For example, to understand how dangerous this earnings reporting season can be, take a look at what one of the largest US multinational firms had to say recently after it reported earnings. The Minnesota-based Fastenal, which is the largest fastener distributor in North America, reported worse-than-expected second-quarter earnings and revenue. Shares of Fastenal promptly tanked more than 4%. But what the management said about the quarter was very interesting. The company said in its press release that its strategy to raise prices to offset tariffs placed to date on products sourced from China were not sufficient to also counter general inflation in the marketplace.

In fact, companies that collect more than half their sales outside the U.S. are expected to see a 9.3% slump in second-quarter earnings, according to FactSet estimates. This quarter’s earnings overall are expected to drop by 2.3%–making it the second quarter in a row of declining EPS growth.

What I find most interesting is that we have a capital spending slowdown, a global manufacturing recession, global GDP grinding downward, US Q2 growth falling to about 1.5% from the 3% level seen last year, and an S&P 500 earnings recession. All of this is happening in the context of asset prices that are at all-time high valuations and are clinging precariously to a worldwide fixed income bubble that is destined to go supernova and obliterate asset prices.

I’ve gone on record indicating that the daggers for the bubble on Wall Street and the global bond market are inflation and recession. A recession would blow up the $5.4 Trillion worth of BBB, Junk and Collateralized Loan markets; And rising rates of inflation would leave the entire fixed-income spectrum in tatters.

But what happens if you get both occurring at the same time? What if we see the return of stagflation? What if rates undergo a massive spike due to global central bank insanity and their inability to ever come even close to normalizing interest rates; and then you also have a recession that causes multiple trillions of dollars’ worth of bonds to default? The answer is, yields would soar like a surface to air missile from the currently insane level of low rates that could only make sense in the twilight zone.

How insanely-low are interest rates you ask? There are now Junk bonds in Europe that have a negative yield, Austria recently issued a one-hundred-year bond with a yield of just 1.2%, And, almost every single country in Northern Europe and the nation of Japan have sovereign bonds with a negative yield– some of which going out ten years in duration!

Therefore, because rates have been forced down by central banks to such an insane level, a gradual normalization that is fairly innocuous for markets is virtually impossible to occur. What is more probable is a violent interest rate shock like we have never before seen; especially if we end up in an environment of stagflation that causes yields to jump by 100s of bps very quickly and destroys the global equity markets with catastrophic expediency. Speaking about the insanity of low yields, the Treasury Department recently stated the deficit grew 23% from October 2018 through June, for a total Fiscal ’19 Deficit of $747 billion with one quarter of the year still left. Annual deficits near $1 trillion are happening outside of a recession. During an economic contraction, deficits should surge towards $2.5-$3 trillion.

The global bond market suffers from a plethora of insolvent corporations and sovereigns that are issuing debt with yields that offer less than zero percent. The day of reckoning may not be imminent, but you must be fully prepared for its eventuality. It is possible to profit from it, but if you don’t anticipate its occurrence, the economic consequences will be severe.

But central banks and governments are unconcerned about these asset bubbles. Incredibly, they are printing and borrow more money. To this end, we should all be aware that the Fed no longer has a dual mandate consisting of stable prices and full employment. The Fed’s primary concern is to try and levitate asset bubbles. After all, Trump says this is the best economy ever and even members of the FOMC assent that underlying growth is very strong. The unemployment rate is at a record low, and the CPI for all items less food and energy rose 2.1 percent over the last 12 months. So, core inflation is over the Fed’s asinine target, and the jobs market is very strong at this time; initial unemployment claims are at a 50-year low.

Why then would Powell indicate during his latest testimony before congress that a rate-cutting cycle will begin later this month?  The truth is the economy is very fragile precisely because it has become 100% dependent upon perpetual asset bubbles. Powell became aware of this when stocks plunged in Q4 of last year and the Junk Bond market completely shut down. The truth is that Powell, and his merry band of counterfeiters, have become absolutely petrified about a recession because they know that it will implode the entire corporate bond market…turning an average run of the mill recession into a depression in short order.

Therefore, he will now run to the printing press at the slightest hint of a downturn. But the chances are high that a 25-basis point rate cut won’t be enough to bail out the global economy.  Nor will several more like it do the trick. It should take 100s of bps and a return to QE to push prices higher.

Are we supposed to believe that central banks are going to make this all ok by easing monetary policy further from here? After all, they have already forced $13 trillion worth of sovereign debt below zero, and the European Central Bank and the Bank of Japan already have negative rates and have been at that level for years. And the Fed only has 225bps of rate cuts available, when it usually has needed 500bps or more.

Perhaps central bankers can manage to force a few more drinks down the hatch in order to delay the inevitable hangover. But that just makes the eventual collapse all the more severe.

 

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.”

 

Will Fed Easing Turn Out Like ’95 or ‘07?

July 15, 2019

 You should completely understand that the market is dangerously overvalued and that global economic growth has slowed to a crawl along with S&P 500 earnings. However, you must also be wondering when the massive overhang of unprecedented debt levels, artificial market manipulations, and the anemic economy will finally shock Wall Street to a brutal reality.

Artificially-low bond yields are prolonging the life of this terminally-ill market. In fact, record-low borrowing costs have been the lynchpin for perpetuating the illusion. Therefore, what will finally pull the plug on this market’s life support system is spiking corporate bond yields, which will manifest from the bursting of the $5.4 trillion BBB, Junk bond and leveraged loan markets. And, for that to occur, you will first need an outright US recession and/or a bonafide inflation scare.

We already have a manufacturing recession abroad and a contraction in the US, as illustrated in the new orders data from the June the ISM report. Wall Street is now starting to understand that there will be virtually zero earnings growth for the S&P 500 for the entirety of 2019. However, what is holding up the high-yield market and, consequently, equity prices now is the view that the Fed’s new rate cutting path will allow this ersatz economy a bit of a reprieve by taking interest rates back to zero and thus suppressing junk-bond yields as well.

The answer to the question regarding when stock prices will crash back toward a fair valuation hinges upon whether or not the Fed’s return trip back to free money will be enough to levitate asset prices and the economy a bit longer. Therefore, you must determine if Jerome Powell’s quick retreat on monetary policy will be like the rate cutting exercise that occurred in 1995, or will it be more like the 2001 and 2007 FFR cutting cycle, which turned out to be far too late to save stocks.

Those three economic cycles all experienced a flat or inverted yield curve with rapidly decelerating economic growth; similar to what we find today. But unlike the relatively innocuous period of ’95, the ’01 & ’07 cycles proved that the rate cuts implemented were not nearly enough to avert a brutal stock market collapse.

Let’s look at a bit of history. After first having raised the Fed Fund Rate (FFR) by 300 bps leading up to the middle of the 1990s, the Fed then began cutting rates by February of 1995. It ended its three 25 bps rate cutting cycle by January 1996. The total amount of 75 bps of rate reductions were enough to not only steepen the yield curve and propel the economy out of its two-quarter growth recession but also launched the S&P 500 on an epoch five-year run of 140% by the year 2000. Of course, Wall Street would love for you to believe that Jerome Powell’s new-found dovishness will lead to a similar result.

In sharp contrast to what occurred nearly a quarter century ago, the Fed’s last two attempts to pull the economy out of a nose-dive ended in disaster.

The Fed began to raise interest rates in June of 1999 in an effort to put a damp cloth on the red-hot NASDAQ bubble. By May of 2000, it had undergone a total of 175 bps worth of rate hikes. Mr. Greenspan then began to lower rates in January of 2001 and finally ended his rate cutting cycle in June of 2003 after he reduced the FFR by a whopping 550 bps. Nevertheless, those rate cuts were not enough to save equity prices.  By the fall of 2002, Greenspan had already lowered the FFR by a total of 525 bps, but that didn’t stop the NASDAQ from losing 78% of its value by that time and for investors to see $5 trillion worth of their assets obliterated.

It was a similar situation regarding what occurred during the Great Recession. Chairs Greenspan and Bernanke collaborated to raise the FFR by 425 bps from June of 2003 thru June of 2006. Ben Bernanke then began cutting rates in September of 2007 with an oversized 50 bps reduction right off the bat. He then, in a rather aggressive manner, took rates to virtually zero percent by December of 2008. In other words, he slashed rates to a record low level and by a total of 525 bps, and it only took him one year and three months to do it! However, even that wasn’t enough to keep the stock and housing bubbles from crashing. By March of 2009, the Dow Jones had shed 54% of its value, and home prices plunged by 33%  on a national basis.

Again, this begs the crucial and salient question: will the hoped-for rate cutting cycle, which Jerome Powell indicated at his testimony before Congress on July 10th will probably begin on July 31st, be enough to keep the record equity bubble from imploding? Of course, nobody knows for sure, but there is a strategy to help us accurately model the answer.

First off, the rate cutting cycle in the mid-nineties was abetted by the massive productivity boom engendered by the advent of the internet. There is no such productivity phenomenon of commensurate capacity evident today. In addition, China was on the cusp of bringing 200 million of its population into the middle class by taking on $38 trillion in new debt. The building of that giant pile of debt was responsible for creating 1/3rd of global growth and cannot be duplicated again. Indeed, global growth today is careening towards the flat line rather than being on the cusp of a major expansion.

Not only this but the debt burden in 1995 pales in comparison to that of 2008 and 2019. Total Public and Private US debt as a percent of GDP was just 260% in 1995. However, by the year 2008, it had surged to 390% of GDP, and that figure still stands at 365% today. That is over 100 percentage points higher than it was in ’95.

Another comparison to view is the amount of overvaluation in the stock market between periods. In 1995 the total market cap of equities to GDP was around 70%. But by 2000, it shot up to 148% of GDP. That figure was 110% at the end of 2007 and has now climbed all the way back to 146% today.  The bottom line is the economy is much more fragile today than it was in 1995.

But perhaps even more important than the overvaluation of equities and the massive debt burden the economy must endure is the fact that the Fed could only raise the FFR to 2.25% before stocks began to falter during this last hiking cycle. Therefore, it can only cut rates nine times before returning to the zero-bound range. In each of the previous three rate-cutting cycles, the Fed had plenty of dry powder. In fact, in ’95 it had 600 bps, in 2000 it had 650 bps, and in 2008 it had 525 bps of rate cuts available to deploy.

Also, when looking at the effective number of rate hikes the Fed has engaged in during this latest tightening cycle, you get approximately the equivalent of 625 bps of hiking since 2014. This would include the wind-down of $85 billion in QE, 225 bps of nominal FFR hikes, and the $700 billion QT program – which for the first time in U.S. history saw a tremendous amount of base money destroyed. That amount of monetary tightening is absolutely extraordinary.

The unavoidable conclusion is that the efforts from Mr. Powell will not be nearly enough to thwart the market from its well-deserved day of reckoning.

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.”

Baoshang Bank Could Be China’s Indybank

June 17, 2019

For the first time in nearly 30 years, the Chinese central bank and the Banking Regulatory Commission announced it would take control of one of its banks. The troubled Mongolia-based Baoshang Bank had assets of 576 billion yuan ($84 billion), and its seizure is indicative of the deteriorating health of small-scale banks, mostly in rural areas and in smaller cities, as China’s economy slows.

The turmoil surrounding its conservatorship has led interbank lending rates to spike, forcing the Bank of China to inject billions of yuan to quell the fear of systemic contagion. For years China’s regional banks have used shadow-financing to obfuscate their exposure to precarious borrowers. While China has made an effort to rein in shadow-banking activity, this is the first time in decades that regulators have assumed control of a bank in this way. In 2015 and 2016, they recapitalized lenders and merged stronger banks with weaker ones, but these restructuring efforts were disorganized, inadequate, and didn’t address the main issue at hand…insolvency.

According to data compiled by Bloomberg, for the first four months of the year, companies defaulted on 39.2 billion yuan ($5.8 billion) of domestic bonds. This is 3.4 times the total for the same period during 2018.

With the solvency issues plaguing the smaller banks and the rise in defaults, it is becoming evident that funding needs for China’s major commercial banks are becoming intractable for Beijing. The PBOC is running low on the U.S. dollars it needs for activities both at home and abroad. In 2013, China’s four largest commercial banks had around $125 billion more worth of dollar assets than liabilities. But today they owe more dollars to creditors and customers than are owed to them.

Making things even worse for the Chinese banking system is that its problems extend beyond mainland China; there is a looming banking crisis in Hong Kong as well.

Hong Kong pegs its currency to the US dollar and therefore has been overaccommodative with their monetary policy since 2008. This has led to a massive bubble in real estate. Hayman Capital’s Kyle Bass believes Hong Kong is reminiscent of Iceland, Ireland, and Cyprus, whose banking systems imploded during the European banking crisis. The commonality was that each country had allowed their banking sectors to grow to almost 1,000% of GDP, leaving them vulnerable to the smallest economic hiccup. Bass believes that Hong Kong is in a similar situation with its banking system sitting as one of the most levered in the world at approximately “850% of GDP (with 280% of GDP being lent directly into mainland China)”.

Mainland China would be directly on the hook for Hong Kong’s failure as the two largest banks in that nation (Standard Chartered and HSBC) were once filled with British depositors, but now have mostly Chinese obligations.

China’s government has operated its economy much like a Ponzi scheme. It has been stimulating growth by printing money and issuing debt since the year 2000. This is much the same throughout the developed world. But this practice has been on steroids in since 2009. For example, M2 money supply in has skyrocketed by over 133 trillion Chinese Yuan, nearly $20 trillion during that timeframe. But during that same period, China’s annual GDP grew by approximately only $8.4 trillion—proving much of that debt issuance was of the non-productive variety. Therefore, it takes an ever-increasing supply of new money and debt to grow its economy and continue the economic charade.

China is in the midst of one of the largest financial bubbles in modern history. The ratio of banking assets to GDP is much higher than the US at the top of the housing bubble and higher than the EU right before its sovereign debt crisis in 2012.

Still, there are many in the market who believe that with the impressive $3.2 trillion pile of foreign exchange (FX) reserves held by China, nothing can go wrong. Those people should note that that figure was $4.0 trillion not long ago and is currently declining at a rate of $100 billion per month.

Kyle Bass notes that China needs $2.7 trillion of required minimum reserves just to keep trade functioning properly. Thus, making that FX safety cushion a lot narrower.

China is just now experiencing cracks in its banking system that will test their newly established deposit insurance system, making a run on the banks a real possibility. For the Chinese government to save the banks, it may have to destroy their currency in the process. As it stands right now, the yuan is getting close to breaking the all-important 7 per dollar key psychological level. If this level is indeed breached, you may see a massive flight of capital out of the Chinese yuan.

Therefore, the government is forced to continuously issue a massive amount of new currency and debt to keep the economic mirage in place. Yet, at the same time, must find a way to keep its currency afloat. This is the Achilles heel of China’s communist command and control economic model, and it is negatively affecting the yuan’s purchasing power. Consumer prices in May increased by the most in 15 months, while food inflation spiked 7.7% year over year.

Will the conservatorship of Baoshang bank be the event that finally unravels their banking system’s Potemkin Chinese Wall of solvency?  That still is not clear. But with each new iteration of stimulus, the yuan weakens–even against other currency manipulators like the Fed and ECB.

Very few investors thought back in July of 2008 that Indybank was the canary in the coal mine, which gave an advanced warning regarding the insolvency of much of the US financial system. At the time of the bank’s failure, FDIC Chair Sheila Bair assured markets not to worry and that its failure was well within the range of what they could handle. Fed Chair, Ben Bernanke, also gave assurances that the incipient subprime mortgage crisis was completely contained. It wouldn’t be until later that year when investors realized the full extent of the banking crisis that led to the conservatorship of Fannie Mae and Freddie Mac and the collapse of Lehman Brothers, the takeover of Washington Mutual in September of 2008–and, soon thereafter, the near collapse of the entire global economy.

Given that China’s total debt has quadrupled in the past twelve years, a feat that is absolutely unapparelled in history, it wouldn’t be surprising if the collapse of Baoshang Bank forebodes the same fate for China’s economy as Indybank did for the United States.

Fed Running Out of Time and Conventional Weapons

June 10, 2019

The buy and hold mantra from Wall Street Carnival Barkers should have died decades ago. After all, just buying stocks has gotten you absolutely crushed in China for more than a decade. And in Japan, you have been buried under an avalanche of losses for the last three decades. And even in the good old USA, you wouldn’t want to just own stocks if the economy was about to enter another deflationary recession/depression like 2008. Likewise, you wouldn’t want to own any bonds at all in a high-inflation environment as we had during the ’70s.

The truth is that the mainstream financial media is, for the most part, clueless and our Fed is blatantly feckless.

The Fed has gone from claiming in late 2018 that it would hike rates another four times, to now saying that it is open to actually start cutting rates very soon.

My friend John Rubino who runs the show at DollarCollapse.com recently noted: “bad debts are everywhere, from emerging market dollar-denominated bonds to Italian sovereign debt, Chinese shadow banks, US subprime auto loans, and US student loans. All are teetering on the edge.” I would add that the banking system of Europe is insolvent—look no further than Deutsche Bank with its massive derivatives book, which is the 15th largest bank in the world and 4th biggest in Europe. Its stock was trading at $150 pre-crisis, but it has now crashed to a record low $6.90 today. If this bank fails, look for it to take down multiple banks around the globe.

The US is in bad shape, and there is little doubt about it, but the nucleus of the next crisis does not have to emanate from America. I find it incredible that so many people ignore the “melting down nuclear reactors” around the world. China’s factory data shows that the nation’s manufacturing sector is now contracting. China’s National Bureau of Statistics released official manufacturing PMI for the month of May, which fell to 49.4 from 50.1 in April. South Korean GDP shrank in Q1 by 0.4%. In case you were not aware, South Korea and copper prices both have PhDs in the global economy. Copper for its use in construction and Korea for its production of semiconductors. Both are highly sensitive to economic activity, and both are crashing.

Here is one example as to why the Fed is so deathly afraid of a recession. Wisdom Tree and Factset did a study on Zombie companies. They are defined as those with current trailing 12-month interest expenses that exceed the average of the past three years of earnings before interest and taxes. That number is now just under 23%, which is much higher than the 13% rate that what was evident in 2007 just prior to the Great Recession.

To put this in perspective, nearly 1/4 of firms in the Russell 2000 don’t even make enough money to service their debt much less pay back the debt. As economic growth begins to slow sharply, interest rates on high yield debt will start to rise, and zombie companies will get shut out of the credit market. If they cannot service the debt, they go bankrupt and close the doors. As these companies lay off their workforce, the economy will slow further, and that will push junk bond yields higher. This will cause more companies to go belly up and increase the unemployment rolls creating a death spiral of debt defaults, rising unemployment and crashing junk bond prices (soaring yields). A recession/depression would be virtually guaranteed given the record amount of corporate debt– there’s $5.4T worth BBB, junk & leveraged loans outstanding compared to $1.5 trillion sub-prime mortgages in 2007.

This means the EPS on the S&P 500 may not be anywhere close to the ridiculous $186 projected for 2020. Don’t forget; S&P 500 earnings dropped by over 80% in the last recession. Crashing EPS will most definitely pop the equity bubble, and stock prices should fall more than 50%. There will also be a rising strain on government transfer payments (welfare, unemployment, food stamps), which will cause deficits to explode well north of $2 trillion per annum.

Now let’s discuss the yield curve. Yes, it does matter, and no, it’s not different this time. The spread that most matters in the world of the yield curve is the 10year minus Fed funds. This is because of something called negative carry. The current spread between the 10year and Fed Funds Rate is minus 30bps. If shadow banks were to borrow money overnight to invest in longer-duration assets, they would be losing money on each trade. Hence, they stop borrowing; causing money supply growth to dry up quickly. At that point, banks’ profits and the economy contract at a faster pace. In reality, it doesn’t matter why the curve inverts; the effect is the same. So don’t believe the perma-bulls when they tell you the curve has inverted for technical reasons and therefore it is different this time. It matters a lot– especially to the Fed.

The Fed funds futures market is now pricing in 3-4 rate cuts over the next 12 months. It is the market that tells the Fed when it is time to cut rates because of the inverted yield curve. The Fed’s comparable minuscule intellectual capacity has no possible ability to compete with the market’s collective wisdom about where the economy is heading. That’s why we don’t need a central bank at all, especially one that has inserted itself into markets to such a degree that it has now supplanted them entirely.

The salient question is will the coming rate cut(s) be enough to pull the US out of its march towards recession and does it also save China, Japan, Korea and the rest of the maimed global economies around the globe? And, does it also rescue the European banking system as well? The answer is no. What the global economy really needs to perpetuate the growth illusion is a resolution to all the trade wars, along with rate cuts and another massive QE to re-inflate faltering asset prices.

In conclusion, here is a recent a quote from Fed chair Powell, offering more evidence that the Fed– and every other central bank on the planet–are simply slaves to the stock market and headed firmly down the path towards creating a condition of global stagflation:

“Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future Effective Lower Bound (ELB) spells, which we hope will be rare.”

“ELB” spells are central bank speak for when rates are brought down to zero percent and stay there for a decade they will need to not openly go back into QE, but then even find new ways to get a massive amount of money directly into the hands of consumers.

Therefore, the Fed will be forced to once again try to bail out the economy and stock market later this year. However, it only has 225 bps of easing left before the ELB is reached. It is most probable that the Fed is already too late and also does not have enough conventional weapons to stave off a depression in markets and the economy. That is why before too long, we will have to deal with the unconventional weapons of Universal Basic Income, Helicopter Money, and Negative Nominal Interest Rates.

The chances of this leading to a viable solution to markets and the economy is less than the level of where the Fed Funds Rate will end up..which looks destined to be headed somewhere south of zero.

 

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.”

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.”

Some Predictions for 2019

January 7, 2019

Bond Yields Continue to Fall in First Half of Year

The epoch bond bubble continues to build and become a dagger over the worldwide economy and markets. Wall Street Shills are fond of claiming that global bond yields remain at historically low levels due to central bank manipulations, but this argument is no longer tenable. It was once true, but QE on a net global basis has now gone negative. And the data shows the amount of U.S. publicly traded debt relative to GDP is much greater today than it was prior to the start of the Great Recession—even after adjusted for the size of the Fed’s balance sheet–in other words, taking into account all the debt the Fed has purchased and is still rolling over.

The amount of publicly traded debt in the U.S. has soared to 58% of GDP. This is up from 29% in 2007 when the U.S. 10-year Note was yielding 5%. The Fed is now selling $50b of bonds each month, with an extra $7.8T in publicly traded debt that it doesn’t own; and that equates to nearly 2x the amount of debt compared to GDP than what existed just prior to the Great Recession. This debt must now be absorbed by the private market and at a fair market price, instead of just purchased mindlessly by the Fed…and yet yields are still falling. This means investors are piling into sovereign debt for safety ahead of the global economic crisis even though they understand that debt is, for the most part, insolvent.

Recession Begins Prior to Year’s End

The yield curve continues to invert and presages a recession that begins in late 2019. Meanwhile, the nucleus of the next credit crisis (the leveraged loan and junk bond markets) implode; as corporations need to roll over more than $800 billion of debt at much higher interest rates this year.

My Inflation/Deflation and Economic Cycle Model has 20 components. 19 out of 20 indicators are indicating we are about to enter into a recession. Only initial unemployment claims remain at a positive level. I believe GDP growth in Q1 2019 will have a one handle in front of it because the 2nd derivatives of growth and inflation are slowing significantly. Therefore, we are headed into sector 1 of my Inflation/Deflation and Growth Spectrum; where assets are falling sharply as the economy is deflating.

Trade War Truce

The Main Stream Financial Media will continue to obsess over Trump’s twitter account to find out if some U.S. trade delegation met with someone in China and had a nice conversation. And, if President Trump announces that General Tso’s chicken is his favorite meal.

Trump will end the trade war soon and claim that it was the biggest and greatest deal in human history. Hence, my prediction: the tariffs against China are lifted in Q1 2019. This is what all the perma-bulls are waiting for. But that isn’t going to bail out the market. A trade deal with Mexico was reached back on August 27th, but that didn’t stop its stock market from crashing 20%.

Debt and Deficits Soar Globally

Sovereign debt skyrockets at an even faster pace than the breakneck speed witnessed since the Great Recession. In this same vein, in the U.S. the federal budget deficit surged to a record for the month of November to reach a negative $204.9 billion. The Treasury Department says that the deficit for November was $66.4 billion higher than November of ’17. For the first 2 months of this fiscal year, the deficit totaled $305.4 billion, up 51.4% from the same period last year. Deficits this high outside of a recession are both highly unusual and dangerous.

My Prediction: the U.S. deficit for fiscal 2019 breaches far above $1 trillion; and this type of fiscal profligacy is replete throughout Asia, Europe and in emerging markets. Indeed, there isn’t a shred of prudence found pretty much anywhere in the world.

This massive increase of $70 trillion in debt since 2007, which adds up to $250 trillion globally, must now rely on the support of investors instead of the mindless and price insensitive purchases of central banks. Therefore, the potential for a 2012 European-style debt crisis occurring on a global basis is likely in 2019.

Equity Markets Go into Freefall

The U.S. stock market takes its most significant leg down since 2008 in the first half of the year. The economic data and earnings reports will be extremely negative in comparison to the first half of 2018. For instance, Q2 of last year reported GDP growth of 4.2%. However, it is very likely that Q1 of this year will have GDP growth of just around 1% and Q2 could come in negative.

The total value of the market could drop by 25% and still be at a valuation level that is equal to 100% of GDP. And that assumes GDP doesn’t drop. But at 100% of GDP the market would still be, historically speaking, about twice as overvalued as it was from 1974-1990. Hence, I predict the worst of the stock market is still very much in front of us. The Fed will continue its $50 billion per month of reverse QE—at least until the stock market drops another 20% from here. And, the ECB is now out of its massive €80 billion per month QE program. Therefore, despite the fact that the Fed goes on hold with further rate hikes, asset prices remain in peril–at least until the Fed is actually cutting interest rates and ends Quantitative Tightening.

D.C. Chaos

And finally, 2019 will be marked by a conflagration in our government. The year will be marred by budget showdowns and shutdowns, debt ceiling brinksmanship and indictments from Special Prosecutor Robert Mueller. Those hoping for cooperation between Democrats and Republicans on things such as a massive debt-funding infrastructure spending package to save the economy will be greatly disappointed. The cacophony between Democrats and Trump adds to the dysfunction in D.C. and puts added pressure on the market.

Concluding Prediction

The global bond bubble continues to slam into the reality of the end of central bank support. That is the salient issue concerning economies and markets worldwide. Household net worth (think real estate and equity portfolios) as a percent of GDP reached over 525% at the start of Q3 last year. According to Forbes, the average for that figure is 380% going back to 1951. The sad fact is that the “health” of the global economy (however uneven and biased against the lower and middle classes) has become completely reliant upon the perpetual state of these unprecedented asset bubbles. Therefore, as they implode they are taking the global economy down with it.

This process will only intensify throughout 20109. As former Fed Chair Alan Greenspan said recently, “run for cover”…he’s finally got it right.

Investors Still too Bullish

It’s been a wild ride on Wall Street lately. Major averages had hit their highs in late September. But if this sell-off continues, it will be Wall Street’s worst year since the financial crisis and the worst December since the Great Depression! This should have been enough to shake investor confidence. But judging from the data in the chart below, compiled by my friend Kevin Duffy of Bearing Asset Management and using data from Charles Schwab, we see that investors on both the retail and institutional level have a near-record low level of cash. They are anything but scared of this market.

This data was compiled on November 30, 2018, when cash levels registered just 11.2%. That was not up much from the low reading of 10.3% held on September 30th. The retail investors is, relatively speaking, all in.

And, analysts aren’t pulling in their horns either.

According to FactSet: Overall, there are 11,136 ratings on stocks in the S&P 500. Of these ratings from Wall Street analysts, 53.9% are Buy ratings, 40.8% are Hold, and just 5.3% are Sell ratings. Yet, with the mounting weight of evidence in favor of a sharp slowdown in global growth, it has not dissuaded analysts from still having ebullient forecast for earnings growth next year. Analysts are projecting S&P 500 EPS estimates for the Calendar year 2019, according to FactSet, to grow at 8.3% with revenue growth of 5.5%.

The global economy is showing signs of cracking now that QE has gone from $180 billion per month in 2017, to a negative number in 2019. That has sent the Emerging Markets into chaos and help lead European and Japanese economies into contraction.

And now China, which has been responsible for 1/3rd of global growth coming out of the Great Recession, is entering into a recession. Of course, having the government force an increase of debt to the tune of 2,000 percent since the year 2000 guarantees a crash of historic proportions. In fact, the government in Beijing is so concerned about the current debacle that it has banned the gathering of private economic data.

According to the South China Morning Post, China’s central government has ordered authorities in the Guangdong province – China’s main manufacturing hub–to stop producing a regional purchasing managers’ index. This means the province will not release the purchasing managers’ index (PMI) data for both October or November. Instead, all future purchasing managers’ indexes will be produced in-house by the National Bureau of Statistics.

It is evident that Beijing is trying to suppress the dissemination of economic data because its economy is growing at a much slower rate than what the communist party will admit to…that is, if it is growing at all. This is hindering its position in negotiations with the United States in the trade war. And it also reiterates the complete lack of transparency in the Chinese markets and the desire on the part of the Chinese government to keep the world in the dark about the true state of its economy.

Perhaps December’s continued debacle in global markets and economies was enough to begin pushing U.S. investors toward the exit–we will monitor this dynamic closely. However, history shows that it is a multi-month process to move investors’ psyche from euphoria to panic. This dynamic is still in its infancy.

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.”