Commentary

The Demand Shock of 2022

October 11, 2021

 Investors are growing cautious as we approach the fourth quarter, and their trepidation is justified. Here’s a brief summary of the situation: there is a potential global financial crisis stemming from the Chinese property market meltdown, supply chain bottlenecks are growing worse, Q3 Earnings warnings are being reported from many large corporations, interest rates are rising, inflation is at a 40-year high, tax hikes are coming in ’22, and the threat of a U.S. debt default still hangs in the air until the end of November.

The macroeconomic situation today is one of stagflation. Meaning, inflation rates are higher than normal at the same time GDP growth is slowing. To this point, the data shows that 6.2 million people lost their benefits in the week of September 11th, as most government pandemic unemployment relief programs expired. These people all need to find a job, and quickly, to supplant that huge government weekly stipend that is now gone. Instead, we find that weekly layoffs are consistently higher than any other time since before the pandemic all the way back through 2015. And, we see that only 194k net new jobs were added during the month of September.

Capital Economics has this to say about the situation:

“with the labor force still three million individuals lower than it was in February 2020, and surveys suggesting that the number who don’t want a job is increasing, it’s looking more and more likely that labor supply has suffered a permanent hit from the pandemic.”

We also note that the Q3 GDP growth estimate from the highly accurate Atlanta fed plunged to just 1.3%, from the 6.7% pace of growth recorded by the BEA during Q2.

So, it is stagflation for now; but deflation is just a few quarters away because there is a demand shock set to occur stemming from plunging asset prices. The stock market’s recent volatility can be likened to a typical pothole in the pavement. However, a huge crater has formed just down the road. The perfect storm for the stock market and economy is in full development and should hit the U.S. by the second quarter of next year.

Here are a few more details on what we are facing very soon. We have the baneful conditions of higher taxes coming next year on capital creators and its formation, higher interest rates, and higher inflation than what has been witnessed for the past few decades. Not only this, but we have the world’s second-biggest economy (China) that has seen its economic growth derailed by the collapse of its real estate bubble, which has been the very foundation of its growth for the past 20 years. In fact, China’s factory output fell into contraction in September, indicating the economy is already faltering. Then, you add in the dysfunction in D.C., which is unable to agree on another massive fiscal stimulus package. Meaning, government deficit spending, which was 18% of GDP ($3.7 trillion) in 2020, and 16% of GDP ($3.1 trillion) in 2021, will plunge to a still awful, but just about 5% of GDP ($1.2 trillion) in 2022, according to the non-partisan CBO.

Of course, it should be abundantly clear that monetizing huge government deficits actually harms economic growth in the long term. However, printing a massive amount of new money and handing it directly to consumers and businesses does, in the short term, cause an economic adrenalin rush to occur. The payback from that will be acutely felt next year.

Hence, the biggest fiscal cliff since the end of WWII will hit GDP at the very same time the Fed will be forced to tighten monetary policy due to the highest rates of inflation in the past 40 years–leading to the biggest monetary cliff on record. Namely, our central bank has printed $4.4 trillion (an average of $250 billion worth of new money creation each month) over the past 18 months. But Mr. Powell has already indicated the Fed should be printing zero new dollars by the middle of next year, which will set the table for rate hikes towards the end of ‘22. All of these things will collide into the most overvalued stock market in history–and by a humongous margin. The total market cap of equities as a percentage of GDP is 200% today, while the average is 80%. And, the previous peak was 140%, which was reached at the apex of the Great NASDAQ bubble in 2000. As a reminder, from that level the S&P lost 50% and tech stocks plunged by 80% from 2000-2002.

So, for now, it is just an ordinary and pedestrian decline for the stock market to endure that will be marked by extreme volatility in both directions. However, investors should prepare to short high beta stocks and junk bonds when the timing is appropriate. Buckle up; another crash is coming. The question is, will investors continue to abide in the 60/40 stock and bond portfolio if equities are plunging and the bond ballast is broken? Or, will they be prepared to dynamically adjust their portfolios to protect and profit from the great reconciliation of fixed income and equity prices that lies just ahead?

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 Great Deflation of 2022

August 30, 2021

 It is not very surprising to me that nearly every talking head on Wall Street is convinced inflation has now become entrenched as a permanent feature in the U.S. economy. This is because most mainstream economists have no clue what is the progenitor of inflation. They have been inculcated to believe inflation is the result of a wage-price spiral caused by a low rate of unemployment.

In truth, inflation is all about the destruction of confidence in a fiat currency’s purchasing power. And there is no better way to do that than for the government to massively increase the supply of money and place it directly into the hands of its citizenry. That is exactly what occurred in the wake of the global COVID-19 pandemic. The U.S. government handed out the equivalent of $50,000 to every American family in various forms of loans, grants, stimulus checks, enhanced unemployment, tax rebates, and debt forbearance measures. In other words, helicopter money and Modern Monetary Theory (MMT) were deployed—and in a big way. The result was the largest increase of inflation in 40 years.

We’ve had some of the highest GDP growth rates in U.S. history over the past few months and the greatest increase in monetary largess since the creation of the Fed. But this is mostly all in the rearview mirror now. Consumer Price Inflation is all about the handing of money directly to consumers that has been monetized by the Fed. It is not so much about low-interest rates and Quantitative Easings—that is more of an inflation phenomenon for Wall Street and the very wealthy.

The idea that Consumer Price Inflation is now a permanent issue is not grounded in science. As already mentioned, inflation comes from a rapid and sustained increase in the broad money supply, which causes falling confidence in the purchasing power of a currency. At least for now, that function is attenuating.

After all, what exactly is there about a global pandemic that would cause inflation to become a more permanent issue in the U.S. economy? In the 11 years leading up to the pandemic, inflation was not a daunting issue—it was contained within the canyons of Wall Street. In fact, the Fed was extremely concerned the rate of Consumer Price Inflation was too low. And, that the economy was in peril of falling into some kind of deflationary death spiral. This is despite ultra-low borrowing costs and money printing from the Fed.

The proof is in the data. The Effective Fed Funds Rate was below one percent from October of 2008 thru June of 2017. The Fed was also engaged in QE’s 1,2, & 3 from December 2008 thru October 2014. And yet, here are the average 12-month changes in CPI for each of the given years:

2009 = -0.3%

2010 = 1.6%

2011 = 3.2%

2012 = 2.1%

2013 = 1.5%

2014 = 1.6%

2015 = 0.1%

2016 = 1.3%

2017 = 2.1%

2018 = 2.4%

2019 = 1.8%

 

This means, in the 11 years following the start of the Great Recession, all the way through the start of the Global Pandemic, consumer price inflation was quiescent despite the prevailing conditions of zero interest rates and quantitative easings. However, consumer price inflation began to skyrocket by the second quarter of 2021. In fact, it has averaged nearly 5% over the past four months. What caused the trenchant change? It was The 6 trillion dollars’ worth of helicopter money that was dumped on top of consumers’ heads. Regular QE just creates asset price inflation for the primary benefit of big banks and Wall Street.

But, the helicopters have now been grounded for consumers and soon will be hitting the tarmac for Wall Street once the Fed’s tapering commences this winter. Hence, CPI is about to come crashing down, just as is the growth in the money supply. M2 money supply surged by 27% in February 2021 from the year-ago period. But, in June of this year, that growth was just 0.8% month over month, or down to just 12% year-on-year.

The Government Lifeline is Being Cut

The highly-followed and well-regarded University of Michigan Consumer Sentiment Index tumbled to 70.2 in its preliminary August reading. That is down more than 13% from July’s number of 81.2. And below the April 2020 mark of 71.8, which was the lowest data point in the pandemic era. According to Richard Curtin, Chief economist for the University of Michigan’s survey, “Over the past half-century, the Sentiment Index has only recorded larger losses in six other surveys, all connected to sudden negative changes in the economy.”

Of course, a part of this miserable reading on consumer confidence has to do with falling real wages. But I believe the lion’s share of their dour view is based on the elimination of government forbearance measures on mortgages, along with the termination of helicopter money drops from the government. All told, this amounted to $6 trillion worth of bread and circuses handed out to consumers over the past 18 months. This massive government lifeline (equal to 25% of GDP) will be pared down to just 2% of GDP in ’22.

Indeed, this function is already showing up in consumer spending. Retail sales for the month of July fell 1.1%, worse than the Dow Jones estimate of a 0.3% decline. The reduced consumption was a direct result of a lack of new stimulus checks handed out from D.C. Keep in mind that retail sales are reported as s a nominal figure; they are not adjusted for inflation. Hence, since nominal retail sales are falling sharply—at least for the month-over-month period–the economy must now be faltering because we know prices have yet to recede, and yet nominal sales are still declining. This notion is being backed up by applications to purchase a new home, which are down nearly 20% from last year. That doesn’t fit Wall Street’s narrative of a reopening economy that is experiencing strong economic growth and much higher rates of inflation.

On top of all this you can add the following to the deflation and slow-growth condition: Federal pandemic-related stimulus caused a huge spike in the number of Americans that owed no federal income tax. According to the Tax Policy Center, 107 million households owed no income taxes in 2020, up from 76 million in 2019. So, multiple millions more Americans should now have to resume paying Federal income taxes this year because last year’s tax holiday has now expired.

Oh, and by the way, the erstwhile engine of global economic growth (China) is now blown. China’s huge stimulus package in the wake of the Great Recession helped pull the global economy out of its malaise. This debt-disabled nation is now unable to repeat that same trick again.

Back to the U.S., the Fed facilitated Washington’s unprecedented largess by printing over $4.1 trillion since the outbreak of COVID-19—doubling the size of its balance sheet in 18 months, from what took 107 years to first accumulate.

But all that is ending now. Next year has the potential to be known as the Great Deflation of 2022. This will be engendered by the epiphany that COVID-19 and its mutations have not been vanquished as falsely advertised, the massive $6 trillion fiscal cliff will be in freefall, and the Fed’s tapering of $1.44 trillion per annum of QE down to $0, will be in process.

Then, the economy will be left with a large number of permanently unemployed people and businesses that have permanently closed their doors. And, the $7.7 trillion worth of unproductive debt incurred during the five quarters from the start of 2020, until Q1 of this year, which the economy must now lug around.

All this should lead to a stock market that plunges from unprecedentedly high valuations starting next year. And, in the end, that is anything but inflationary. Indeed, what it should lead to is more like a deflationary depression. But the story doesn’t end there. Unfortunately, that will cause government to change Modern Monetary Theory from just a theory to a new mandate for the central bank. And hence, the inflation-deflation, boom-bust cycle will continue…but with greater intensity. The challenge for investors is to be on the correct side of that trade.

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.”

 

Happy 50th Anniversary Gold

 Happy 50th Anniversary Gold

August 23rd 2021

 Friday the 13th of August 1971 was a very important date in U.S. history. It was the date that set the table for the beginning of the end of the USD’s world reserve currency status. And, greatly expedited the road to perdition for the dollar’s purchasing power.

That means this past Friday was the 50-year anniversary of President Nixon’s absolute termination of the dollar’s ability to be redeemed for gold. Therefore, I thought it would be a good idea to review gold’s performance since that time against some popular investments—especially since the MSFM took this same opportunity to impugn this most precious of metals—as they are always prone to do. And, to also once again explain what really drives the gold market.

Here’s a good example of what the media is saying about gold right now: “Nobody wants your rocks, right? I mean, the gold bugs have come up with every story under the sun as to why gold should go up, and it doesn’t,” that’s according to one J.C. Parets, Allstarcharts.com founder and chief strategist, in an interview with Yahoo Finance. He continued: “In fact, over the last year, you’d be hard-pressed to find a worse investment over the last year [than] gold.” Joining Yahoo in the poo-poo parade for gold, Bloomberg and the Wall Street Journal ran comparisons between gold and the S&P 500 since 1971–both before and after dividends are factored in. According to the reports, gold beat the nominal return of the benchmark Index but trailed once dividends are factored into the picture. Their conclusions: gold is not a great short-term hedge against inflation, and stocks offer far better protection from a rising Consumer Price Index.

Here’s my take: I’ve said many times before that while I might be a gold bug at heart, there are times when gold can also rip your heart right out. However, the truth is that gold is great hedge against inflation over the long run; but it does even better if you actively manage your allocation weighting.

When looked at with a less biased eye than Wall Street’s, there are some salient conclusions that can be drawn from the performance of gold since the Fed broke the gold window in 1971. Gold has not only kept pace with the return on the S&P 500 (before inclusive of reinvested dividends) but has actually beaten intermediate-term bonds over the past five decades. So no, it hasn’t become the worthless rock that Wall Street and the Bitcon crowd would like you to believe. Also, there are intervals and cycles when gold vastly outperforms and underperforms the market. Hence, while it is true that gold can be a very profitable investment, it is also true you should actively manage your allocation to PM to hopefully avoid the huge drawdowns that take place.

Some more facts you should know: The July reading on CPI had it rising at 5.4% and the PPI soaring 7.8% Y/Y. That’s the highest U.S. consumer price inflation in nearly 40 years and the highest producer prices on record. However, the dollar price of gold is actually down over 6% this year and down about 10% over the past 12 months. And the miners, as represented by GDX, have shed nearly 14% this year and are down 25% y/y. So, why is this most-beloved inflation hedge performing so badly of late? That is because the price of gold depends mostly on the direction of real interest rates. Real rates had been rising in the first two quarters of this year, forcing gold lower. However, the direction of real interest rates has begun to fall during Q3. I believe this process should intensify next year. Falling nominal and real rates next year should provide the gold market with a strong rebound, especially after the tapering of QE begins.

But what all this proves is that Wall Street is not only biased against gold but hopelessly ignorant as to the real function of the precious metal. It is crucial to understand that gold isn’t really an investment, like stocks or bonds. It doesn’t grow its earnings, or pay dividends, or even offer any interest like fixed income. Gold mining stocks are investments, but the metal itself is not. Gold is a competing currency that must be measured against the return on cash. It offers a viable replacement for dollars that exist in a completely liquid savings or checking account or short-term Treasuries. In other words, the performance of gold is most accurately measured when compared with the returns on holding cash or cash equivalents. Gold should not be compared with stocks or long-duration bonds. However, gold can still very favorably compete with those investments, especially during times of stagflation.

When nominal interest rates are being capped by central bank money printing, the rate of inflation tends to rise, and economic growth tends to falter. That’s called stagflation (a combination of slowing economic growth and rising inflation), which is the best environment for gold.

Even though gold is not technically an investment (investments are meant to provide a real, after-tax return on your money), it is the best form of money humans have ever found. And, despite gold being the best place to park your wealth to maintain its purchasing power, it still has a 50-year history of being very competitive with bonds and stocks—even though that comparison isn’t a fair one.

Of course, when compared with the Fed’s crappy currency, gold shines brighter than a supernova. For proof of this fact, it took just 35 dollars to buy an ounce of gold in 1971; but today, it takes about $1,800. Sadly, since 1913 the dollar has lost 96% of its purchasing power. Hence, you must evaluate gold in a fair and honest fashion. When doing that, gold proves its value over many millennia. No fiat currency can do that. In fact, all eventually have gone to zero.

Testing a theory in an objective and unbiased fashion is the only way to arrive at the truth. Gold isn’t an investment but still beats U.S. government bonds and the S&P 500 prior to dividends.  And, it trounces the performance of all fiat currencies. Indeed, gold is a great store of value that has proven effective to maintain your standard of living for thousands of years. Knowing how to trade gold can make it even more precious.

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.”

 

Fed: Murderer of Markets and the Middle Class

July 26th 2021

 The Fed’s manipulation of the money supply and its cost has served to obliterate the function of asset price discovery, just as it has also caused the middle and lower classes to reduce their standard of living. Since a greater percentage of their falling real incomes goes to the purchase of food and energy–the things most effected by money printing–the wealth gap, which the fed avows to care about, has become greatly exacerbated.

After foolishly and desperately pursuing inflation many years, the dog finally caught the truck. But predictably, the freedom killers at the FOMC are coming to realize inflation is easily tractable on both ends of the spectrum. Its asinine 2% inflation goal was meant to be a ceiling when first proposed; but was underachieved for many years. However, that level has now been transcended by leaps and bounds. The evil inflation genie was released out of the bottle and putting it back in will entail destroying the stock market and economy as a direct consequence. In other words, it took trillions upon trillions of helicopter dollars to get inflation and asset prices where they are today. And unless the Treasury and Fed assent to doing that same thing on a more consistent basis, asset prices and the economy should succumb to a deflationary meltdown next year. A Pyrrhic victory over inflation is the best we can hope for.

On a slightly brighter note, James Bullard, President of the Saint Louis Fed, is now conveying a rare bit of sanity from the odious organization he represents. He conveyed in a recent Bloomberg interview that the time to taper the fed’s asset purchases is now. Most importantly, he went on to say that the fed no longer has the luxury of tapering its QE program in a pre-determined timeline, as Ben Bernanke laid out in the first Taper back in 2013. Bullard said the fed must have flexibility this time around. But the Fed President emphasized that this is not because of the fear that he might unwind purchases too quickly. But rather, because of the fear that inflation is running so hot that the fed must have the ability to end its bond purchases sooner.

However, this is where the wisdom of Mr. Bullard unfortunately ends. He said he expects GDP growth to be stronger in the next few years than it was prior to the pandemic. This assumption was based primarily on hope; and no specific reason was offered to support this view other than some amorphic blather about technological improvements that have supposedly been made over the past two years—really? In contrast, any potential economic growth has been severely encumbered by inflationary pressures, much bigger and more unstable asset bubbles and a humongous increase in the debt load.

To this point, Total non-financial debt has skyrocketed from $54.3 trillion, at the start of the pandemic, to $62 trillion as of the end of Q1 2021, according to the latest data available from the Flow of Funds Report. That is a $7.7 trillion increase in the past 5 quarters. To put this in context, in the 5 quarters leading up to the pandemic, Total Non-financial Debt increased by just $2.9 trillion. Which was, by the way, already an incredibly onerous increase in new debt that was being piled on to an economy that was already debt disabled. It is an immutable economic law that debt is a tax on future growth, as it deprives the economy of crucial capital investments, just as it also chokes off consumption.

In the last year and a half, the fed’s balance sheet has skyrocket by $4.1 trillion. This means from the creation of the Federal Reserve back in 1913, all the way through to the start of 2020, the fed’s balance sheet grew to $4.1 trillion. Incredibly, it has now skyrocketed to $8.2 trillion. Meaning the fed took 18 months to permanently print what it formerly took 107 years monetize. However, sometime during 2022 the fed’s balance sheet will stop growing once Mr. Powell ends QE. Hence, the amount of newly created money that will be flowing into the markets will go from a $4.1 trillion pace to $0. Also, in the last year and a half the government dumped $6 trillion of fiscal stimulus into the economy. In 2022 that number will crash from 25% of GDP, to just 2% of GDP–in other words, just a few hundred billion dollars. Also, investors should not ignore the mutations of COVID-19 that are already causing governments to put on new restrictions and shutting down parts of the globe. If anybody thinks the stock market will be unaffected by all this, they are either lying to you or ignorant about what drives stock prices.

You just cannot have the stock market trading at more than 2x underlying US GDP unless something very unusual is going on. Either the economy is growing at warp speed, or the fed’s balance sheet must be booming in similar fashion in order to justify these equity market valuations. The problem is you will have none of it come next year.

I think this quote from my friend John Rubino of DollarCollapse.com sums up the precarious position central banks have placed the equity market in perfectly: “But hey, working into one’s 70s while loading up on volatile assets like stocks is just the price we have to pay so the big banks and their favored customers make enough money to finance incumbent politicians’ re-election campaigns. See, the system works!”

My follow up quote is as follows: The soul of America has been sold out to deep-state war mongers, race-baiting politicians, Wall Street avarice and arrogant-anti-capitalist central bankers. May God help us through this current turmoil and the chaos that is to come.

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.”

Peak of the Fake Bull Market

July 12th 2021

We are probably very close to the peak of this ersatz bull market and economy. Peak vaccination distribution, along with the peak optimism about the vanquished pandemic and the re-opening of the economy. U.S. corporations are experiencing peak profit margins. The economy has enjoyed peak fiscal and monetary stimulus and those tailwinds will soon become strong headwinds. Also, peak tax relief is now in the rear-view mirror; and higher taxes are around the corner. Finally, peak asset valuations have arrived and the associated wealth effect is now waning.

Confirming this view is a series of slowing economic data–a reduction in the rate of change in growth and inflation. For now, this is not a crisis or a recession; but is set to become one next year.  Here are some facts and data:

Personal income decreased $414.3 billion (2.0 percent) in May, according to the Bureau of Economic Analysis. Personal consumption expenditures were virtually unchanged. Despite the fact that job openings are at an all-time high, at the same time, initial jobless claims are running at a level that is 75% above/higher than the pre-pandemic level. This begs the question: why is the US laying off people at a rate that is three quarters greater than before COVID-19, despite the fact that the economy has reopened? After all, the pandemic crisis is now a year and a half old; shouldn’t layoffs be almost non-existent?

The U.S. international trade deficit in goods widened 2.8% to $88.1 billion in May. The current account deficit, a broader trade measure that includes earnings on investments, widened to a 14-year high in the first quarter. What this means is that the US economy is not really booming at all, it is just taking newly minted dollars and buying things that are made overseas. What we have is peak consumption of things that aren’t made in the USA. Hence, there is not a condition of sustainable and robust GDP growth.

And, even the once-mighty housing market is starting to cool down sharply. Mortgage applications to purchase a home were 17% lower than the same week ending June 25th one year ago. The reason: home prices have risen to the highest level ever—up 14.6% y/y; and are becoming more and more unaffordable relative to incomes, while the cost to take out a loan has increased.

What all this means is that the stock market has reached a point that is in peak danger of a crash. This condition is virtually unavoidable given that the boom was completely artificial and thus unsustainable. In fact, the economy in an even more fragile state than it was prior to the pandemic. However, and this is crucial, even though chaos is coming, the timing for it to start is not at this moment. We need to be vigilant for a recession and/or credit crisis because that will be the catalyst for the 30-80% plunge to begin. This is what my 20-point IDEC model is designed to predict.

There now exists the greatest amount of margin debt on record, both in nominal terms and percentage of GDP terms. The numbers are $812 billion, which is nearly 4% of GDP. Also, passively managed funds now account for nearly half of all mutual fund and ETF assets. Up from just 14% in 2005. This means investors are just blindly piling into funds that mirror the averages. Hence, when the next bear market arrives, the market will go no bid as a result of the massive liquidations of these funds that occur simultaneously. This will force these same funds to sell the underlying securities to meet redemptions, which will in turn cause more passive holders to panic out of these funds.

Avoiding huge draw-downs in your investment portfolio is absolutely mandatory. According to NED Davis research, since 1960, the average time for the S&P 500 to recover from a 20% correction is 3 years. But a 20% correction isn’t the real risk. As already indicated, the more likely danger is a 50%+ plunge. That is how much the market would have to drop just to get back to fair value, according to the most relevant metric total market cap of equities to GDP. Hence, the greatest opportunity to make money in this market should be to short it.

The catalyst will be the same as what caused the downdrafts in 2000, 2008, 2018, & 2019: The Fed believes its own hype and begins to remove the monetary stimulus in the hope the economy has recovered. However, what the fed doesn’t understand, or refuses to acknowledge, is its massive manipulation of interest rates has caused the level of debt and asset prices to skyrocket far beyond the support of the free market, which places the economy in a much more dangerous position. Therefore, an innocuous removal of its falsified stimulus is impossible.

Bottom line: the bull market is ending because the fed is set to kill it. The process may be slow to evolve because the Mr. Powell probably won’t start tapering until the end of this year. However, once the process is in full gear, the reality check should begin.

 

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.”

 

 

 

 

How Central Banks Murdered the Markets

June 28th 2021

The Japanese Government Bond market is nearly $10 trillion in size. It is the 2nd biggest bond market in the world. However, it comes as a shock that this humongous market barely trades any longer.

The government of Japan has systematically supplanted and killed the entire private market for its bonds. Meaning, there are almost no private investors who will touch it any more. The Bank of Japan has bought so much debt that it forced interest rates below zero percent back in 2016; and the result is the free market has subsequently died.

Investors are now refusing to buy JGBs, which are guaranteed to lose principal in nominal terms—and deeply negative results after adjusting for inflation. But at the same time, are not in any hurry to sell their existing holdings because they understand the government will be propping up bond prices.

In this same vein, the 5-year greek yield recently turned negative. This is prima facie evidence that centrals banks have committed murder-one when it comes to markets. Back in February of 2012, at the height of the European debt crisis, the Greek 5-year Bond Yield skyrocketed to 63%. The free-market deemed the nation to be insolvent and that it could never pay back its debt without returning to the Drachma; and then turning it into confetti. Hence, bond yields surged—makes perfect sense, correct? Also in 2012, the Greek National debt to GDP ratio was 160%. Today, that ratio has soared to an all-time record high of 210%; and yet, these bonds display a negative cash flow going out 5 years in duration. Only one thing has changed: central banks deemed it mandatory to step in and replace the entire demand for government debt in order to force interest rates towards zero percent. It is the only way these countries would have any semblance of solvency.

Sadly, the U.S. is headed in this exact same direction as Greece and Japan. And, that is why we can be certain central banks’ monetary tightening cycles can’t last for very long and will end in disaster–as per usual. In fact, Mr. Powell will probably torpedo markets before he is able to end his current historic and massive QE program.

If you want to know how fragile markets really are, just look at the 2.5% selloff during the week surrounding Powell’s June FOMC press conference. The fed hasn’t started to end QE yet. In fact, it hasn’t even set a date to start the taper. All the fed’s money printers have done is admit that they have begun to discuss when to think about a time for the start of tapering $120b per month in asset purchases.

Now let’s talk about the gold market because it is related to what this commentary is all about.

We issued a warning on gold back in Sept of 2020 because of what we termed “the vaccine dead zone” was approaching, which would cause real interest rates to soar. That is exactly what occurred. Gold dropped by 20% from August ’20, thru April ‘21. Now the Fed has admitted that it has begun to talk about ending QE. But this is not the start of another bear market in gold. Instead, it is most likely the end of the bear market and the incipient beginnings of a massive bull market. Why? because of what I pointed out at the start of this commentary. The fed can’t remove very much liquidity from the system before chaos reigns on Wall Street.

The simple truth is, asset values and debt levels have grown to become such enormous monstrosities that they prohibit the tightening of monetary policy much at all before the entire fragile and artificial edifice collapses.

Right now, my 20-point Inflation/Deflation and Economic Cycle model indicates there is still some room to run on this bull market. This is what prevents us from panicking out of stocks prematurely, as some are prone to do. However, the time for a massive reconciliation of asset prices is growing close.

Wall Street’s favorite mantra post the Financial Crisis was: either the economy improves enough to boost earnings and the market, or the Fed will keep printing money in order to support stocks and engender a perpetual bull market. Now, as a result of the Fed’s “success” with creating runaway inflation, the exact opposite calculation is now true: either the economy soon slows down significantly enough on its own, which will depress EPS & inflation, or the Fed will tighten monetary policy until inflation is tamed, which will cause asset bubbles to collapse.

Central banks have destroyed price discovery across the board. As these maniac money printers begin to exit their market manipulations, the free market will demand much lower asset prices. The challenge for investors is to actively manage your portfolio in order to maintain—or perhaps even increase–your standard of living, in spite of the carnage that is set to occur on Wall Street and Main Street.

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 Japanese Government Bond market is nearly $10 trillion in size. It is the 2nd biggest bond market in the world. However, it comes as a shock that this humongous market barely trades any longer.

The government of Japan has systematically supplanted and killed the entire private market for its bonds. Meaning, there are almost no private investors who will touch it any more. The Bank of Japan has bought so much debt that it forced interest rates below zero percent back in 2016; and the result is the free market has subsequently died.

Investors are now refusing to buy JGBs, which are guaranteed to lose principal in nominal terms—and deeply negative results after adjusting for inflation. But at the same time, are not in any hurry to sell their existing holdings because they understand the government will be propping up bond prices.

In this same vein, the 5-year greek yield recently turned negative. This is prima facie evidence that centrals banks have committed murder-one when it comes to markets. Back in February of 2012, at the height of the European debt crisis, the Greek 5-year Bond Yield skyrocketed to 63%. The free-market deemed the nation to be insolvent and that it could never pay back its debt without returning to the Drachma; and then turning it into confetti. Hence, bond yields surged—makes perfect sense, correct? Also in 2012, the Greek National debt to GDP ratio was 160%. Today, that ratio has soared to an all-time record high of 210%; and yet, these bonds display a negative cash flow going out 5 years in duration. Only one thing has changed: central banks deemed it mandatory to step in and replace the entire demand for government debt in order to force interest rates towards zero percent. It is the only way these countries would have any semblance of solvency.

Sadly, the U.S. is headed in this exact same direction as Greece and Japan. And, that is why we can be certain central banks’ monetary tightening cycles can’t last for very long and will end in disaster–as per usual. In fact, Mr. Powell will probably torpedo markets before he is able to end his current historic and massive QE program.

If you want to know how fragile markets really are, just look at the 2.5% selloff during the week surrounding Powell’s June FOMC press conference. The fed hasn’t started to end QE yet. In fact, it hasn’t even set a date to start the taper. All the fed’s money printers have done is admit that they have begun to discuss when to think about a time for the start of tapering $120b per month in asset purchases.

Now let’s talk about the gold market because it is related to what this commentary is all about.

We issued a warning on gold back in Sept of 2020 because of what we termed “the vaccine dead zone” was approaching, which would cause real interest rates to soar. That is exactly what occurred. Gold dropped by 20% from August ’20, thru April ‘21. Now the Fed has admitted that it has begun to talk about ending QE. But this is not the start of another bear market in gold. Instead, it is most likely the end of the bear market and the incipient beginnings of a massive bull market. Why? because of what I pointed out at the start of this commentary. The fed can’t remove very much liquidity from the system before chaos reigns on Wall Street.

The simple truth is, asset values and debt levels have grown to become such enormous monstrosities that they prohibit the tightening of monetary policy much at all before the entire fragile and artificial edifice collapses.

Right now, my 20-point Inflation/Deflation and Economic Cycle model indicates there is still some room to run on this bull market. This is what prevents us from panicking out of stocks prematurely, as some are prone to do. However, the time for a massive reconciliation of asset prices is growing close.

Wall Street’s favorite mantra post the Financial Crisis was: either the economy improves enough to boost earnings and the market, or the Fed will keep printing money in order to support stocks and engender a perpetual bull market. Now, as a result of the Fed’s “success” with creating runaway inflation, the exact opposite calculation is now true: either the economy soon slows down significantly enough on its own, which will depress EPS & inflation, or the Fed will tighten monetary policy until inflation is tamed, which will cause asset bubbles to collapse.

Central banks have destroyed price discovery across the board. As these maniac money printers begin to exit their market manipulations, the free market will demand much lower asset prices. The challenge for investors is to actively manage your portfolio in order to maintain—or perhaps even increase–your standard of living, in spite of the carnage that is set to occur on Wall Street and Main Street.

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.”

15% Nominal GDP With a 1.5% Benchmark Treasury Yield!?

June 21, 2021

The Producer Price Index for the month of May was up 6.6% year over year. This was the greatest yearly increase since the Bureau of Labor Statistics began tracking the data. In addition, the Headline Consumer Price Index rose 5% year over year in May, which is the fastest pace since August 2008. Import Prices also surged in May, soaring by 11.3% in the past twelve months—the greatest surge in a decade. However, those blistering rates of inflation didn’t rattle the bond market much at all. In fact, the bond market is completey unfazed by the current inflation data.

Below is a chart of the Benchmark Treasury yield intra-day on June 10th, the day of the hottest CPI print in 13 years. And it wasn’t a sell-the-news even either, because interest rates had been falling into the release of the strongest inflation print in over a decade.

But it’s not just the bond market that is quiescent about inflation. Commodity prices have started to slip too. Lumber prices are tumbling, as new home prices have now climbed above the reach of most consumers. And, Dr. Copper is declaring that peak growth and inflation has arrived too, regardless of the strong data seen today.

 

Of course, having interest rates this low are completely ridiculous. The Atlanta Fed GDP estimate for Q2 real economic growth is 10.3%–estimate as of June 16, 2021.  When you add Consumer Price Inflation into the calculation, you get 15.5% nominal GDP growth. Now, what would you think an investor would require in a fixed income instrument offered by Uncle Sam going out 10 years when nominal growth is above 15%? Well, history dictates that it should be close to that 15% nominal GDP figure. But instead, Benchmark Treasuries offer just 1.5!

That is the most distorted and manipulated rate in the history of the United States, thanks to relentless central bank intervention. However, such a low relative yield could only exist if the current rate of growth and inflation is deemed to have peaked by whatever is left of the free market. Who are these players? For the most part, they are an elite group of individuals with massively deep pockets and access to the best information.

But still, the current inflationary environment is confounding many investors and most in the main stream financial media; who tend to just perform the exercise of linear extrapolation to predict the future.

So why are bond yields falling, along with key commodity prices, when the current data on growth and inflation are so strong? The answer is threefold. These savviest of investors understand that the bulk of government fiscal stimulus has passed. In fact, approximately 88% of the total amount earmarked for direct relief has already been disseminated, according to the IRS. Also, the Fed is on the precipice of winding down its humongous and record-setting $120 billion per month stimulus scheme. But perhaps the most important reason for the certainty we have that growth and inflation rates have peaked, is that this past pandemic-induced recession was anything but typical.

During most economic downturns, the economy goes through a period of sharp deleveraging. But the exact opposite occurred during the COVID-19 recession. Total debt, both public and private, has now soared to just below $80 trillion, which is now 380% of GDP. The previous cycle-high was 370%, which occurred back in Q2 2009—at the nadir of the Great Recession. And debt is still being piled on. Household debt totaled $16.9 trillion for the 1st quarter of this year. It soared at a 6.5% annual rate, which was the fastest pace of debt growth since 2006.

The fact is, the economy was late-cycle prior to the pandemic, and has simply returned to late- cycle once again. Meaning, there has been no deleveraging of the corporate or consumer balance sheets, as is the usual case at the end of a recession and the start of a new business cycle. Debt levels have increased significantly across the board–especially at the Federal government level. The US economy was debt-disabled prior to the pandemic and it will be even more so ex post. An economy with a debt to GDP ratio near 400% just can’t grow quickly and will experience low inflation–that is, of course, unless and until the currency plummets and causes interest rates to soar.

Not only this, but there has been absolutely zero reconciliation of asset prices this time around. In an ordinary recession, asset prices are sold as debt is paid off. In this case, real estate, equities and bond prices are trading at all-time record-highs. Hence, the economy should soon return to its pre-pandemic late business cycle conditions of below trend growth and inflation, with the most dangerous and deflationary asset price correction in history still ahead.

Mr. Powell and his merry band of money printers at the Fed recently wrapped up the June FOMC meeting. After aggressively courting inflation for years, they have finally received satisfaction. But they now want to spurn it–happily, in my opinion. Hence, they pulled forward the dot-plot to indicate 2 rate hikes by the end of 2023. And, during Powell’s press conference he indicated the tapering talks have begun. However, the 10-year Note still was anchored around 1.5% despite the more hawkish fed.

Here’s a glimpse of what lies ahead for the market: by the second quarter of 2022, which is only 3 quarters away now. The year over year rate of change in growth and inflation will not just be slowing down, it should be plunging. At the same time, as mentioned already, virtually all the fiscal stimulus will be over and done. No more expanded child income tax credits, no more stimulus checks, enhanced unemployment will have ended, student loan/mortgage and rental forbearance will have expired. And, the Fed won’t just be talking about tapering, it will be in the middle of eliminating its $120 billion per month bond-buying scheme.

In other words, the credit markets should be freezing up and the stock market should be plunging from record high valuations by that time. Today’s Fed decision expedited the timeline for that chaos to begin. The buy and hold portfolio is a danger to your retirement’s health. the time to get into a dynamically-managed strategy in now.

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.”

 

Transitory Inflation Debate

June 14, 2021

Inflation is running white-hot right now, and the reason is clear. It is because the Treasury poured $6 trillion into the economy between March of 2020 to March of 2021. That amounts to nearly $50,000 per US family in the name of pandemic relief. According to David Stockman, the government’s largess was equal to 7.5 times the $800 billion of economic growth lost due to the various lockdowns and restrictions—both self-imposed or mandated. This time around the money wasn’t just sent to Wall Street, as it was in the wake of the Great Financial Crisis of 2008. Covid-19 was a perfect excuse to deploy Modern Monetary Theory (MMT) directly to state and local governments, consumers, and businesses as well.

In other words, the government didn’t just re-liquefy the banking system and then maybe hope consumers would receive some of the monetary crumbs as an ancillary consequence. The various virus-related rescue packages circumvented banks and pushed funds directly to the mass population. Paying people to lay fallow while at the same time giving them money to actually increase their consumption habits is a perfect recipe for rapidly rising Consumer Price Inflation. However, such a feat cannot be duplicated anytime soon without destroying the US dollar and the full faith and credit in our sovereign bond market.

As far as the stock market is concerned, you can’t drive the proverbial investment vehicle while looking in the rearview mirror. It’s always the next macroeconomic condition for which investors need to prepare for, as the current state of affairs is always priced-in. Accelerating rates of growth and inflation should prove to be transitory because they have been based on the artificial measures of fiscal and monetary carpet bombs.

However, the experiment with MMT is in the process of ending…for the time being. September 4th will mark the end of the $300 per week in enhanced unemployment subsidies. These erstwhile employees will have to head back to work, many for less pay. But they will be producing goods and services, which will be key towards relieving supply shortages and reducing bottlenecks that tend to increase prices. Not only this, but 41 million people have to start paying student loans once again come October 1st. Americans now owe about $1.7 trillion of student debt, more than twice the size of their credit-card liabilities, according to Bloomberg. And, over the course of this fall, mortgages and rent forbearance ends. Meaning, consumers must soon resume paying their greatest monthly expense–thus, vastly reducing their discretionary spending.

Hence, the US economy is about to go over a massive fiscal cliff; and the monetary cliff is just as deep. Indeed, the plunge has already begun. First, the Fed will end up having reduced the annual growth in its balance sheet to around $1.5 trillion for all of 2021, from $3.2 trillion in debt that was monetized during all of 2020.

Second, Mr. Powell announced on June 2nd that the fed would begin to sell $13.7 billion of its corporate bonds and ETF holdings. Now admittedly, this is a very small fraction of the total $10 trillion corporate debt market. But it’s the psychology of markets that matter. Back in March 2020, the Fed said it would purchase an unlimited number of Treasuries and MBS, as well as buying corporate bonds and ETFs for the first time in its history. Wall Street became completely aware that the Fed was going to create a bull market in prices across the entire fixed-income spectrum. And predictably, investors began to front-run the central bank’s indiscriminate and infinite bids.

Therefore, it didn’t matter that Mr. Powell only had to purchase $13.7 billion of corporate debt. The Fed went all-in on its backstop for bonds, and everyone became aware it would not let these prices drop. In fact, it eventually sent bond prices and yields to the twilight zone.

For instance, the yield on CCC corporate debt, which is the junkiest of junk-rated corporate debt and only one notch above “D” for default, is just 7%. That yield is the lowest in history and more than 700 bps points below their long-term average. This is one of the many illustrations why the next time QE ends, and interest rates rise, the results will be disastrous.

 

If you want to know why the stock market has stalled out over the past couple of months, your reason is the fiscal and monetary juice that has supported asset prices, and the economy has started to wane. This will cause a period of disinflation to emerge very soon, requiring investors to own the asset classes and sectors that benefit under such a regime — such as dividend payers that tend to increase their payout. However, the disinflation could turn into a very destabilizing deflationary environment next year. Hence, the next opportunity to make a significant amount of money in the stock market could very well be to short it, as equity prices begin their toboggan ride down the slide.

No one can be sure when this will happen. It could occur during the course of the official tapering of asset purchases. Or, even perhaps once the rate hiking cycle commences. In either case, the fuse has already been lit on the next deflationary recession/depression, which should fracture the equity market deeper and harder than any other time in history when it arrives.

Fed’s Tools are Broken

June 7, 2021

The U.S. central bank has metastasized from an institution that was originally designed to assist distressed banks, to one that believes its purview now includes perpetuating asset bubbles, fighting global warming and reconciling racial inequities. Another distortion of the original purpose of the Fed is that its mandate has changed from providing stable prices and full employment, to creating an inflation rate above 2% for a period of time equivalent to the duration it was below that level.

But the members of the FOMC claim there is nothing to fear if inflation were to ever grow too hot because it has the tools to bring it under control. In other words, when necessary, the FOMC can not only stop QE but it can raise rates aggressively enough to vanquish inflation without destroying the markets and economy along the way. Let’s see just how true this contention really is.

But before we get to how “successful” the fed will be to tame inflation, a funny thing happened on the way to achieve its 2% goal. Our central bank focuses on the incredibly distorted core rate of inflation found in the Personal Consumption Expenditures Price Index. But meanwhile, prices are surging in the real world. For instance, headline PCE inflation increased by 3.65% year over year in April. And even in the fed’s preferred metric, prices jumped by 3.1% y/y. Not only this, but a slightly less massaged reading of inflation, which can be found in the headline CPI metric, had prices rising by 4.2% y/y.

If you want an even more accurate view of the current rate of inflation just look at home prices, which are up 21% y/y, according to Redfin data. Also, the 19 commodities in the CRB Index have soared by over 60% in the past 12 months. Safe to say, the actual rate of inflation is already far above the Fed’s inane 2% target.

These absurd inflation rates were brought about by paying citizens $6 trillion between 3/20-3/21 to lay fallow at home and not produce goods and services. Hence, creating supply shortages; and a huge void to absorb the massive liquidity wave. Therefore, the rate of inflation has already climbed to a point that is dramatically destabilizing to the economy. This is the conundrum for our Treasury and Fed: keep printing money and cause inflation to run intractable, which will destroy the stock market and the economy. Or, stop monetizing debt and let the gravitational forces of deflation implode the gargantuan asset bubbles. Given the history of the Fed, it is clear Mr. Powell will soon try to once again convince investors that the U.S. economy has healed and it’s time to normalize monetary policy.

Most in government and on Wall Street claim that the Treasury can slowly and innocuously reduce its spending while the Fed gradually stops printing money. However, this is virtually impossible because of the massive amount of debt taken on since the start of the global pandemic and the mind-boggling level of asset prices–which are predicated on free and continuous money printing.

Twenty percent of the largest U.S. corporations are in the zombie category (meaning they don’t earn enough money to even pay interest on outstanding debt). Those big businesses are carrying some $2.6 trillion in debt, according to Barron’s. Once the free-money spigot is turned off, massive bankruptcies will emerge. The asset bubbles in junk bonds, real estate and equities have been built on top of that risk-free-rate of zero percent. Take it away and the game ends in catastrophe.

History is clear regarding this dynamic. In the year 2000—the peak of the NASDAQ bubble–the Fed Funds Rate (FFR) was 6.5%. It was reduced to 1% by June 2003, in order to help ease the pain of the imploding stock market. But by June 2006, the Fed promised the crisis was over and had the FFR back to a lower high of 5.25%.

However, Mr. Bernanke had it all wrong. Bringing interest rates close to the average rate caused the housing market to crash. In the wake of the Great Financial Crisis, the FFR was taken to zero percent by December 2008—it was the first time in history that money became almost free.

Of course, the members of the FOMC are very slow learners. The Fed was once again assuring a weary consumer that the once in a hundred-year storm had passed, and the current Fed-Head Jerome Powell finished the job started by Janet Yellen when he took rates to another lower high of just 2.5% in 2018. Nevertheless, a crash in the equity market in the fall of 2018, plus a REPO market crisis in the summer of 2019 caused the Fed to cut rates three times, to 1.75% by October of that same year. Unsurprisingly, the global Pandemic eventually put the FFR back to zero percent, but it was already on its way there before the advent of COVID-19.

Money printing, debt accumulation and asset bubbles have become the fragile foundation for which this current economy is built. Therefore, the notion that the Fed can end its $120 billion per month QE program and gradually raise interest rates back anywhere close to the normal level of 5-6% is ridiculous. Indeed, it would be shocking if it could get rates close to the previous high of 2.5%–the new lower high on the FFR is probably below one percent given the massive increase in the number of insolvent companies and unsustainable level of equity valuations.

Forget about 2% core PCE inflation. Intractable inflation is acutely manifest in asset prices right now! However, the government and many businesses can only pretend to be solvent while borrowing costs are close to zero. Take the free money away and the whole system goes belly-up.

For proof, just think about the following three key data points. For proof, just look at the following three key charts.

 

If the Fed couldn’t normalize rates before, how could it possibly come close to doing so now?

The truth is any real effort to tighten monetary policy back to the previous old high of 2.5% will cause the credit markets to freeze once again, which should cause a more intense market crash than the other previous attempts to normalize borrowing costs. Nevertheless, Mr. Powell will soon lead the average investor down this predictably perilous path toward perdition. The question is, what happens when consumers and investors reach the epiphany that the Fed’s tools for the purpose of taming inflation have now become broken?

 

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.”

 

Peak Growth and Inflation

May 10, 2021

The rates of growth and inflation are now surging in the U.S., but that shouldn’t be a surprise to anyone. What else would you expect when the Federal government has sent $6 trillion dollars in helicopter money to state and local governments, businesses, and individuals over the past year. Then, at the same time, millions of homeowners are told they don’t have to pay their mortgages. In addition, our central bank has printed trillions of dollars to push asset prices through record-high valuations and continues to create $120 billion each month in order to keep Wall Street happy.

All the above is happening while the economy opens up due to the dissemination of COVID-19 vaccines. The markets have anticipated this economic boom and have now nearly fully priced it all in. For instance, home prices have soared by 12% year over year in February, which was the fastest increase in the past seven years. And, the total market cap of equities is now over 200% of GDP—about twice the level reached at the start of the Great Recession.

But that rate of change in growth and inflation will be peaking in the next two months. I’ll explain why that is and what that means for investors?

First off, borrowing costs and the rate of inflation are much higher than they were a year ago. Consumer Price Inflation jumped by 2.6% year-over-year in March, as compared to only a 0.3% increase y/y in April 2020. And, the rate on Benchmark Treasuries has increased by more than 100 bps since last year. Not only this, tax rates are headed higher on both corporations and on those consumers who are traditionally responsible for creating job growth. A rising cost of living, increased debt service payments, and an attack on capital formation—and indeed capitalism itself–should serve to vastly inhibit economic growth later this year and especially into 2022.

This dovetails into the overall fiscal cliff that is rapidly approaching. The $6 trillion in pandemic assistance over the past year was a powerful adrenaline shot that greatly boosted consumption. But artificial sugar highs are temporary, and there are no more comparable helicopter money drops in the works. Even if all of President Biden’s proposed $4 trillion infrastructure and American Families Plan is made into law, it will be spaced out over ten years. Hence, the impact will be much more muted and diffused than the previous two massive fiscal carpet bombs. Also, the total of 18 months’ worth of mortgage forbearance ends on approximately 2.7 million distressed homeowners come this fall. And, the Pandemic Emergency Unemployment Compensation Program provided 53 weeks of additional jobless benefits. That extra $300 per week expires the week ending September 5, 2021.

Secondly, we are approaching peak COVID-19 optimism. The number of individuals getting vaccinated per day is now dropping quickly. In other words, peak vaccination in the U.S. has arrived. The U.S. averaged 2.4 million vaccinations per day during the last week of April, according to the Centers for Disease Control and Prevention data. That level is down from a peak of 3.4 million vaccinations administered on April 13. What is more discouraging is that the global death rate from COVID-19 is rising sharply. The 7-day average was 13,235 deaths on April 30. That is twice as high as it was during the April 2020 peak and four thousand more deaths per day than the month-ago period. Come this fall and winter, we will learn more about the longevity of these vaccines. What exactly is the duration of the immunity they provide, and do they protect from the more contagious and virulent variants that are currently ravaging places like India, Laos, and Thailand? We may need to re-vaccinate the majority of the population all over again. If so, how smoothly will that happen? The current belief is that the pandemic will be behind us come this summer. But we must be vigilant against a COVID resurgence later this year, which will likely bring with it the associated economy-killing restrictions and lockdowns.

And thirdly, the most salient factor that is set to implode the array of asset bubbles that are currently in existence is the monetary cliff. Fed-Head Jerome Powell should officially announce the plan to taper his asset purchase program this summer. In fact, Dallas Federal Reserve Bank President Robert Kaplan thinks the time to discuss tapering has already arrived. He said the following on April 30: “We are now at a point where I’m observing excesses and imbalances in financial markets,” He especially highlighted stock valuations, tight credit spreads, and surging home prices as the real dangers. However, the truth is the unofficial tapering of asset purchases is already underway. The Fed’s balance sheet increased by $3.2 trillion during all of 2020, but that figure should “only” increase by $1.5 trillion for this year. Turning off the monetary firehouse completely in 2022 will be far more destructive than the last time it occurred in the years following the Great Recession.

The last time the Fed announced a plan to taper its $85 billion per month QE program was back in May 2013. As a consequence, the S&P 500 dropped 6.5% in three weeks. But that relatively minor hiccup occurred because the stock market was extremely cheap in comparison to where it sits today. The Total Market Capitalization of Equities compared to GDP was just 103% at the time of the first Taper Tantrum. In sharp contrast, it is 205% of GDP today!  And Jerome Powel’s $120 billion per month QE scheme is almost 1.5x the size of then-Fed Chair Ben Bernanke’s money printing endeavor.

Also, during the two years prior to “The Taper Tantrum” (from May 2011 thru May 2013), the Fed’s balance sheet increased by just $600 billion. This compares to the whopping $4.7 trillion of asset purchases that will have occurred from January 2020 thru the end of this year—assuming the Fed doesn’t start reducing its purchases until 2022. Those trillions of dollars helped send asset prices to the thermosphere and have inflated a much bigger bubble than has ever existed before. Hence, this removal of monetary support should carry much greater significance this time.

Yet another consequence of the Fed’s monetary manipulation is the effect it’s having on the corporate bond market. U.S. corporate debt outstanding has surged to reach $10.6 trillion. That is a record high 50% of GDP. For context, this figure was just 16% of GDP back in 1980. Junk-rated debt yields are at the tightest spreads to Treasuries, and their yields are the lowest in history. Of course, the yield on Treasuries has been massively distorted by the Fed as well. In fact, the government was able to sell $40 billion in T-bills on April 29 with a yield of exactly zero. Yes, the bubble in fixed income is incredulous.

Asset prices have been driven higher precisely because of the near $5 trillion in newly minted money that was thrown at Wall Street over the past two years. However, sometime next year, we will learn what happens to these bubbles when the monetary speedometer goes from $5 trillion to $0.

What all this means is that the rates of growth and inflation are about to slow. This isn’t a reason to panic…yet, but it does require a change in your investment allocations.  For now, the deceleration should be at a gradual pace for the remainder of this year, which means bond and bond proxies should start to fare better than the asset classes, style factors, and sectors that are geared towards a rapidly accelerating economy.

However, disinflation and slowing growth could morph into deflation and recession next year. Such macroeconomic conditions should prove devastating for these record asset bubbles. Good money managers must know how to appropriately navigate these cycles. And, most importantly, be able to determine when it is time to sprint for the emergency exit before the real chaos begins. That requires the ability to know when to raise cash, move into short-duration bonds, get the long the dollar, and allocate to a net-short position in equities.

 

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.”