Commentary

Recession Question Answered

June 28, 2022

 President Joe Biden, Treasury Secretary Janet Yellen, the entirety of the money printers who inhabit the Federal Reserve, and virtually all of the deep state of Wall Street are still busy trying to convince you that a recession is unlikely. Well, here’s some news for all of them. Whether or not we will have a recession is no longer a question. The recession is already here. The only question is, how deep the recession will become.

The consumer is getting attacked on all fronts, and their consumption accounts for nearly 70% of GDP. Falling real wages, spiking debt service costs, plunging cryptocurrencies, sinking stock prices, and battered bond values are seriously injuring their financial health. And coming soon to a theater near you, a real estate wreck is in the offing. Instead of home prices rising 20% per annum as they have over the last couple of years, the pace of home price appreciation should soon decline sharply. Home affordability is at a record low, while new listings and price reductions are on the rise. Home equity extractions have been severely depressed due to rising mortgage rates. And now, depreciating real estate values shut down the bad consumer habit of relying on equity extraction to boost consumption.

The final blow to this consumption story will be the labor market. A rising number of US corporations are now placing hiring freezes and/or engaging in outright layoffs.

All this is exactly what the Fed wants and needs to occur to bring inflation back towards 2%. However, the Fed has an abysmal record of getting anything right—especially when it comes to inflation and its targeting. The Fed couldn’t get inflation to rise to its 2% target during most of the period between 2008-2020. Then, with the help of Treasury, managed to send inflation soaring past 2%. In fact, it went all way to 8.6% rather quickly with the launch of a massive helicopter money scheme in the wake of the COVID-19 outbreak.

And it is this intractable inflation that is preventing Mr. Powell from pivoting dovish anytime soon, despite a blatantly obvious recession staring him in the face. Sales of existing homes were 8.6% lower in May of this year compared to the same period in 2021. That is lowest reading since June of 2020, during the early stages of the pandemic-induced shutdowns. Can it really be possible to have an expanding economy when existing home sales are falling this sharply? In May, the seasonally adjusted annual rate of housing permits to build a home decreased 7% month over month. And, actual Housing starts fell 14.4% m/m. That fall in housing starts was the largest m/m decrease since April 2020.

The June Philadelphia-area Manufacturing Survey contracted by 3.3% vs. an expected gain of 5.5%. New orders in this survey plunged by 12.4 vs. a positive 22.1 last month. Does this sound like an economy that is growing? No, it does not. Q1 GDP posted a reading of -1.4%, and the Atlanta Fed GDP Now estimate for Q2 is 0.0%. This means the US economy shrank during the first six months of 2022. That is a recession by the technical definition or any other honest measurement of the economy.

It isn’t any wonder why consumer sentiment is at an all-time low. Despite this recession, the maestro of the Fed’s Gong Show stated at the June FOMC Press conference and also at his testimony before Congress that the US consumer and economy are very strong and can withstand the most hawkish monetary policy in history. Perhaps Powell should try his luck at stand-up comedy.

Instead of the cheerleading, you’ll find in the Main Stream Financial Media, I’ll offer the top two reasons why this bear market is much worse than any bear market since homo-sapiens began roaming the earth.

  1. Asset prices are falling, and the economy is shrinking at the same time, inflation is at a record high. This means for the first time in forever, the Fed is forced to hike rates into a recession. In fact, we have the most aggressive hiking cycle ever. Powell is raising the Fed Funds Rate by 75 basis point increments, while Quantitative Tightening is destroying $47.5b of money supply each month. That is, until September when it will then spike to $95 billion per month. Powell now states he wants the Fed Funds Rate at 3.25-3.5% by the end of ’22.
  2. The second reason why this bear market will be epoch in nature, is that the total amount of outstanding debt is higher today than at any other time in history, both in nominal terms and in terms of GDP. At the end of last year, corporate debt had soared to $11.6 trillion, which is 48% of GDP and an all-time record high. And, Total Non-financial debt has skyrocketed to $65 trillion, which is another record high and an incredible 270% of GDP. What we have in reality is an 84% increase in corporate debt and a 94% jump in Total Non-financial Debt since the Great Recession! A greater amount of defaulting debt leads to a greater economic disruption.

Making matters even worse, it’s not only the US that finds itself in this dire situation. A plethora of the world’s major central banks are fighting much the same battles. Here is a list of countries that are in the process of raising borrowing costs: USA, Australia, Chile, South Korea, Brazil, Great Britain, Canada, Czech Republic, Hungary, Israel, India, Mexico, New Zealand, Norway, Poland, Saudi Arabia, South Africa, Sweden, Switzerland, and the Entire European Union is expected to join the parade this July.

Despite all the damage that has been done to the stock market, the valuation of equities as a percentage of the underlying annual production of the economy is higher today than at any other time in history prior to 2020. The total market cap of equities as a percentage of GDP is currently 155%. That is over ten percentage points higher than the peak of the NASDAQ bubble in 2000 and over 50 percentage points higher than it was going into the start of the Great Recession in December of 2007. As a reminder, the NASDAQ lost 80% of its value between 2000-2002, and the S&P 500 shed 57% from October of 2007 to March 2009. In other words, the bottom pickers should continue to end up with very smelly fingers until inflation is vanquished and the recession is fully priced into stocks.

Then, a new bull market should arise, but it will be marred with the stench of stagflation all over it. Meaning, the buy-and-hold, 60/40 portfolio died a long time ago and won’t be resurrected anytime soon. The inflation/deflation dynamic is growing more intense with each boom/bust cycle, and that requires a different approach to investing than what is offered by most Wall Street firms.

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.”

 

Sell the Bear-Market Bounce

May 27, 2022

Bear market bounces are violent yet short-lived. The latest excuse for an oversold rally was provided by JP Morgan’s Jamie Dimon. The bank’s CEO stated at Morgan’s Investor Day Conference on Monday, May 23rd, that the US economy remains strong despite gathering storm clouds. He said, “I’m calling it storm clouds because they’re storm clouds. They may dissipate.” This was indicative of the typical vapid speech of the optimistic bank CEO. While he was at it, he also raised the bank’s outlook for Net Interest Margin at the bank’s conference, causing the usual parade of Dimon groupies to celebrate with orgasmic delight about his confidence in the economy.

Perhaps Dimon is compelled to do his impression of PT Barnum because shares of JPM have lost 30% of their value so far this year. But before you believe Dimon is some economic oracle, listen to what he predicted about US economic growth on Jan. 11th when he publicly proclaimed his 2022 outlook, “We’re going to have the best growth year we’ve ever had this year, I think, since maybe sometime after the Great Depression.” He said this during a quarter that would later show to have shrunk at a 1.4% annualized rate. And that bad economic data didn’t cease at the end of Q1. S&P Global US Composite PMI Output, which tracks the manufacturing and services sectors, fell to a reading of 53.8 in May, from a 56.0 reading in April, which means the economy is fast approaching contraction territory in Q2. A slew of manufacturing PMIs also supports the view that the US and, indeed the entire global economy is faltering. The plunging numbers on home purchases and refinancing activity indicate danger is ahead. Nevertheless, despite a parade of sharply declining economic data, the financial media is promoting the view of Wall Street analysts that earnings growth is actually going to be robust this year and next.

This is one reason why the bottom of the bear market isn’t yet in sight. In fact, if the stock market were to return to a more normal valuation, one where the total market cap of equities was equal to annual total output of the economy, it would have to decline by 37% from the current level. But bear markets seldom, if ever, just decline to fair valuations; they usually slice through that level and find support once the market displays a broad array of metrics that indicate it is undervalued. So, despite a brutal bear market, the grand reconciliation of asset prices should continue on.

How brutal has it been? Ycharts calculated the percent declines from all-time highs of some widely held stocks at the end of last week.

As bad as this has been, it is more indicative of how overvalued the market had become rather than being a sign of an imminent bottom.

Vanda research recently reported that the average retail portfolio is down 32% this year. And this bloodbath isn’t limited to stocks. The flagship crypto (BTC) is down 55% since November of last year, long-duration Treasuries are down 20% YTD, and the housing bubble is the next in the queue to implode.

The bear market should continue until a sufficient amount of disinflation is manifest, which can then give Chair Powell the economic and political cover to turn dovish. But this probably won’t occur until around September or October.

There is still a lot of damage that can be done between now and then. Of course, what exactly the Fed will do and how it will affect the market is too early to determine at this juncture. But investors should not expect the “Fed Put” anytime soon just because the economy is rapidly decelerating. The Fed now blames the weakening economy precisely because of inflation that ran too far away from its 2% target. Hence, getting inflation back toward 2% is Powell’s number one priority—that is, unless the credit markets stop functioning. However, another round of Universal Basic Income and QE, which may be deployed once again if the credit markets meltdown, will occur while the wounds of record-high inflation have not even begun to heal. That could end up being devastating for our currency and debt markets. In other words, there is no pain-free path for the Fed to take. Turning dovish may not send all asset prices soaring as it has done in the past because intractable stagflation is the salient risk and indeed the most likely outcome—and that isn’t good for most stocks.

Powell should have resigned a long time ago.

In response to the upcoming recession, expect the Fed, Treasury, and D.C. to coordinate the monetization of trillions upon trillions in helicopter money. But think twice if you believe that will fix everything. Just imagine the consequences of turning back towards a massive inflationary policy while the sting of destabilizing inflation is still raw in the minds of consumers and investors. The US now has record-high inflation while also enjoying a tremendous dollar bull market over the past year. But just imagine how destructive that inflation will become once the Fed’s balance sheet vaults over $10 trillion and then quickly races towards 100% of GDP; with no end in sight. And, at the same time, the dollar crashes–not only against goods and services like what is happening now, but against our major trading partners–causing import prices to surge.

In conclusion, the bear market has many innings to go, the Fed pivot is still months away, and that turn towards a more dovish policy isn’t going to solve all the economic and market problems. Indeed, it will make them much worse. This is why the buying and holding of a typical 60/40 portfolio no longer works. And why an Inflation/Deflation investment strategy is growing more crucial to successful investing with each boom/bust cycle.

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 Crash Landing

May 20, 2022

Wall Street, we have a margin problem. Shares of Target (TGT) fell by 25% on Wednesday the 18th as their margins shrank by the same amount. TGT margins collapsed due to higher input costs, overstocking, and overstaffing. So much for the mantra that stocks are a great hedge against inflation. In reality, inflation is destroying American corporations, the economy, and the middle class.

Walmart (WMT) is America’s and the world’s largest private employer. Its earnings report on Tuesday the 17th had a lot to say about the US economy. The company missed earnings primarily because of inflation and margin pressure. One of the primary drivers for the margin compression was that WMT has TOO MANY EMPLOYEES. The reason is clear: after the COVID stimulus checks expired, these furloughed workers found themselves out of savings and in need of money. Hence, they returned to work en masse. The key point here is that the world’s largest employer is no longer hiring but instead will be letting workers go. There are over 2.7 million people employed by WMT and TGT.

A weakening labor market would normally get the Fed to turn dovish. However, Mr. Powell and the Fed cannot turn dovish imminently. Nevertheless, Wall Street is still hoping that the Fed put is nigh. But record-high inflation is the primary problem facing consumers and corporations. Chair Powell finally understands this. Therefore, the Fed has been forced to adopt the most aggressive tightening monetary policy since 1980. This is precisely because an economy cannot function properly while inflation is extremely high.

In spite of this, the Fed, along with its lackeys in MSFM, are busy trying to convince investors why this current tightening cycle won’t end in recession and a stock market meltdown like nearly every other time in history. They hasten to liken this tightening cycle to the one that ended in a soft landing in 1994. The Fed took interest rates from 3% at the start of 1994 up to 5.5% by the end of the year. That total of 250 bps of rate hikes did not cause a recession and is viewed as proof that the Fed’s ability to engineer a soft landing is readily achievable this time around. Indeed, GDP growth for all of 1994 came in at a solid 4%. So, will 2022 turn out like 1994, as the perma-bulls would have you believe?

The chances of a soft landing in the economy are near zero–this rate hiking cycle will be nothing like 1994.
Fed Chair Alan Greenspan started hiking rates by 25bps to 3.25% in February of that year. CPI averaged 2.6% during 1994, with a high print of 3%. Three percent inflation is not even close to the 8.3% inflation we suffer today. Also, the 10-2 Treasury yield curve spread was a healthy 150 bps in ’94, which is indicative of a healthy economy. In sharp contrast, the Fed started hiking rates this time around when that yield spread was flat to inverted. In addition, GDP growth was 3.9% in Q1 of 1994. Q1 GDP growth for 2022 actually started out with negative 1.4% annualized growth. Hence, the situation today is one where inflation is much higher, and the starting point of GDP is significantly lower than it was during that extremely rare soft landing enjoyed 28 years ago.

Most importantly, the Fed was only raising the Fed Funds rate in 1994 in order to bring down inflation. However, this rate hiking cycle is being paired with a Quantitative Tightening (QT) program that is nearly 2x greater than the previous failed attempt to reduce the Fed’s balance sheet back in 2018. Also, the asset bubbles and debt levels seen today dwarf what was in place several decades ago. As Guggenheim’s Scott Minerd points out, the fed has never reduced inflation by more than 2 percentage points without engendering a recession. Mr. Powell is now tasked with reducing inflation by over 6 percentage points. Soft landing, no. Crashlanding, yes.

A few recent and important data points need to be highlighted. Nonfarm productivity, a measure of output per unit hour of work, declined 7.5% during Q1. That means worker productivity fell to start 2022 at the fastest pace in nearly 75 years. At the same time, unit labor costs soared 11.6%, bringing the increase over the past year to 7.2%, the biggest gain in labor costs since Q3 of 1982. Productivity is how you grow a healthy economy, not by inflation. Mr. Powell, we have an inflation problem.
Hence, the Fed must continue with its very hawkish monetary policy stance until one or more of the following three things occur: back-to-back negative Non-farm Payroll reports; the credit markets freeze (no high yield, commercial paper, CLO etc. issuance) or inflation drops back below 4% on a y/y basis and the m/m increase drops below 0.3%. The latter is your only hope for a significant and sustainable market rally. If the job or credit markets falter first, the market will go into freefall before Powell has time to react. So, the bulls have to hope for inflation rates to drop precipitously within the next few months.

However, the May 11th release of April CPI data dampened the idea that inflation is going to significantly cool off anytime soon. In contrast, the m/m inflation rate is actually increasing. So, the markets and economy are in a race against the Fed. Inflation has to subside imminently–before the 50 bps rate hikes of June & July occur and the $95 billion per month QT program ramps up in September. The economy and markets are already sputtering, and this is before the Fed Funds Rate is above 1% and before QT begins on June 1st. Save the bottom fishing talk for the mainstream financial media.

This still nascent bear market will eventually set investors up for a great buying opportunity, but only after inflation becomes fully tractable. That great buying opportunity is reserved only for those who had the foresight to preserve their capital during this bear market (which includes raising extraordinary amounts of cash in the short term).

For most of Wall Street, who have bought and held the whole way down, there is only a painful crash landing in stocks and the economy with no chance of deploying a substantial hoard of cash once the bottom is in. Whereas investors with their capital intact will have a better chance to profit once this liquidity crisis is over.

Wall Street’s Inflation/Deflation, Boom/Bust cycles continue unabated. Progressively greater doses of helicopter money and debt monetization should ensure these cycles will continue to grow more dangerous with each iteration. That is really bad news for most investors. But for those who know how to trade these dynamics, it may just provide more opportunities to shine.

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.”

Perma-Bulloney

April 14, 2022

 The economy is faltering, and markets are becoming chaotic. In spite of this, the mainstream financial media is busy convincing investors that the bull market is solidly intact.

The 10-2 Treasury yield curve inverted on Tuesday, March 29, 2022. This inversion has occurred for the first time since September 2019. Meanwhile, the 30-5-year Treasury yield spread has also inverted in late March, the first time such an inversion has occurred since 2006. Such inversions nearly always signal the economy has weakened sharply and is headed for a recession.

But right on cue, Wall Street apologists are data mining parts of the yield curve to try and explain why the economy is strong and that a recession isn’t in the cards. They try to deflect your attention away from the most salient 10-2 curve inversion and instead point to the 3-month, 10-year curve spread to dismiss the whole flattening and inversion thing going on everywhere else. Why? Well, because they always need an excuse to stay bullish.

Newsflash, the 10-3month Treasury yield spread is only temporarily lagging behind the more relevant parts of the curve simply because the Fed has long dithered to raise the Funds Rate. The fact is, the 3-month T-bill is always pegged very close to the FFR. And since the Effective Fed Funds Rate is still stuck at around .33%–again, that to Powell’s reticence to fight inflation– this part of the curve has yet to invert. However, once Mr. Powell really gets going with the tightening process, this part of the curve should invert too, as the overnight lending rate eclipses longer duration yields.

Allow me to briefly explain why all this curve inversion stuff is so important. It is all about money supply growth and the access to credit. You see, we have a debt-based monetary system. This means money is created when a bank makes a loan. Banks make a profit between what they pay to depositors (borrow short) and the income they receive from their assets (lend long). When the yield curve inverts, their profit motive is greatly eroded, just as the risk of making new loans increases. This dynamic occurs at the same time consumer’s demand for credit decreases due to their need to reduce leverage. The monetary liquidity then dries up, and asset prices begin to tumble.

Of course, Wall Street abounds with Pollyanna’s that come up with reasons for the investor lemmings to walk blindly off the cliff. Enter Deutsche Bank and its soothing words offered to us regarding the history of curve inversion. Their research indicates that after the 10’s-2’s inversion takes place, the market has peaked between 3-25 months later. And the average increase for the S&P 500 after that initial inversion is 19%.

Let’s take a look at the more relevant data that the Deep State of Wall Street so conveniently overlooked. We will first dismiss the last curve inversion that occurred in the late summer of 2019–just a few months before the economy and markets tanked–because of the assumption that the yield curve just got lucky due to the unpredictable COVID-19 pandemic.

So, let’s instead look at what happened during the time leading up to the Great Recession of December 2007 thru March 2009. The spread between the 10 and 2 Year Note first inverted on December 27th 2005. The economy was so strong back then that the Fed was able to hike rates by 325 bps (from 1% to 4.25%) during the timeframe beginning with the first hike in 2004 until that first inversion occurring at the end of 2005. But after that initial curve inversion, the Fed was only able to push through another 100 bps in rate hikes before it had to stop tightening policy in June 2006. This pause was due to a clear deceleration of economic activity. Despite the Fed’s relaxation of its hawkish monetary policy stance, the economy continued to deteriorate, and the stock market topped out a year later in the summer of 2007. The Great Recession began just a few months later.

Today’s economic situation is very different. The economy is so weak right now that it only took one, 25 bp rate hike to invert the 10-2 yield spread. This leaves just about 100 bps of hiking that can be done before the economy slows enough to turn a hawkish central banker into a dove. The problem is, since inflation is at a 40-year high, Mr. Powell cannot easily turn dovish. In fact, he has scheduled another 225 bps of rate hikes this year alone. And, due to that 8.5% CPI, 11.2% PPI & 12.5% Import Price spike; he must continue with his rate hike campaign–in conjunction with QT—until inflation is under control or markets plunge…whichever comes first.

Another part of the recession cover-up story is the idea that leverage in the system has all but disappeared. Let’s compare the period of time just prior to the start of the Great Recession, which is regarded as the most overleveraged economy in U.S. history, to the state of the economy as of the latest reported data at the end of 2021. In December 2007, corporate debt was $6.3 trillion (42% of GDP). At the end of last year, corporate debt soared to $11.6 trillion (48% of GDP, which is a record high). And, Total Non-financial debt was $33.5 trillion (227% of GDP) at the start of the Great Recession. But now, Total Non-financial debt has skyrocketed to $65 trillion, which is an incredible 270% of GDP. What we have in reality is an 84% increase in corporate debt and a 94% jump in Total Non-financial Debt in just the last 14 years!

The major point here is the amount of debt has increased significantly in both nominal terms and as a percent of GDP after each recession. This means the level of interest rates it takes to break the economy keeps reducing. In the year 2000, it took a Fed Funds Rate of 6.5% before the market melted down. Leading up to the Great Financial Crisis of 2007-2009, that level dropped to 5.25%. Then, due to the massive leverage prompted by the Fed and Treasury following that crash, it then took a FFR of just 2.5% to cause the credit markets to freeze and stocks to falter in 2018. Today, it will probably take a FFR with just a one-percent handle before the financial markets once again meltdown.

Therefore, don’t be fooled. The economy is much closer to a contraction than Wall Street wants you to believe. The Fed’s tightening cycle is very far from routine this time around. Inflation isn’t just high; it’s at a 40-year high! This means Mr. Powell will not only be raising the Fed Funds Rate by 50 bp increments instead of the usual 25 bp hikes, but he will also be engaged in the monetary destruction mechanism known as Quantitative Tightening at the same time. Powell will be burning around $95 billion of the base money supply each month beginning around May, which is $45 billion more than what was done during the height of the last QT. Indeed, the March FOMC minutes show that the ramp-up to that level will only take three months, instead of the baby steps that were taken the last time the Fed tried to reduce its balance sheet.

The Fed is not now trying to slow down an economy that is overheating. In sharp contrast, GDP and earnings growth are now both rapidly slowing. An accurate recession indicator can still be found in an inverted yield curve. But that inversion usually occurs after the Fed has raised interest rates several hundred basis points over several years’ duration. However, this latest yield curve inversion has occurred after just one measly 25 bp rate hike. That is indicative of a very weak economy. The powerful inflation-fighting measures of monetary destruction (QT) and significant rate hikes still lie ahead. And that can only greatly exacerbate the current weakness; despite Wall Street’s best efforts to convince you otherwise.

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 Post Rate Hike Rally Won’t Last

March 24, 2022

The recent stock market rally is a trap. This is because Wall Street is vastly underestimating how hawkish the Federal Reserve will have to get in order to fight inflation. And how much weaker earnings and GDP growth will become as a result. The fact is Mr. Powell has finally become enlightened to the inflation crisis engendered by his own hand. The Fed Chair’s inflation epiphany is mainly the result of his observation that shelter costs are soaring out of control. He now realizes that he will have to pop the housing bubble in order to vanquish inflation.

The data on this front is shocking. Home value growth was so extreme last year that it actually surpassed median salaries in 25 of 38 metropolitan areas across the country, according to research firm Zillow. And, rent prices have surged by nearly 20% Nationwide year over year in January, while in the sunbelt, they have skyrocketed by 50%! Some 30% of these properties are owned by Wall Street and other investors.

What else would you expect to occur when the Fed guarantees access to money for next to nothing. Wall Street then uses that cheap credit to purchase massive tracks of single-family homes with a cash deal and then rents them out to would-be first-time homebuyers that have been priced out of the market by this very process. Wall Street wins big, profiting from both the increase in real estate prices and the increased cash flow derived from rising rent payments. While the people the Fed professes to care the most about fall further behind the American dream.

Hence, that is why the Fed will now fight inflation aggressively…at least until the credit markets meltdown once again. We should see more evidence of an enlightened Powell in the May FOMC meeting and press conference, where he most likely will not only raise the Interbank Lending Rate by 50 bps, but most importantly, begin to destroy the base money supply as well. He will also, at that time, lay out his plan to aggressively increase the pace of such monetary destruction (QT).

Indeed, St. Louis Fed President James Bullard wanted a 50-basis point increase as a result of the March FOMC meeting and wants to take the Fed Funds Rate up to 3% this year. Joining Mr. Bullard is Fed Governor Christopher Waller and Cleveland President Loretta Mester, who recently stated that the central bank might need to enact one or more half-percentage-point rate hikes in the months ahead.

Despite the hawkish Fed and the uniqueness of this tightening cycle, the Perma-bull, Pollyanna’s on Wall Street, trotted out the data on what happens to stocks after the Fed first begins to hike rates. Spoiler alert, it’s usually good. The S&P 500 has returned an average 7.7% in the first year after the Fed begins to raise rates, according to a Deutsche Bank study of the past 13 hiking cycles. Of course, the lemmings bought Powell’s March rate hike with reckless abandon, believing that this cycle will be like the others.

In sharp contrast, the current tightening cycle will not be anything like the previous 13. This time around, the Fed is hiking rates because inflation is at a 40-year high as calculated under the CPI’s latest massaged methodology. But the fed knows that if calculated as it was in the ’70s, inflation is at an all-time high. So, this tightening cycle will be unusually aggressive. Also, the Fed normally hikes rates into an economy that is strong and getting stronger. However, the economy is now weak and getting weaker–Q4 2021 GDP growth was 6.9%, but Q1 GDP growth this year is projected to be just 1.3%. Last year, S&P 500 EPS growth was 47%; but EPS growth for the first half of ’22 is projected to be around 5%, which is wildly optimistic given all the current circumstances but still one of the most rapid decelerations in history.

While the stock market remains brainwashed by its own bullish B.S., the bond market isn’t nearly as delusional. The spread between the ten and two-year Note is under 20 bps. That is very close to an inversion, and an inversion nearly always presages a recession. History shows that when the yield spread is this tight, the Fed can only hike just two times before the yield curve pancakes and the economy and stock market poop the bed. This normally turns a hawkish Fed back into a Dove, but the big problem now is Powell can’t easily pivot this time around because of that pesky 7.9% CPI.

Not only this, but this tightening cycle will be one of the most aggressive tightening ever. Mr. Powell will be hiking rates at the same time he is draining the balance sheet at a record pace and quantity. Rate hikes in conjunction with QT had happened only once before and didn’t work out well for the bulls.

In October of 2017, the Fed began to very slowly drain its balance sheet and raise rates at the same time. And by slowly, I mean baby steps on both QT and rate hikes. The Fed started QT by allowing just $6b per month for Treasuries and $4b per month for mortgage-backed securities to roll off its balance sheet. The amount of balance sheet reduction was capped at $600 billion per year at the peak of QT in 2018. Also, the Fed hiked rates by just 50 bps throughout all of 2017.

By the fall of 2018, the stock market began to meltdown, and Powell promised to stop raising rates in December of that same year. However, he dared to continue to reduce the size of the balance sheet with disastrous results. Only a few months later (in March of ’19), he was forced to reduce the pace of QT. And by July of 2019, the Fed had no choice but to end QT altogether–a few months earlier than Powell indicated it would end–because the credit markets were in full meltdown mode.

This next QT program, which should begin in May, will not start with baby steps at all. It is promised by Powell to be much more aggressive at the start and is projected to quickly ramp up to remove around one trillion per annum from the money supply. The only other attempt at QT was able to reduce the balance sheet from $4.4 trillion to $3.7 trillion (a total of $700 billion) before utter chaos was unleashed. The Fed’s balance sheet is now $9 trillion today for comparison.

Therefore, this hiking cycle is totally incomparable to any other. And it will have an extremely negative effect on the record-high values seen in the equity market and real estate bubbles. There are times when investing in the market without any hedges at all is worth the risk. This is definitely not one of those occasions. Indeed, this bear-market bounce gives investors one last chance to prepare for what should be one of the worst market crashes in history. The time to get your portfolio on board the four horsemen of the economic apocalypse is probably just a couple of months away.

A Recession Unlike Any Other

March 7th, 2022

The U.S. economy is already deteriorating due to the humongous fiscal and monetary cliffs. These cliffs are now being compounded by the war in Eastern Europe and near record-high inflation. And, the Fed’s “PUT” is much lower and smaller in size than Wall Street believes.

The war in Ukraine will exacerbate the negative supply shocks that are already in place due to COVID-19. Worsening bottlenecks will combine with rising inflation to produce a contraction in global growth. Russia produces 12% of the world’s oil supply and exports 18% of the world’s wheat consumption. Ukraine accounts for 25% of global wheat production. Sanctions and war will serve to slow the economy further and send prices for these vital commodities even higher.

But the upcoming recession will be extraordinarily unique. Not only will it occur while inflation is at a multi-decade high, it will be the first U.S. economic contraction to take place while the Federal Reserve had its target interest rate at or near zero percent. For comparison, look at how much room the Fed had to reduce borrowing costs during previous economic contractions.

The following historical data indicates the level of the Fed Funds Rate just prior to the outset of all 10 U.S. recessions since WWII: 1957 3.5%, 1960 4.0%, 1969 10.5%, 1973 13.0%, 1979 16.01%, 1981 20.61%, 1989 10.71%, 2000 6.86%, 2007 5.31% and 2019 2.45%.

In addition, the swoon in GDP will occur after the Fed has just finished printing $4.5 trillion over the past two years and with the national debt vaulting over $30 trillion due to the massive increase in government deficits in the wake of the COVID-19 pandemic. Such borrowing helped send the government’s debt to GDP ratio soaring to 125%. For perspective, that ratio was just 53% back in 1960, and only 58% as recently as 2000.

Inflation is destroying real wages, and rising borrowing costs are destroying consumers’ ability to consume. Consumption is 70% of GDP, and that means the rate of economic growth is set to plunge. This would normally spur the government into remediative action. But the fact remains that the ability of the Treasury and Federal Reserve to turn around a recession expeditiously by borrowing trillions of dollars and having that debt monetized by the Fed has become greatly fettered this time around.

Mr. Powell is in a conundrum that is mostly of his own making; and from which there is no innocuous outcome. If the Fed gets overly concerned about slowing GDP due to the conflict in Ukraine, it could, for the most part, shelve its plans to raise rates and the planned reduction in the size of its balance sheet. But that would risk propelling inflation even further away from Powell’s stated 2% target, which he has exceeded by 3.75x. Inflation expectations could then rise intractably from there. In other words, doing nothing isn’t a viable option for Mr. Powell–not with inflation running at a 40-year high and the WTI oil price vaulting above $110 per barrel.

Commodities are indeed soaring, but the inflation doesn’t end there; rents have soared by 20% year over year, which is closer to the actual rate of inflation, rather than the massaged 7.5% CPI reported by the Labor Department. If inflation were to continue to increase even close to that rate, it would push those in the middle class into the lower class; and those in the lower class into poverty. Of course, this would end up destroying markets and the economy anyway. It could also put at risk confidence in the U.S. dollar and sovereign bond market.

Therefore, the Fed is now forced to combat inflation whether it really wants to or not. At the nucleus of the inflation issue is runaway owners’ equivalent rent costs, which at 30%, make up the greatest weighting in the CPI metric. But to tackle owner’s equivalent rent inflation, Mr. Powell must first pop the record-setting real estate bubble. The negative ramifications of accomplishing this task for the banking system and economy will be enormous.

Nevertheless, if Mr. Powell prosecutes his plan to raise rates six or more times this year—just as the Fed destroys the money supply by shedding a trillion dollars in Treasuries and Mortgage-backed Securities–the upcoming recession could quickly morph into a depression.

So, which is it, Mr. Powell? Keep monetary policy loose and risk an intractable rise of inflation and the complete loss of confidence and credibility of the central bank. Or tighten monetary policy enough to deflate the massive bubbles in bonds, real estate, and equities. Either strategy is now destined to end in disaster for the market and economy.

Such are the consequences derived from the Fed counterfeiting trillions of dollars for the purpose of distorting and obliterating free markets.

The bottom line is this: the view of Pento Portfolio Strategies is that the Fed will now be forced to tighten monetary policy into one of the greatest decelerations of economic growth and earnings ever. A great defense is always a requirement in a winning portfolio strategy.

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 the Pivoter Cannot Now Pivot Back to a Dove

February 7, 2022

 The current Fed Chair is perhaps best known for his quick pivots from hawkish back to dovish and vice versa. Maybe he is just too dependent on the prevailing winds of the current economic data. Or, perhaps more accurately, he is most swayed by the performance of the stock market. In either case, Jerome Powell received more reasons to become hawkish just one day following his already hawkish FOMC press conference.

The Bureau of Economic Analysis reported Q4 2021 GDP growth at a 6.9% SAAR. This is a big problem for the Fed, since it falsely believes inflation comes from an economy that is growing too fast. Add in the 7% CPI print for December, and you have a Fed that now understands it is far behind the inflation curve and it’s time to pivot towards an even tighter monetary policy stance. Nevertheless, the FOMC fails to grasp the rapid growth and inflation was engendered by unprecedented fiscal and monetary stimulus, which has now gone in reverse.

Hence, what you have in reality is a massive fiscal and monetary drag that is already set to drive GDP growth towards the flat line. And, when you factor in the inventory build, which added 4.9 percentage points to the GDP figure in Q4, you get a slowdown this year that will be profound. But despite this organic slowing of the economy, inflation will be much more reluctant to become tractable. Rising energy prices, higher wages, and surging Owner’s Equivalent Rent values should keep CPI well above the Fed’s 2% target throughout most of 2022. Indeed, average rents rose 14% last year to $1,877 a month. In certain cities like New York and Miami, the yearly surge increased by as much as 40%, according to data from real estate firm Redfin.

Also pushing Powell along with his tighter monetary policy stance will be the data on inflation-adjusted incomes. Real disposable personal income decreased by 5.8% in the fourth quarter of last year.

What this all means is the dithering Fed will now be forced to catch up with the process of raising interest rates off the zero bound range and start draining its $9 trillion balance sheet. But this tighter monetary policy will occur in the context of an economy that is already slowing down. The Atlanta Fed estimates Q1 GDP growth at just 0.1%. Members of the FOMC have made it clear that they will look right past the first quarter weakness because of the Omicron variant’s negative effect.

The rapid drop in GDP growth, alongside the continuing headwinds of fiscal and monetary drags, should ensure that any stock market rally enjoyed in the remainder of Q1–following the January drubbing of equities–should be short-lived. Powell has well-telegraphed that the liftoff from the zero bound range will happen in March. And, unless inflation surges higher from the current 7% level between now and then, that first rate hike will be just 25 bps, not the feared 50 bps. Wall Street is prepared for that gentle liftoff and should be able to sustain the mild blow.

Nevertheless, by the end of the second quarter, the full impact from the monetary meltdown should begin to be felt. During May and June, the second and third interest rate hikes should take place. Also, in June, the FOMC will lay out its plan for the commencement of draining its massive $9 trillion balance sheet (QT) and also layout the pace of its decline. We can derive some clues about the Fed’s second QT operation by analyzing the statements made by the Fed Chair during his last press conference.

There are two salient quotes from Mr. Powell’s press conference. Regarding rate hikes, the Fed Chair stated, given the strength of the labor market and economy, “I think there’s quite a bit of room to raise interest rates without threatening the labor market.” The second and perhaps more important statement from the Fed-head was made in response to a question about the pace and timing of the Quantitative Tightening program. Powell said, “The balance sheet is much bigger and [its composition] has a shorter duration. And the economy is much stronger, and inflation is much higher. So, that leads you to being willing to move sooner than we did the last time and also perhaps faster.”

By how much should we expect the Fed to reduce its balance sheet? Well, Powell didn’t put an exact number on how much will be shed. But he did say he will “Significantly reduce the size of the balance sheet.” He also said he wants the Fed’s asset holdings to be limited to Treasuries. This means Powell will need to dump all of the $2.7 trillion of Mortgage-Backed Securities it currently holds on the market in relatively short order. That could spell disaster for the real estate market, which is the most overvalued in history based on the home price to income ratio, and was built on the back of record-low mortgage rates.

The Fed again had the temerity to try and claim this upcoming QT regime would simply run innocuously in the background—just like they claimed the last one would before stocks plunged and the REPO market froze. Previous Fed Chairs claimed that QT would be so uneventful it would be like watching paint dry. Let’s see just how true that is. The first time the Fed began draining its balance sheet was in October of 2017. The initial pace of asset reduction was $6 billion of Treasuries and $4 billion MBS. But by 2018, that pace increased to $30 billion in Treasuries and $15 billion in MBS. However, the stock market began to revolt by the fall of that same year. This prompted the Fed to announce in March of 2019 that it would cut in half the rate of asset sales starting in May and would cease QT entirely by September. As it turned out, the Fed had to completely end QT even earlier than indicated due to the 30% plunge in the Russell 2000 and the complete dysfunction in credit markets.

What all this means is that while Powell may desire to pivot back to a Dove as the stock market and economic data begins to falter, he cannot easily do so…not while inflation has risen to a forty-year high. During the previous round of QT, inflation was below the Fed’s 2% target. Powell no longer has the luxury to claim inflation is quiescent. Also, the Fed’s balance sheet has doubled since the first QT program. That is why the upcoming iteration of QT will likely run at twice the $45 billion per month pace seen when the first failed attempt to reduce the balance sheet began.

Of course, the Fed will eventually pivot back to Quantitative Easing to rescue the markets. But that will most likely be after the credit markets freeze and/or the major averages plunge greater than 30%. Until then, the Fed must continue to fight the battle against all-time, record-high inflation. Jerome Powell’s calculation is easy: defending the portfolios of the wealthiest Americans cannot take precedence over continuing to destroy the purchasing power and living standards of the voting middle class. Buy and holders of the 60/40 portfolio, better beware!

Fiscal and Monetary Cliffs Have Arrived

January 10th 2022

 According to Doug Ramsey of the Leuthold Group, 334 companies trading on the New York Stock Exchange recently hit a 52-week low, more than double the amount that marked new one-year highs. That’s happened only three other times in history — all of them occurring in December 1999.

How did we get back to the precipice of the year 2000, where tech stocks plunged 80% and the S&P 500 lost 50% of its value over the ensuing two years? Well, start off with the fact that the amount of new money created by our central bank in the past 14 years is $8 trillion. That, by the way, is an increase in base money supply only and does not include all of the new money created by our debt-based monetary system. So, from 1913 to 2008, the Fed created $800 billion. And, it took from 2008 until today—just 14 years–for it to have created $8.8 trillion in base money supply. Is there really any wonder why inflation has now become a salient issue, especially for the middle and lower classes, and why the stock market is now set up for a meltdown similar to the NASDAQ collapse of two decades ago?

Some might claim that the bubble in the stock market was much different in 2000 than it is today. They are correct. The overvaluation 22 years ago pales in comparison to today. With its record high P/S ratio of 3.5, as opposed to just 1.8 back in 2000. And the mind-numbing record high 210% TMC/GDP ratio, which is an incredible 68 percentage points ahead of where it ascended to 22 years ago.

Ok, so the stock market is much more expensive today than at any other time in history, but what will the catalyst be to set it tumbling off the cliff? Last week I talked about the monetary cliff coming in the next two months. To review: The Fed will wind down its record-breaking $120 billion per month counterfeiting scheme to zero dollars in that timeframe. This Q.E. involved the process of handing newly created money to banks, consumers, and businesses to boost consumption. But by ending this flow of new money, the Fed will also end its tacit support for the municipal bond market, primary dealers, money market mutual funds, REPO market, International SWAP lines, ETF market, primary and secondary corporate debt markets, commercial paper market, and support for student, auto and credit card loans. All of which were directly supported by Jerome Powell’s with the Fed’s latest Q.E. program.

But it doesn’t end there. Mr. Powell cannot be content with just ending Q.E., not with CPI running at 6.8%! Therefore, very soon after Q.E. is terminated, interest rates are heading higher, and the balance sheet of the Fed must start shrinking. However, an occasional 25-bps rate hike here or there won’t cut it. He has to hike rates by 680-bps just to get to a zero percent real Fed Funds Rate. Now, of course, Powell doesn’t intend to hike monetary policy that much because he is fully aware it would collapse the whole artificial market construct well before he gets anywhere close to that level. But the point here is that the FOMC has lost the luxury of being able to delay and dither as it has in the past because inflation is running at a 40-year high. Hence, the Fed will need to hike rates rather aggressively until inflation, the economy, or asset prices come crashing down. But since all three are so closely linked together, they will likely all cascade simultaneously.

And, now this week, I want to shed some new light on the concurrent fiscal cliff and shoot a hole through Wall Street’s excess savings B.S. As most of you are already aware, I’ve been pretty clear about the negative consumption effects that will result from the ending of $6 trillion in government handouts over the previous two years. This massive and unprecedented largess caused the savings rate in the U.S. to jump from 7.8% in January 2020 to 33.8% by April of the same year. However, that savings rate has now collapsed back down to 6.9%—below its pre-pandemic level. But what about the stash of savings consumers are sitting on that is supposed to carry GDP ever-higher this year?

Well, it appears that the rainy day fund is dwindling quickly. According to the N.Y. Times and Moody’s Analytics, the excess savings among many working- and middle-class households could be exhausted as soon as early 2022. This would not only reduce their financial cushions but also potentially affect the economy since consumer spending has risen to become nearly 70% of GDP.

We have already seen multiple pandemic-era federal aid programs expire last September, including the massive federal supplement to unemployment benefits. Now, with the Expanded Child Income tax credit having expired, which gave up to $300 per child under 6, and up to $250 per child ages 7 to 17 over the period from July to December, the fiscal challenges have become salient for many Americans.

But what about that pile of savings? Estimates are that it now amounts to around $2.0 trillion (8.5% of GDP). It’s mostly in the hands of the very rich, who are savers and have a much lower marginal propensity to consume than those in the middle and lower classes. According to a study from Oxford Economics, 80% of that savings is in the hands of the top 20% of earners, and 42% went to the top 1%. Again, this is important because it is the middle and lower classes that are responsible for the majority of consumption. So, how is this economically-crucial cohort doing? Well, in addition to getting hurt by inflation and falling real wages, they are running out of their stimulus hoard quickly. According to a recent study done by JP Morgan Chase, households making $68,896 per year or less only have an extra $517 in their checking accounts on average compared with their pre-pandemic level. As unimpressive as that sounds, add in the fact that people don’t eat into their savings with the same zeal that they spend a fresh government handout, and you can see that so-called “mountain of savings” Wall Street loves to tout isn’t much more than a molehill.

When you factor in the massive fiscal and monetary cliffs together with the most overvalued stock market in history, you have the recipe for potential unprecedented stock market chaos, which should be front-end loaded in ‘22. If your retirement savings is with a deep state of Wall Street firm, you hold some mix of stocks and bonds that is set on autopilot. Their fate should be the same as the Hindenburg and Titanic.

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 Reconciliation of Asset Prices

December 20th, 2021

The coming new year will be fraught with risk due to the removal of central bank and government supports. This could very likely lead to the collapse of the most overvalued stock market in history.

According to the Conference Board, US economic growth is set to slow from 5.5% annual growth for all of 2021, to 3.5% during 2022. Of course, Wall Street apologists almost never predict a recession until we are in the middle of one. Nevertheless, it is clear that the growth of the economy will slow significantly next year. And, in the view of Pento Portfolio Strategies, the risk of a recession and an asset bubble collapse is high.

S&P 500 EPS growth will plunge from 45% this year, to just 5-6% in ’22. Again, this is the optimistic view that leaves a great deal of room for error to the downside and virtually zero to the upside. After all, you can only open up an economy once following a global pandemic, and that already happened this year. And, it will be nearly impossible to comp the previous two years’ $6 trillion fiscal support, along with the $4.6 trillion expansion of the monetary base.

We recently learned from the Bureau of Labor Statistics (BLS) that Consumer Price Inflation (CPI) surged by 6.8%, and Producer Price Inflation (PPI) shot up by 9.6% y/y in November. This helped to send Real Average Hourly Earnings down by 1.9 percent from November 2020 to 2021. CPI is running at a 40-year high and is at a rate that is 3.4 times higher than the Fed’s asinine 2% target.

Of course, the clueless Fed finally started reacting to all this inflation by announcing at the December FOMC meeting that it would be speeding up the pace of its taper by two times. But this is happening just when the rate of inflation is actually peaking. In reality, Fed-Head Jerome Powell had no choice but to expedite the tapering of his QE program. After all, it is an untenable notion that the Fed should be adding to the supply of money at a breakneck pace when CPI is the highest since 1982. But without question, Mr. Powell deserves much derision for waiting until inflation reached a multi-decade high before starting to taper asset purchases, let alone begin to raise interest rates off the current level of 0%.

It will take (ten) 25 basis point rate hikes to reach a 2.5% Fed Funds Rate (FFR), which the FOMC now regards as a neutral overnight lending rate. Powell believes a neutral FFR would be 50 bps above the FOMC’s 2% inflation target—assuming inflation falls to that level. In spite of these plans, the chances are very small that the Fed will end up being able to hike rates very much at all before the entire artificial economic construct comes crashing down. This is because the yield curve is already rapidly heading towards inversion even before the tapering of QE has really even begun. An inverted yield curve is a predictor of a recession that has worked 100% of the time. The spread between 2 and 10-year Notes has already contracted from 159 bps at the end of March to just about 75 bps today. Meaning, by the time the QE taper is consummated, there probably won’t be very much room at all to hike rates before an inversion takes place.

But regardless of the Fed’s feckless nature, the fact remains that the biggest buyer and direct supporter of Mortgage-Backed Securities and Treasury Bonds, along with its stated support of corporate debt (including Junk bonds), will be exiting the market entirely come March ‘22. This leaves a tremendously dangerous vacuum in place, especially in non-government-backed debt. The Fed’s QE program has kept the massive real estate and equity bubbles afloat, as well as the $12 trillion worth of Business debt from imploding. But Powell’s Put has expired because inflation is now a big problem.

Then, you must factor in the stubborn COVID Delta variant and the new and more contagious Omicron mutation, which Mr. Powell now views as potentially adding upward pressure on inflation. This could cause the Fed to tighten its monetary policies even more quickly. The consumer will also be left with the complete lack of any fiscal support of any significance next year, after receiving $50k on average per American family over the previous two years.

The truth is, the solvency of nearly every developed nation on earth is contingent on interest rates that remain in the sub-basement of history–AKA, record lows and around zero percent. This is only possible if central banks maintain complete domination of free-market forces and keep their hydraulic presses down on yields. Let’s be honest, without the backstop of these state-owned entities, solvency and inflation concerns would combine to force yields much higher. In the case of the US, with CPI inflation at 6.8% and a national debt-to-income ratio above 725%, it would be impossible for a 10-year Treasury bond to yield just 1.4% without the heavy hand of the Federal Reserve. The point here is that the US has immense solvency and inflation problem now, yet still enjoys record-low borrowing costs thanks to the Fed.

However, this function is now changing. A central bank can usually usurp the free market regarding its sovereign borrowing costs as long as both solvency and inflation concerns are quiescent. For example, the Fed has yet to truly exit its yield curve suppression programs, which have existed for the better part of the last two decades, because consumer price inflation was not an issue. This is true even though our Nation’s debt to GDP ratio is higher today than any time since WWII. Up until this point, that growing trend towards insolvency has been veiled thanks to the central bank’s interventions. But the resurgence of inflation, in conjunction with that humongous debt burden, has become extremely problematic.

In the absence of inflation, central banks have been able to print enough money to ameliorate recessions, bear markets, real estate debacles, and solvency concerns–such as the European debt crisis circa 2012. Where Bond yields in the southern periphery soared to 40% before European Central Bank chief Mario Draghi promised to monetize the debt issues away. Again, he could only accomplish that because inflation was not a concern a decade ago in the Eurozone.

Turning back to the US, the next recession, which is likely to occur in ’22, will cause solvency concerns to spike as revenue collapses and the National Debt-to-Federal-income ratio soars. However, this time around the Fed’s ability to monetize away collapsing asset prices and crumbling economic growth will be fettered by an inflation rate that is already many times greater than it is comfortable with.

That leaves the Fed and Treasury with a dangerous dilemma: allow asset prices and the economy to implode, which will certainly fix the inflation problem; but will most likely lead to a depression. Or, try and pull the economy and assets higher by once again borrowing and printing multiple trillions of dollars, which will send the rate of inflation skyrocketing from its 40-year high. That will risk destroying confidence in the USD and any faith that remains in the bond market. Therefore, the stock market and economy would collapse anyway as inexorably rising inflation pulls yields on sovereign, municipal and corporate bonds ever higher.

Wall Street’s perma-bulls will never admit that the Fed’s Put has now expired. Of course, the Powell Pivot will indeed happen once again as he continues to meander between hawkish and dovish depending on the lagging economic data he receives. But his next pivot back to an uber dove will only occur ex-post the Great Reconciliation of Asset Prices. This is why a buy-and-hold strategy no longer works and why identifying inflation and deflation cycles has become so critical.

 

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.”

 

Interest Rate Normalization is Impossible

November 8, 2021

Stagflation is undermining the U.S. economy, and that poses a huge problem for Mr. Powell and his merry band of money printers.

Inflation is running at a pace that is just about 3x faster than real GDP growth–a figure the Fed can no longer ignore. This is why Mr. Powell had no choice but to announce at November’s FOMC press conference that the Fed would reduce its purchases of MBS and Treasuries by $15 billion each month starting this month. Therefore, officially pushing the economy further towards the edge of the monetary cliff. Meaning, the amount of new monetary creation will go from a record $120 billion per month to zero by the middle of 2022.

Slowing Growth

The U.S. economy grew at a SAAR of just 2.0% in the third quarter, down from 6.7% in the prior period. This deceleration of growth will continue into next year, despite a brief reversal of this trend in the current quarter.

The most astute money managers look at the shape of the yield curve for clues to economic growth. A compressing difference between long- and short-term interest rates means the economy is slowing. When short-term rates are higher than long-term rates, it means a recession is high. Well, there’s no inversion now, so no reason to fear a further contraction in GDP. Right? Wrong! Did you know that the U.S. 30-year Treasury has a lower yield than the 20-year bond? This isn’t the most monitored duration. 10’s and 2’s are. But it would be unwise to ignore this extremely rare event.

Disposable Personal income actually fell by 1.3%, or $237 billion, during September. This can’t be good news for consumers faced with 5.4% CPI. They are drawing down savings quickly as the government subsidies wound down during the last month of the quarter. That trend of depleting savings will escalate into next year. Perhaps this is why the world’s largest retailer outside of China, Amazon, warned last week for the 4th quarter on weaker revenue and earnings. In fact, that slump in income means that the personal savings rate fell to 7.5% last month, which is now below its pre-pandemic level.  It isn’t much of a mystery why consumer confidence is so dour. The Index of Consumer Expectations is down 14.3% on an annual basis.

Despite these facts, Wall St. predicts an economic rebound during 2022. Of course, there should be a brief period of accelerating growth in the 4th quarter primarily due to a reduction in the COVID Delta Variant and the issuance of Expanded Child Income Tax credits. This temporary rebound was evident in the ISM Services Index, rising to 69.8 in October. Nevertheless, starting in Q1 of next year, the economy will have already experienced the full benefit of any reduced Delta cases–assuming the new Delta Plus mutation fizzles out, which is a big assumption. Also, the front-end loaded child tax credit payments end in December. Therefore, the fiscal cliff will be in full effect, just as the global monetary cliff will be in free fall. Add in higher interest rates, high inflation, supply chain bottlenecks, a shrinking labor force participation rate, and a faltering Chinese real estate bubble, and the picture becomes even direr.

Jerome Powell’s Inside Joke

The narrative from Wall Street is that central banks will merely have to lightly tap on the monetary breaks, and inflation will gradually ease back down to 2%. This will lead the financial markets to continue to pile up record high after record high. That might have been a possible scenario if global central banks had not distorted interest rates to such obscene levels. And, as a direct result, conjured the most overvalued equity market in history into existence.

For example, investors must think about this: what would be the yield on European 10-year bonds without the ECB’s record-breaking pace of money printing, which must soon end to combat a 4% inflation rate in the Eurozone? Interest should begin to normalize, and that wouldn’t ordinarily be a problem. However, due to unprecedented interest rate manipulation, the German 10-year Bund is starting off at a negative 0.08 percent. That yield was 5% in the year 2000, before the ECB, along with the other major central banks, adopted interest rate suppression measures. It’s the same dynamic throughout the developed world–including the United States. Benchmark Treasuries were 6% back in 2000, which was prior to the great interest rates suppression scheme taken on by the Fed. Today that yield is just 1.5%.

Hence, interest rate normalization wouldn’t be much of an issue if yields were so distant from historically normal levels. In sharp contrast, they are at the very minimum at least 450 bps away from normal. I say at the very least, because interest rates should be much higher today than they were 20 years ago. This is due to a much higher rate of inflation than witnessed in 2000, coupled with the increased solvency concerns on Treasury debt. To put figures on that statement: The rate of inflation is 200 bps higher than it was in 2000. And, the National debt to GDP ratio is an incredible 70 percentage points higher today than it was at the turn of the millennia.

The simple truth is interest rate normalization would render the U.S. an insolvent nation. The National debt is already $29 trillion–a full 725% of Federal revenue. And, the amount of money needed to service that debt would soar into the trillions each year if rates were to rise anywhere close to a normal level.

Also, rate normalization would result in the wipeout of the record-setting equity bubble, as evident in the current Price to Sales (P/S) and Total Market Cap (TCM) to GDP ratios. There aren’t any better measurements of the valuation of equities than those two ratios. The TMC/GDP ratio was 130% back in 2000. However, it is a shocking 211% today. Similarly, the P/S ratio was 1.5 in 2000; it has skyrocketed to around 3 recently.

Hence, not too far along Mr. Powell’s effort to end Q.E. and the raising the Fed Funds Rate, asset prices should collapse—including the real estate complex–and cause the Fed to once again inform Wall Street that it was just kidding when it comes to allowing the free market to set prices.

Then, watch out for a humongous amount of permanent Universal Basic Income to be deployed, which will be monetized by the Fed. The Stagflation suffered today should pale in comparison to what is to come, as any faith left in the currency and bond market will be destroyed.

Riding these inflation and deflation waves appropriately is crucial to your investment success.

 

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.”