| August 30, 2024
While the long-anticipated recession still lies ahead of us, the fact remains that the US economy is anemic and getting weaker. Therefore, it is imperative to be aware of the reasons why those predicting any sort of economic rebound should be extremely disappointed and instead should be preparing for the inevitable collapse of asset prices and negative GDP growth. Most importantly, at the same time understand how to profit in these current macroeconomic conditions. The following are reasons why the soft-landing narrative has a very low probability of materializing. History proves an economy that is saddled with an onerous amount of debt cannot exhibit strong growth. The ratio of US total non-financial debt to GDP is at a record high level. As of Q1 2024, the amount of total non-financial debt to GDP was 260%. To put this tremendous figure into perspective, the ratio was 240% in the Great Recession of 2008. And, this crucial ratio was at a significantly lower level of 185% of GDP at the start of the NASDAQ implosion in 2000. The simple truth is that the total amount of government, corporate, business, and household debt as a percentage of the underlying economy has never been worse. The Index of Leading Economic Indicators predicts GDP growth with a zero percent handle in the current quarter and growth of just one percent during Q4. Even though that anemic pace of growth does not equate to a recession, it is a GDP rate of increase that will be far insufficient to produce the 15% EPS growth for S&P 500 corporations predicted for the coming year. The yield curve has been inverted for the longest duration in history. This indicator has been a near-perfect recession predictor since 1955. The one exception occurred back in 1965. There was no recession back then, but GDP growth absolutely plummeted from 10% to 0.2%, and the market fell by 20%. So, that really doesn’t count as an exception. Investors can ignore this indicator at their peril. The real Fed Funds Rate (FFR) level has been in positive territory for over a year. History shows that when the FFR is greater than CPI, a recession usually ensues as asset prices tumble. The Fed’s balance sheet is shrinking. Mr. Powell has overseen a decrease of $2 trillion dollars’ worth of Fed assets over the past two years. Previous attempts to reduce this base money supply have ended in the seizing up of money markets and produced an air pocket in stock prices. While many in the mainstream financial media love to extoll the virtues of consumers with rather healthy balance sheets, they fail to realize that inflation has already wiped out their purchasing power and standard of living. Therefore, while it is true that the household debt to GDP is 73% as of its latest reading, which is down from 98% at its peak in 2007—but for reference, still up from 69% in 2000—what you also must take into context is the ravaging effects of inflation. In other words, whereas debt service payments have fallen from 13.2% of disposable income from the peak during Q4 2007 to 9.7% today, inflation has eviscerated the balance of disposable incomes for most of the middle class. Consumers have a cash flow problem regardless of their inflated balance sheets, which are being exaggerated by ephemeral asset bubbles. Banks’ lending standards have tightened, so the fuel behind consumption (new credit creation) is waning. A great example of this dynamic is new mortgage demand. Lending to the housing sector is 9% lower now than a year ago. The reasons are clear: consumers are stretched, and real estate prices are at a record high. When the net percentage of banks tightening lending standards has increased in past cycles, recessions have usually been the result. It is also crucial to recognize that we have, for the first time in history, three asset bubbles existing concurrently: in equities, real estate, and credit. Hence, the economic foundation has never been more fragile. Of course, the Fed is aware of these facts and has already indicated that it is ready to ride to the rescue. Mr. Powell said last week that the time has come to start cutting interest rates. This is even though inflation is rising faster than his asinine 2% target and from a price level that has already severely injured the vast majority of consumers. Nevertheless, Wall Street is loudly banging the economic soft-landing drum and promulgating a new equity rally that will take stocks further into record valuation territory. However, history gives us a bit of a pause on that cacophonous drum beat. The Fed started cutting interest rates in December of 2000. Three months later, a recession ensued. And by the time it was over, the S&P 500 lost 50% of its value and the NASDAQ plunged by 80%. Fast forward a few years later, and we find that the Fed started cutting rates in July of 2007 after it managed to sniff out some trouble in the housing market, which we were told at the time would end up being a non-event that is totally contained within a relatively few sub-prime mortgages. But just six months later, the Global Financial Crisis began where the S&P 500 would once again lose half of its value and home prices took a 33% drubbing. Powell’s well-promulgated handful of rate cuts coming over the next few months should not bring about a panacea. In contrast, the history behind such pivots usually leads to chaos. Our Inflation/Deflation and Economic Cycle Model has us squarely in the disinflation camp and on high alert for the deflationary recession to begin. The yield curve is just about to steepen back into positive territory, which usually means a recession should begin within 3-6 months. The reason behind this recession obsession is because that is when equities plunge by 35% or more. Let’s end with this bit of information: According to data compiled by my friend John Rubino, the value of stocks, homes, and oil have gone nowhere when pricing those assets in terms of gold. And, even GDP is lower today than it was when Nixon broke the gold window in 1971 in terms of AU, which was no longer artificially pegged to a government-fixed price. In other words, when using an accurate measurement of the dollar’s depreciation debacle, as only gold can do, the organic increase of asset prices and GDP growth look far less impressive. In truth, oil, equities, real estate, and the economy have, at best merely managed to keep pace with the actual rate of inflation over the past 53 years—not the massaged CPI figure published by the BLS. The illusion of appreciation comes from a depreciating dollar, which is backed primarily by the Fed’s printing press. As Mr. Rubino puts it himself: “What a difference a single policy decision can make. Had the US just gotten its act together in the 1970s and maintained sound money, today we’d be buying stocks for their 2% dividend yield rather than betting our life savings on never-ending boom/bust cycles. We (and more important, our kids) would be living in affordable houses. We’d have no trouble filling the gas tank to get to work. And the Aristocracy wouldn’t be feasting on the peasants and shredding the fabric of society.” To that I shout a loud Amen! 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.” |