November 15, 2024
Fiscal and monetary policy changes are what drive the data behind the 20 components in my IDEC Model. The election of DJT will most likely provide for significant fiscal and maybe even monetary policy changes. The political winds are behind lower taxes on corporations, reduced, if not the elimination of taxes on tips and S.S., huge tariffs on imported goods from China and a slightly reduced tally on the rest of the globe, massive reductions in business and banking deregulations, along with the potential deportation of millions of illegal immigrants. This is a prescription for higher growth and higher inflation. This has big implications for investors.
Let’s start with gold in the immediate term. Gold thrives in recessions and stagflations (in my IDEC Model, those are sectors 1,2 and 5). This is simply because those macroeconomic conditions offer less competition for gold, which is real money but one that offers no yield. Recessions cause nominal rates to fall, leading to weaker earnings for stocks, making gold more attractive. And stagflations lead to a drop in real interest rates. Therefore, holding gold, which maintains its purchasing power during inflation spikes, tends to do best when investors lose faith in the value of sovereign bonds and the currency they are expressed in. However, gold hates it when inflation and growth are both rising in tandem. Higher growth and inflation mean nominal and real rates are rising, which is more competition for gold. And, with rising growth, equities—which offer price appreciation and a dividend yield—provide a better alternative than an asset without a yield.
It took me decades to learn this. Gold can be a wonderful asset to hold in your portfolio. In 3 out of 5 sectors, it is mandatory to own and can outperform even stocks as it has done since 2000. However, and this is a big however, the long-term outlook for gold has never been better. In the coming years, the Fed will be forced to monetize multiple trillions of dollars in government debt. After all, the election of DJT does not eliminate the massive bubbles in credit, real estate, and equities. Their inevitable demise will lead to a recession/depression, sending debt and deficits to the thermosphere. This will force the Fed to warehouse a great deal of this debt on its balance sheet. Meaning, real interest rates will be falling along with a crash in the faith of our dollar and Treasury market. That is sector 5, where gold thrives the most.
Turning quickly to the Fed’s meeting last week, Chair Powell cut rates again on November 7th, This time by 25bps because borrowing costs are still in restrictive territory, according to FOMC. Jerome Powell was asked why he has now cut rates further after his 50bp cut last meeting, even after the election of Trump, which is presumed to be very stimulative to growth and inflation. Powell response to the reporter’s question was that the Fed doesn’t comment on fiscal policy. Ok, that may be true, but he failed to mention that the Fed enables fiscal policies to expand and the debt to GDP ratio to skyrocket by printing trillions of dollars to purchase publicly traded debt and then placing them in cold storage on its balance sheet. Thus taking Treasuries out of the free market and out of the realm of price discovery. Powell was directly asked about the future path of inflation in light of the election of Trump 2.0. After all, wouldn’t raising tariffs, lowering taxes, deregulating the economy, and having the king of debt and lover of a weaker dollar at the helm lead to more economic growth and tend towards increasing the money supply and inflation?
Powell’s answer was incredibly revealing about the ineptitude and sophistry of the Fed. He said that he can’t look into the future but will wait to see how the data plays out. There are huge problems with that plan. The data on jobs is backward-looking and inaccurate. He is driving the interest-rate vehicle with his feet on the steering wheel while looking at the rearview windshield. Hence, Powell is cutting the FFR when he should be at least standing firm on monetary policy, and by doing so, he is pouring gasoline on a potential inflation inferno, which could and should exert humungous upward pressure on long-term interest rates. This is the Achilles heel of the market and economy, much like what occurred leading up to the 1987 crash. Overvalued stocks, rising interest rates, and the fear that the Fed was behind the inflation curve caused stocks to plummet by 23% on October 19th, 1987. That cannot happen again today because the NYSE has circuit breakers that shut the market down if it drops 20% in one day. It also shuts trading down for 15-minute intervals when the market drops by 7% and then again by 13% intraday. Does that make you feel much better?
The election does not negate the existence of the triumvirate of asset bubbles. Target date funds and passive indexed investing have pushed the most amount of stock ownership to a record high and into just a handful of companies. Can you really blame investors? The Fed’s Put has been thoroughly inculcated throughout the decades. Whenever we had a recession or periods of market illiquidity the Fed has ridden to the rescue with trillions of monetary reserves. By the way, in October of 1987, the total market cap of equities as a percentage of GDP was 65%; today it is a staggering 205%! Interest rates are rising, and inflation is still a salient issue. One more important point about the coming bond market collapse, when bond yields soar due to inflation and insolvency issues, there isn’t a thing government can do to stop it. A government can only borrow and print more money, which will only exacerbate the dynamic already in play.
The most dangerous tactic you can have right now is to invest in the same manner as Mr. Powell is conducting monetary policy. That is, to make decisions without a model or strategy and void of any foresight whatsoever.
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.”