Commentary

Central Planners: Out of Room and Running Out of Time

December 9, 2019

One would have to place their trust in unicorns, sasquatch, leprechauns, and the tooth fairy to believe the current economic construct is sustainable. You also need to be woefully ignorant of history. In fact, there has never been a nation that engaged in massive debt monetization and did not eventually face hyperinflation, depression, and mass chaos. There is simply no such thing as magic, and you can’t build an economy on the foundation of debt, asset bubbles, and unlimited fiat money printing.

Perhaps the reason why the market hasn’t imploded yet is that the developed world has coordinated this so-called “strategy” of unbridled central bank lunacy to engage in permanent ZIRP and QE. Therefore, a currency crisis has been averted so far. However, now that these money printers have gone all-in, the next recession or freeze-up in credit markets cannot be averted by a dovish turnaround in monetary policies, as governments already have the gas pedal to the monetary and fiscal floor. The globe now has $255 trillion in debt, and the U.S alone is adding one trillion to that pile each year. The Fed is back in QE, along with the ECB and BOJ. And, no central bank in the developed world has room any longer to cut rates enough to boost consumption.

In the past few months, we have seen the yield curve invert, credit markets freeze, spiking repo rates, stalling global economic growth, an earnings recession, and a crash in equities. The Fed has panicked from the practice of raising rates and from burning the base money supply through its QT program to three rate cuts and a return to QE ($60 billion per month). That trenchant change in monetary policy is the main reason why the market has rallied to near all-time record highs.

Therefore, the salient question for investors is to determine if the economy is in a 1995 type of mid-cycle slowdown, where the Fed cuts rates a few times and stocks rallied nearly 200% into the end of the millennium (That is what Mr. Powell is hoping for and wants you to believe). Or, are we in a 2000/2007 rate-cutting cycle, where the Fed’s efforts to slash and burn banks’ borrowing costs by over 500 bps was still woefully inadequate towards reflating the economy and equities? And, in fact, did nothing to avert an absolute bloodbath in asset prices on both occasions.

It is critically important to answer this question correctly because you don’t want to be short stocks and miss out on the ride up to the massive blow-off top. Likewise, you don’t want to passively buy and hold equities when they are on the cusp of losing over half their value once again. Either way, it is imperative to point out that the Fed was only able to keep the inevitable crash in abeyance for just a few years at best. But, it only exacerbated the eventual demise. So, we are definitely headed for an epoch crash; the only question that remains is from how high?

With the value of equities already in the thermosphere, another massive increase in stock prices like we saw in the late ’90s is out of the question. Global interest rate levels are at an all-time low, while debt levels are at an all-time high. And, the entire developed world’s central bankers are already in some state of QE. Therefore, the incremental monetary and fiscal fuel just isn’t available to boost asset prices much further from here.

Having a model that analyzes 20 rigorously selected components and signals when it is time to bail out of equity-long exposures, get into cash, get net short stocks and increase exposure to gold is crucial. The earnings and GDP growth picture continues to deteriorate and points to trouble ahead. However, as of yet, we do not see any breakdown in the high-yield debt market. Also, the breakeven and LIBOR spreads are still quiescent. And importantly, although the Ten-Two Treasury Note yield spread has started to contract once again after inverting last year, it has not yet set off alarm bells–but it is getting very close. If that spread gets below ten bps or even inverts once again, it will most certainly mean that the Fed’s mid-cycle adjustment was woefully inadequate, and we are headed for another Great Recession/depression coupled with a crash in equity prices. Alternatively, if the yield spread widens due to a rising Ten-Year Note, then it is a sign of increasing economic strength, albeit on a temporary basis.

At the end of last year, investors were pricing in a recession, and the stock market was in freefall. But, as of now, the Fed’s pivot has allayed those fears of recession and has caused most investors to fully price in a global economic recovery. Now the burden is on that recovery to materialize. Otherwise, investors are in for a huge disappointment, given the fact that stock valuations have never been higher relative to the underlying economy. Investors need to monitor the data instead of being brainwashed by Wall Street’s mantra about perpetual growth and fair valuations. Making money during all economic cycles should be the goal and that includes depressions, stagflations and everything in between. This is unique on Wall Street because 95% of money managers just try and mimic the S&P 500 and charge a hefty fee for doing so.

I’ll close with this warning from Vanguard, who is the largest provider of mutual funds and the second-largest provider of exchange-traded funds in the world. “As global growth slows further in 2020, investors should expect periodic bouts of volatility in the financial markets, given heightened policy uncertainties, late-cycle risks, and stretched valuations. Our near-term outlook for global equity markets remains guarded, and the chance of a large drawdown for equities and other high-beta assets remains elevated and significantly higher than it would be in a normal market environment…Returns over the next decade are anticipated to be modest at best.”

The average investor will be lucky to see any returns at all over the next decade and with major drawdowns during that 10-year duration. Given this extraordinary setup, investors may want to plan on shorting the market when the secular downturn arrives. This way they will have the capital available to deploy once the panic is over.

 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.”

 

Priced for Perfection

The stock market has now priced in a perfect resolution for all of its erstwhile perils. Wall Street Shills would have you believe that since the Fed has turned dovish, it will always be able to push stocks higher. The trade war is about to reach a peaceful conclusion, and that will be enough to fix all that ails the global economy. A no-deal Brexit is off the table, and a smooth transition out of the EU will occur. Peace will soon break out in Hong Kong, and its troubled economy will have no contagious global economic effects. And, there will be a sharp rebound in Earnings Per Share (EPS) growth from the current earnings recession because…well…just because we need one.

However, beneath the surface of this economic charade, the carcass is rotting, and the stink can be smelled by anyone who isn’t willingly holding their nose. To this point, the leveraged loan market, which consists of loans made to highly indebted and barely solvent entities, has seen an increase of 100% since 2007, according to the Bank for International Settlements.

There is about $16 trillion worth of U.S. business debt, about 1/3rd of which is comprised of leveraged loans and bonds that are rated junk. Half of the bonds that are in the category of Investment Grade have a rating that is BBB, which is just one level above junk. If that isn’t scary enough, dealers are willing to hold in inventory $12 billion of these types of loans, according to Bloomberg.

The salient question is: what will happen come the next recession when panicked holders try to sell trillions of dollars’ worth of distressed debt to a market that currently provides liquidity for just .075% of the market?

The Conference Board’s Leading Economic Index declined for a third consecutive month in October, and its six-month growth rate turned negative for the first time since May 2016. Meanwhile, Washington D.C. is mired in self-destruct mode. There is still no passage of a phase one trade deal even though one was announced on Oct. 11th with much fanfare. No passage of the USMCA trade deal, even though it has been sitting on Nancy Pelosi’s desk for a year. No passage of a budget deal, and so, the government is forced to fund operations by passing continuing resolutions (CR). This C.R. that was just passed only funds the government until Dec. 20th.

Maybe we should be happy that Washington is broken because when it works, all they can agree on is how to spend a lot more money. To this point, October government spending hit a record $380 billion, which led to a 34% jump in the year over year deficit and caused $134.5 billion worth of red ink to be spilled in one month. The U.S. is mired in permanent QE, is posting trillion-dollar deficits without end, has waring political parties, and operates its government without a budget. We are sadly looking more like a banana republic every day.

Investors have placed their faith in a Fed that has continuously proven its incompetence. Former Fed Chair Janet Yellen avowed not too long ago that there would not be another financial crisis in our lifetimes. However, she is now warning, “… the odds of a recession are higher than normal and at a level that frankly I am not comfortable with,” she was quoted saying this at the World Business Forum on Nov. 21st. What I find most disturbing about her comments made was what she said about retirees and savers. Yellen actually bemoaned the fact that people are forced to save money in the bank and get nothing for doing so. In fact, she was actually concerned that they are getting penalized for doing the right thing and falling further behind inflation. What!?

Ms. Yellen raised interest rates just 50 bps in her total four-year tenure at the Fed. But only now she is worried about savers and the Fed’s role in fostering the wealth gap? But what she has not, and cannot admit to, is how bad the next recession is going to be. While she did allude to the fact that central banks no longer have room to lower borrowing costs, she fails to understand that her willingness to keep offering free money for many years likely means her recession prediction is really a depression forecast. This is based on the record debt levels and historical asset bubbles that have been engendered by the Fed’s actions.

As the march towards global recession proceeds onward, the composite EU Purchasing Managers Index (PMI) for both manufacturing and services released last Friday fell to 50.3 from 50.6. Orders fell for the third straight month, and employment growth also slowed. The Australia, UK, and Japan PMIs all show these economies are still contracting. The Official NBS Manufacturing PMI in China fell to 49.3 in October, from the previous month’s 49.8. Any reading below 50 shows economic contraction. The only slightly better news was found in the U.S. flash services sector purchasing managers index in November. It rose to 51.6 from 50.6 but still is indicative of an economy that is barely growing. Even the “Better than expected” Durable Goods orders being pumped on financial news networks isn’t the real story. While the headline month over month reading for October climbed by 0.6%, the year over year number declined by 0.7%. And, the important Core Capital Goods New Orders figure fell by 0.8% YoY. Falling capital goods means business is not investing in productive assets and GDP growth will indeed suffer as a result.

Wall Street shills keep wishing for a turn in the global economy in 2020 because a booming rebound has already been priced into equities. But the only turn we are getting so far is one to the downside. That is going to be really bad news for the buy and hold crowd.

I want to close with a bit of central bank hypocrisy. The following is an excerpt from a paper published by two economists at the St. Louis Fed, Scott A. Wolla and Kaitlyn Frerking. They warned about the potential dangers involved when a nation’s central bank buys its own debt.

“A solution some countries with high levels of unsustainable debt have tried is printing money. In this scenario, the government borrows money by issuing bonds and then orders the central bank to buy those bonds by creating (printing) money. History has taught us, however, that this type of policy leads to extremely high rates of inflation (hyperinflation) and often ends in economic ruin.”

The paper published this month never acknowledges that this is exactly what the Fed has done and continues to do to this day. Not just a little bit but in a big way. The Fed has already permanently monetized nearly $4 trillion worth of debt, and it is just getting started down this pernicious path. This strategy is a page taken from the how-to-be-a-banana-republic playbook and has been repackaged by some far-left politicians and Sudo-economists and renamed as the Modern Monetary Theory (MMT). MMT is just a euphemism for debt monetization. Nevertheless, no matter what you call it, creating new money from nothing to purchase government debt has never worked in the history of economics and has always led to economic ruin.

There will be times when debt will be explicitly restructured (deflation) and other secular periods consisting of inflationary defaults (MMT, QE, Helicopter Money, or whatever name Jerome Powell is willing to put on it.

Investors need to model these dynamics to make sure they are on the correct side of the cycle, depending upon how the government is defaulting on this debt.

 

Fed Can’t See the Bubbles Through the Lather

November 12, 2019

Recently, there has been a parade of central bankers along with their lackeys on Wall Street coming on the financial news networks and desperately trying to convince investors that there are no bubbles extant in the world today. Indeed, the Fed sees no economic or market imbalances anywhere that should give perma-bulls cause for concern. You can listen to Jerome Powell’s upbeat assessment of the situation in his own words during the latest FOMC press conference here. The Fed Chair did, however, manage to acknowledge that corporate debt levels are in fact a bit on the high side. But he added that “we have been monitoring it carefully and taken appropriate steps.” By taking appropriate steps to reduce debt levels Powell must mean slashing interest rates and going back into QE. The problem with that strategy being that is exactly what caused the debt binge and overleveraged condition of corporations in the first place.

Global central banks have abrogated the free market and are in the practice of repealing the business cycle and ensuring stocks are in a permanent bull market. Massive and unrelenting money printing is the “tool” that they use. The good old USA had its central bank cut rates to 0% by the end of 2008 to combat the Great Recession; and that paved the way for the EU to join the free-money parade by 2016. In fact, the Band of Japan had already been at the zero-bound range years before. This means much of the developed world has been giving money away gratis for the better part of a decade.

And now central banks actually want you to believe that multiple years’ worth of global ZIRP has somehow left asset prices devoid of any significant distortions. All is normal here, or so we are told. So, I thought it would be prudent to shed some light on a few of those glaring imbalances that should be obvious to all except a debased central banker. To be blind to them screams of incompetence or mendacity–or both.

Forty percent of Europe’s investment grade corporate debt offers a negative yield and there are at this time $15 trillion worth of sovereign debt globally with a negative yield as well. The valuation of equities in the U.S. is now for the first time ever 1.5 times its phony and free-money-goosed GDP. Yet, at the same time S&P 500 margins and earnings are shrinking. The U.S. has increased its business debt by 60% since the Great Recession–it now totals $16 trillion, which is an all-time high in nominal terms and as a percent of GDP. Much of this debt has been used to buy back stock and reduce share counts to boost EPS. Corporate buybacks, which were illegal in the U.S. before 1982, will breach $1 trillion this year. As far as the Fed is concerned, issuing a record amount of debt to buy back stocks at record high valuations is just fine.

According to the BIS, 12% of businesses in the developed world have become zombies–having to issue new debt just to pay the interest on existing debt—this figure is also at a record. The average interest rate on the U.S. 10-year Treasury Note prior to the Great Recession was about 7%. Today, this rate is a lowly 1.8%.

It appears central banks are completely oblivious to the global bond bubble even though they are its very progenitor. For further examples, back in the European debt crisis of 2012, the borrowing costs for the insolvent countries known as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) shot up to the thermosphere. The Greek 10-year Note hit a yield of 40% and caused the economy to crash under the weight of its mountain of debt and skyrocketing servicing costs. This led to an explicit and partial debt default of its obligations and a humongous European Central Bank bond-buying program that promised “to do whatever it takes” to bring down yields. The Greek 10-year yield is now just 1.6%, even though the country’s National debt to GDP ratio has actually increased from 159% in 2012, to just under 200% today. How can this be? The answer is, Greek debt is once again in a gargantuan bubble, but this time around it is now and forever on the life support of ECB counterfeiting. It is the same story in Portugal. Its 10-year Note yield shot up to an untenable 16% in 2012. But through the magic of the printing press it is now just under 0.25%. As incredible as that rate is, it exists even though Portugal’s National debt to GDP ratio is still over 120%; just about the same level it was back in 2012 when the market caused its rate to skyrocket.

The U.S. deficit increased by 26% y/y and is now $1 trillion per annum. The annual deficits are projected by the CBO to be at least $1.2 trillion for the next decade. That is, if everything goes perfectly fine in the economy and rates stay at historic lows–and there is never another recession. For Mr. Powell and company, all this is viewed as being completely normal.

In addition, history has proved throughout the centuries that once an economy has more than a 90% total debt to GDP ratio, its economic growth becomes impaired. The total in the U.S. is now 330%, in the EU it is 450%, and Japan has over 600% total debt to GDP. How did the entire developed world become so debt-disabled? The answer is simple: artificial interest rates provided by central banks have incentivized, facilitated and enabled governments to issue massive amounts of debt with impunity. Again, according to central bankers there is nothing to see here.

These are just a  few of the many examples of market distortions arising from central banks artificially pushing yields into the sub-basement of history. Now they have destroyed the market-based pricing of fixed income and equities across the globe. These markets have now become wards of the state forever and ever amen.

The sad truth is that the entire artificial and tenuous construct of markets is predicated on interest rates that perpetually fall and never increase. As long as this baneful dynamic is in place, asset bubbles grow bigger, and debt levels rise. Thus, making the economy increasingly more dependent on lower and lower interest rates. The problem is most central banks have already arrived at the zero-bound range and/or are in various stages of QE. Even the horrific Fed only has one and half percentage points from running out of ammo to reduce borrowing costs and is already printing $60 billion per month in QE. And yes, that is exactly what it should be called. Hence, when (not if) the next economic contraction begins, money markets will once again freeze and the record number of zombie companies will begin laying off millions of employees as a result of being shut out of the credit market. Then, the global bubble in junk corporate debt will crater and cause panic in equity markets like never before in history.

According to the Fed and the deep-state on Wall Street, all is completely normal.

The China stock bubble burst 12 years ago, and the Shanghai exchange is still down 50% from that high. Japan’s bubble burst 30 years ago, and investors are still down 40%. Global central banks have set the table for a record implosion of markets and the major U.S. averages are by far the most overvalued. This is why it is imperative to model the dynamics in credit markets to ensure you can participate in the upside of stocks while the charade lasts. But most importantly, also avoid getting slaughtered like a passively managed pigeon once interest rates spike and the global credit bubble finally bursts.

 

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 to Avoid the Next 50% Market Crash

October 28, 2019

This ageing bull market may soon face the third market collapse since the year 2000. Nobody can predict the exact starting date of its decline—but either a recession or stagflation will surely be its catalyst. During the next debacle, the typical balanced portfolio designed by Wall Street, which consists of approximately 60% stocks and 40% bonds, will no longer provide much protection at all. In fact, that type of portfolio construct has become downright dangerous.

The simple reason for this is that for the first time ever both stocks and bonds are in a massive and unprecedented bubble; and are therefore both vulnerable to significant selloffs. Bonds will no longer provide a ballast or offset to your stock portfolio once reality hits both of those asset classes. If a bond has a 5% yield and has 30 years left to maturity; that holder would lose 25% of his principal if interest rates rise by just 2%. Given the fact that bond yields are the lowest in history, an increase of 2% is certainly not out of the question; and is in fact most likely inevitable.

What happens with the equity portion depends on the reason why rates are rising. If rates increase because of a surge in economic growth, then equities should do well for a while longer. However, if rates rise because of inflation or credit risks; then stocks would likely get hurt very badly indeed. In that case, there is a high probability of losing money in both your equity and fixed income buckets.

Therefore, a smarter way to invest–rather than just blindly buy and hold a closet Index fund and hope for the best—is to map the economic cycle. Given that Wall Street’s version of diversification will most likely no longer work, it is now imperative to understand where the economy lies along the spectrum between Inflation/Deflation and Growth/Recession.

An alternative investment strategy is now necessary because the Fed decided around 20 years ago that recessions could be abrogated and it had the tools to repeal the business cycle. It kept pushing interest rates lower every time there was either a downturn in the economy or a sharp selloff in stocks. This is exactly what happened in the wake of the NASDAQ bubble of 2000 and the Housing Crash of 2008. Indeed, Greenspan started this practice in 1987; but its roots were planted in 1971 when the US left the gold standard completely.

Each iteration of this cycle served to push asset prices higher than what the underlying economy could support. This also caused even more debt to be accumulated. Now, we have a triumvirate of asset bubbles (stocks, real estate and bonds) that exist globally. Speaking of the real estate bubble–although it is no longer the nucleus of the current bubble–it should be noted that National Home prices have increased for 91 months in a row and have advanced 5.9% y/y—far above the pace of income growth. The sad truth is that the Fed, in full cooperation with Wall Street, has once again made home prices unaffordable for many first-time buyers.

The fact is that debt levels have exploded worldwide and yet at the same time interest rates have never been lower than they are today.

Here’s some data points that we all should and need to be aware of:

  • Total market cap of equities as a share of GDP is now 145%. That ratio was 100% in 2007, and has averaged just 80% since 1971.
  • $15 trillion worth of sovereign debt with a negative yield
  • 500 billion euros of junk bonds in Europe with a negative yield
  • $5.4 trillion of BBB, Junk and Leveraged Loans in the US, there was only $1.5 trillion of sub-prime mortgage debt in 2007
  • The US Treasury yields 1.7% but its average is above 6%
  • US deficits breached above $1 trillion in fiscal 2019 and the CBO projects deficits will be $1.2 trillion each year for the next decade but that assumes interest rates never normalize and the economy never has a recession. If rates rise and/or we have a recession, the annual deficit could approach 15% of GDP. Adding to our already-huge national debt of $22.6 trillion.
  • Total global debt has soared to $250 trillion up over $70 trillion from 2008 and is now a record 330% of GDP
  • US Non-financial debt has soared from $33 trillion in 2007 to $53 trillion in 2019
  • US National Debt was $9 trillion in 2007 and has skyrocketed to $23 trillion today
  • Business debt has jumped by nearly 60% since12 years ago

The point here is not to scare you; but to help you make good investment decisions.

The gravitational forces of deflation are immense and trying to bring about a healthy recession. This would cause a significant paring down of debt along with an even greater correction in equity, junk bond and property values. That is, if the economy was left alone and market forces were allowed to rectify the imbalances. However, global central banks are fighting these market forces and trying to keep asset bubbles afloat by pushing interest rates even lower and returning to QE.

The problem is, central banks are simply running out of room to reduce borrowing costs. And speaking of central bankers, if any of you still believe in the Fed’s omnipotence and omniscience then please remember that it was in Quantitative Tightening only a few months ago and now has returned to QE–just don’t call it that–even though Chair Powell is monetizing debt exactly like Bernanke and Yellen were doing. Therefore, buying $60 billion of short-term Treasuries is QE in every sense of the word. The only difference between QE 4 and QE’s 1,2 &3 is the Fed is now trying to steepen the yield curve, while the other iterations of QE were about pushing down long-term interest rates. In either case, it is debt monetization just like any other banana republic would do. Only this round of QE is worse than all others before it because investors know for sure it is permanent. The Fed can no longer pretend QE was temporary.

The truth is that central banks have destroyed free markets and the global economy has become massively unstable. We have artificial interest rates that are in the basement of history as a direct result of global central banks printing the equivalent of $22 trillion since 2008. This has in turn caused a humongous distortion in most asset prices that are now perched at dangerously high levels.

So, what should we do as investors?

What we should not do is just take a 50% stake in gold and go 50% short stocks and then claim that someday we will be right because of what ought to be happening right now. Instead, investors need to intelligently model the economy to determine what sectors and style factors of stocks to own. And, what asset classes should they be most exposed to; equities, bonds or commodities depending on the rate of growth and inflation.

Pento Portfolio Strategies uses the Inflation/Deflation and Economic Cycle Model SM and its 20-components to determine the macroeconomic condition of the economy.

Both public and private debt levels have grown so large that it must be defaulted on; either through inflation or deflation. How governments choose to default on the debt will make a world of difference in how you invest your money. Think back to 2018. It was a year where we were on a path towards interest rate normalization and QT. But that led to a crash in stocks by the end of the year. Now, most central banks have turned dovish and the Fed has redefined stable prices by making 2% inflation a floor rather than a ceiling. The major issue is that there is very little room at all to reduce borrowing costs in order to re-inflate asset prices and the economy.

So, the question now is do central banks have enough ammo to avert a recession? The recession of 2001 saw the NASAQ lose 80% of its value and the Great Recession of 2007-2009 saw the S&P lose half its value and home prices drop by 33%. The sad truth is the distortions evident in the prior two recessions are dwarfed by the record triumvirate of asset bubbles that exist today on a worldwide basis.

The whole idea is to make money slowly and carefully in the current environment but then also make sure we try to protect and profit from the inevitable recession and/or inflation with its mean reversion of interest rates.

This dynamic strategy gives us an opportunity to vastly outperform the major indexes during cycles of stagflation and recession/depression, in which equities undergo a bear market. Holding a static portfolio did not work during the Great Recession and it probably won’t work during the next crisis either.

Given this exceptional time in history–one where the main stream financial news has never been more incompetent and corrupt; and where the global economy has never been more unstable—a source like PPS is mandatory to obtain the correct market guidance.

 

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

Will Rate Cuts Be Enough?

October 14, 2019

 The mainstream financial media is absolutely ebullient about global central banks’ renewed enthusiasm to cut interest rates to a level that is even lower than they already are. And, most importantly, Wall Street is completely confident that theses marginally-lower borrowing costs will not only be enough to pull the global economy out of its malaise; but will also be sufficient to provide enough monetary thrust to blow asset bubbles into the thermosphere.

However, the truth is Fed stimulus does not always work. This was the case during both 2000 and 2008. A significant amount of rate cuts was not enough to avert a recession and also did nothing in the way of preventing the stock market from collapsing.

During the mid to late ’90s, the Fed’s 175bps of rate cuts did help keep the “irrational exuberance” alive in the equity market and helped propel the NASDAQ to what turned out to be a very dangerous level by the end of the decade. But then, reality inevitably came calling; and tech stocks crashed by nearly 80% from March of 2000 through the fall of 2002. That recession and concomitant plunge in stock prices occurred despite the Fed’s 550bps of rate cuts from 2001–2003. Likewise, the Fed’s 525bps worth of rate reductions occurring from 2007-2008 was insufficient to check the Great Recession and the 33% wipeout of home values and half the value of the S&P 500.

Fast forward to today, and we see not only has the Fed cut rates by 50 bps, but also many other central banks around the world have embraced a dovish tone. But again, the question must be asked; will these rate cuts become a panacea for the economy and markets like they were for a few years during the mid and late nineties, or will it turn out to be a complete debacle like the last two rate-cutting cycles. Wall Street and its shills believe in central bank omnipotence and omniscience, but history clearly illustrates their fallibility.

For a current example, let’s look at India. The Reserve Bank of India (RBI) last Friday cut its benchmark repurchase rate for the fifth consecutive time this year. The RBI cut rates by 25bps on October 6th to 5.15%, and the government recently enacted a major tax-cutting package as well. One would assume that the NSE India Nifty 50 Index should be soaring with the amount of fiscal and monetary stimuli thrown at it. However, shares are up just 2.8% since January 2019, yet also down 8% since June. That 2.8% increase for this year is expressed in Rupees. The iShares Nifty 50 ETF (INDY), which tracks the Index in US dollars, is up just 1.6% year-to-date.

India is not in a recession, and its equity prices are by no means crashing, but the massive stimulus already thrown at its market and economy is simply not working at this point. What is clear is that India’s stock market is floundering while its rate of GDP growth has dropped to a 6-year low.

Not only is it true that interest rate cuts don’t always work like magic, but it is also a fact that there is absolutely not much more room to lower borrowing costs on a global basis. It normally takes over 500 bps of rate cuts to eventually stabilize markets. However, now all we have in the U.S. is 175 bps left to cut before money becomes free and the ECB and BOJ are already below zero.

Whether or not rate cuts are effective has to do with debt levels, demographics, the presence of asset bubbles, and the degree in which central banks have the ability to reduce borrowing costs. None of those metrics offer much hope for this current rate-cutting cycle. Once and an economy becomes overleveraged, has insufficient labor force growth, overvalued asset prices, and where its central bank is already close to the zero bound, turning dovish at that point just isn’t very effective.

Global central banks are short on ammo and cannot easily ameliorate the damaged state of worldwide GDP growth. In fact, the OECD cut its forecast for global growth to just 2.9% for this year–that is the slowest rate of growth since 2009. Turning to the U.S., the ISM surveys show the economy took a sharp turn south in September. Overnight lending in the banking system is still so fragile that the Fed had to extend its Repo facility until November 4th. The yield curve remains inverted from Fed Funds all the way through the 10-year Note—which is the most important part of the yield curve–, and this has been the case for the last five months. And, total net new job creation in both the public and private sectors is weakening. The 3-month rolling average for total new job creation for September 2019 was just 146k; that is down from the year-ago level of 189k–that is a decline of 23%. Things were worse in the private sector, where job growth averaged just 119,000 in the last three months, which is down from the 215,000 net new jobs created for all of 2018.

S&P 500 earnings are expected to post three consecutive quarters of negative growth, and the report for this Q3 earnings season is projected to come in at -4.1%, according to FactSet.  Meanwhile, the annual fiscal deficit has breached above the trillion-dollar level for the first time since 2012 and is projected by the Congressional Budget Office to average $1.2 trillion for each year over the next decade. As bad as that sounds, it assumes interest rates don’t normalize, and a recession never occurs throughout the next ten years–neither scenario is even remotely realistic.

My base case scenario is that the current regime of fiscal and monetary policy has become exhausted. This is despite the fact that they have already gone beyond any measure of conventionality or reason. Therefore, to meaningfully boost asset prices higher from the current nose-bleed level, central banks will need to move further into the realm of unorthodoxy by deploying massive amounts of helicopter money directly to the public. Unfortunately, that type of lunacy is most likely where the Fed is eventually headed. Having an investment model that tracks such dramatic changes in the rate of economic growth and inflation has become 100% mandatory.

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.”

 

Gold: It’s All About Real Rates Not the Dollar

The Federal Reserve’s recent need to supply $100’s of billions in new credit for the overnight repo market underscores the condition of dollar scarcity in the global financial system. This dearth of dollars and its concomitant strength has left most market watchers baffled.

Since 2008, the Fed has printed $3.8 trillion (with a “T”) of new dollars in an effort to weaken the currency and boost asset prices–one would then think the world should now be awash in dollar liquidity. Yet, surprisingly, there is still an insatiable demand for the greenback, leading many to wonder what is causing its strength.  And importantly for precious metals investors, there is a need to understand why this dreaded dollar strength has not served to undermine the bull market for gold.

The primary drivers for dollar strength are growth and interest rate differentials. The Federal Reserve was able to raise overnight lending rates to nearly 2.5% and end its QE program, before its recent retreat from a hawkish monetary policy to one that is more dovish. The Fed Funds Rate now stands at 1.75-2.0%. However, the ECB and BOJ both have negative deposit rates and are currently engaged in QE. Not only this, but the extra income investors can receive owning a US 10-year Treasury Note compared to those of Japan and Germany are 175bps and 200 bps, respectively. In addition, year over year GDP growth in the EU was just 1.4% in Q2 of 2019; and Japan’s growth registered a paltry 1.0%. Growth in the US was 2.3% y/y. While that is not an earth-shattering rate of growth, it is still better than our major trading partners.

With sub-par growth and little hope for improvement on the horizon, the ECB and BOJ have decided to continue with ZIRP and QE in a futile attempt to spur growth. Nevertheless, their economies are still stagnating.

The US central bank is now being forced to lower rates once again. This is primarily due to the strengthening dollar that is hurting foreign holders of USD-denominated debt–of which there are a lot.

The BIS estimates that foreign USD-based debt now exceeds $11.5 trillion.

A rising US dollar puts further stress on these dollar-based foreign loans and makes them harder to service. In effect, this creates a squeeze on dollar shorts. When you add in the Fed’s burning of nearly $800 billion worth of base money during its Quantitative Tightening (QT) Program, you can clearly see the reasons for dollar strength.

But those who believed the US dollar would increase its buying power against gold have been dead wrong. This is because the primary driver behind the dollar price of gold is the direction of real interest rates.

Therefore, it is imperative not to measure the US dollar’s real strength by measuring it against other flawed fiat currencies that are backed by even more reckless central banks. Instead, the genuine value of the dollar should be weighed against real money…gold.

Conventional wisdom would tell you that the dollar and gold have a reciprocal relationship. When the dollar decreases in value, gold increases and vice versa. However, recently, the dollar and gold have both been strengthening in tandem.  Just look at a chart of the dollar index vs the GLD.

 

Again, the primary driver of gold isn’t the direction of the dollar but the direction of real interest rates. Hence, if US growth is accelerating in a non-inflationary environment, gold should suffer regardless of the direction of the US dollar. Conversely, the USD dollar can be in a bull market against a basket of fiat currencies—as it has been for the past year—and yet can still lose significant ground against gold as long as nominal interest rates are falling in an environment of rising inflation.

The year-over-year change in core CPI increased 2.4% in August, which was the highest level in a year. All the while the US 10-year Note yield was crashing from nearly 3% to 1.6% over the past 12 months. Therefore, real yields have been crashing as gold has been rising.

These falling real yields were rocket fuel for gold, and this was in spite of the USD’s bull market against the euro and yen. The price of gold increased by double digits even though the Dollar Index has also increased by nearly 5% in the last 12 months. But still, for those of us who love gold it can be a love/hate relationship. It is still down 20% from the highs made in 2011, and the mining shares have crashed by 60%; underscoring the need to know how to trade the cycles of this sector.

The questions for gold investors now are: have nominal yields stopped dropping and what is the direction for the rate of inflation? In the short-run, the answer to that question can be found in the trade talks scheduled for October 10th and 11th. The reason for this is, the boy has cried wolf once too often, and it is now time to poop or get off the pot when it comes to reaching an agreement with China on trade. And yes, that boy is Donald Trump. Wall Street and international corporations cannot do business under this cloud of uncertainty any longer; where one-day tariffs go up, and the next day they are coming down.

Since early 2017, investors and the C suite have dealt with a perpetual series of dizzying trade war escalations and treaties. Just this September alone, Trump raised duties on China on the1st of the month.  Then on the 11th, he announced a list of exemptions to those very same tariffs. Then, on the 25th he attacked China viciously at his UN speech, saying: “”For decades the international trading system has been easily exploited by nations acting in very bad faith. Not only has China declined to adopt promised reforms, it has embraced an economic model dependent on massive market barriers, heavy state subsidies, currency manipulation, product dumping, forced technology transfers and the theft of intellectual property and also trade secrets on a grand scale,”

The very next day, Trump said that a deal with China could come “much sooner than most think.” Then, on September 27th, Bloomberg reported that the White House threatened to ban the listing of Chinese companies on US exchanges. Businesses simply cannot adequately plan capital expenditures under such unstable circumstances.

The US and China meet on October 10th &11th to decide the future of trade between the two nations. Tariffs are set to increase on Oct.15th on $250 billion worth of Chinese goods to 30%, from the current 25%. There is no appetite on Wall Street for the continued ambiguity of this trade war any longer. Therefore, on October the 11th, I expect President Trump to announce the most wonderful trade deal in history has occurred since we purchased Manhattan from the Indians. Such an announcement should provide a temporary boost in the major averages and could also cause a sharp selloff in gold. This is because such a deal should put a temporary hold on the Fed’s rate-cutting cycle.

The Fed’s broken models have caused it to fail to grasp the debt-disabled condition of the developed world. China can no longer boost global GDP because it cannot significantly add to its $40 trillion debt pile without cratering the yuan. Also, fiscal and monetary policies are already extremely stretched and are unable to easily pull the economy out of its malaise.

Global growth is faltering, and US GDP growth has shrunk from over 4% last year, to under 2% in Q3, according to the Atlanta Fed. The most important part of the yield curve remains inverted. There is illiquidity in the Repo market.  D.C. is in utter turmoil and annual deficits have vaulted over the trillion-dollar mark. The Q3 earnings report card is about to arrive, and it will receive an “F.” And global central banks are virtually out of ammo. Meanwhile, the stock market sits at all-time record high valuations.

The pressure on Mr. Trump is now immense. A trade deal must be reached in a matter of days that abrogates future tariffs and rescinds most, if not all, existing duties on China. Any other type of agreement will not be nearly enough to turn the global economy around or fool Wall Street any longer into thinking that it will.

The sad truth is, even a comprehensive trade deal won’t fix the massive debt and asset bubble imbalances that must inevitably implode. Which means, real interest rates should be setting record lows in the near future.

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.”

 

Watching Paint Dry in the Repo Market Part 2

September 30, 2019

The Fed has now begun to pave the way for a return to Quantitative Easing. The reason for this was the recent spike in borrowing rates in the Repo market. At his latest press, Chair Powell said this about the spike in the Effective Fed Funds and Repo rates:

“Going forward, we’re going to be very closely monitoring market developments and assessing their implications for the appropriate level of reserves. And we’re going to be assessing the question of when it will be appropriate to resume the organic growth of our balance sheet… It is certainly possible that we’ll need to resume the organic growth of the balance sheet sooner than we thought.”

But why has the Fed panicked so quickly? Perhaps it is because Jerome Powell only has (7) 25bps rate cuts left before he returns to the zero-bound range. That is not nearly enough ammo left because the Fed normally has needed in the neighborhood of 20 such cuts to be effective in lower borrowing costs enough to jump start the economy. In addition, the Fed’s unprecedented destruction of $100’s of billions in base money supply has left banks with a dearth of reserves. The Quantitative Tightening (QT) process took excess reserves down from $2.2T to $1.4T. That may still sound like a lot of liquidity, but given the demand for US dollars and the predilection on the part of banks to hoard cash, it is clearly not nearly enough. In any case, the Fed’s prediction that is QT program would be a boring and harmless exercise goes down as another stark illustration of the completely opaque condition of its crystal ball.

The stress appearing in the money markets recently caused the EFFR to rise above the top end of the range set by the FOMC. And, Repo rates soared some 800 bps above the price where the Fed wants short-term lending to occur. Heck, even the Secured Overnight Financing Rate (SOFR) shot up to 5.25% on September 17th from 2.43%, which is particularly concerning given that SOFR lending is collateralized by Treasuries!

The excuse used by the mainstream financial media for the stress in the money market is being labeled “technical factors”. This is the same rationale given at the precipice of the Great Recession a decade ago. Such technical factors include; claiming corporations were seeking dollars for quarterly tax payments and that the Treasury needed to replenish its cash position by drawing just over $100 billion from reserves parked at the Fed. Now, quarterly tax payments are not at all a surprising occurrence and in no way can explain the level of dysfunction. And, the replenishment of cash for the Treasury is something that should have been manageable given the size of the $2.2 trillion Repo market.

The truth is there is an acute dollar shortage that has formed, which was caused by the drainage of liquidity from the Fed’s QT program. The fragility of the Repo market is especially concerning given its attenuation following the credit crisis a decade ago. Banks are simply required to hold more reserves now than before 2008 and $800 billion of those reserves were taken away and burned due to QT.

Therefore, the good news is this current crisis is not yet similar to 2008; where distressed assets were being hypothecated by insolvent entities—at least not at this point. The bad news is, what we have now is a liquidity crisis so acute that solvent financial institutions were having to exchange high-quality assets for overnight loans at double-digit interest rates. Just imagine how ugly things will get in the Repo market once those assets become impaired.

Most on Wall Street believe standing Repo facility provided by the Fed will be enough to re-liquify the money markets and thus prevent a crisis similar to the Great Recession. However, no matter how much cash the Fed is willing to exchange for a bank’s collateral, these same assets must be sold back to the borrower the next day. Hence, while the Fed may be able to provide enough liquidity for distressed assets already in existence, what it cannot do is compel financial institutions to provide liquidity for newly issued debt such as; junk bonds, CLOs and MBS, once the upcoming recession becomes manifest. The result will be the inability of marginal businesses to access the credit markets and the ensuing economic and market crash will be severe. Unfortunately, that recession worse than the Great Recession given the liquidity crisis already at hand.

For those that still doubt the fragility of markets and the economy just remember the complete shutdown of the junk bond market and plunge in asset prices that occurred one year ago. Couple this with the very recent spike in Repo rates and wise investors will understand that the current economic construct clings tenuously to the misplaced hope in central banks to keep the skin on these paper-thin asset bubbles from bursting.

Investors are now dealing with a protracted earnings recession, anemic global growth, dysfunctional money markets, an inverted yield curve, a massively overvalued equity market and central banks that are without sufficient ammo to reduce borrowing costs—who knew watching paint dry could be this unnerving. It is imperative to model these dynamics in order to give investors the best chance to protect and profit from these existential dangers to wealth.

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.”

Watching Paint Dry in the Repo Market Part 1

September 23, 2019

The world of fixed income trading has been extremely volatile lately. Rates have not only spiked in the Treasury market, but borrowing costs in money markets have also become extremely disconcerting. The residual effects from Quantitative Tightening, which ended just this past July, are wreaking havoc on the liquidity in bond markets.  Ironically, the Fed’s erstwhile rate hikes and its QT program–what Fed Chairs described as running in the background and like watching paint dry—turned out to be the catalyst for a freeze in the junk-bond market in December of 2018 and is now causing major disruption in the Repo market.

This illustrates clearly the tenuous nature of the bond bubble and that it will someday implode like a supernova—sending yields skyrocketing on a long-term basis. However, it most likely does not yet mark the start of the epoch debt bubble debacle that is in store. We will need a surge of inflation expectations, or the credit markets to shut down on a protracted basis for that to occur. We are moving closer to that eventuality every day.

Turning to Treasury market volatility, the perceived end to the trade war escalation and slightly better economic data was just part of the reason for the US 10-year Note yield to recently leap from 1.4%, all the way to 1.9% in a matter of a few trading days. But what was mostly overlooked by the Main Stream Financial Media, and also served to push bond yields higher, was the huge increase of US debt issuance–the pace of which has been surging. The US fiscal deficit for 2019 breached over the $1 trillion mark in August–with one month still left in this fiscal year. The total amount of red ink rose to $1.07 trillion thanks to the $214 billion deficit for August alone.

The deficit for all of last year was just shy of $780 billion. This year’s deficit is the largest since 2012 and is far greater than the $415 billion deficit which was posted in 2016. That was the year before Donald Trump took office and promised to pay off the national debt, which is now $22.5 trillion and 13% higher than when he took office. This means we have added over $2.5 trillion to the National debt pile. Not only is that debt not paid off, but the pace we are adding to it is rising fast. It’s not just the government that is amassing debt; Consumers added $23.3 billion in total debt for July alone, and corporations issued a record $150 billion worth of debt since September 1st.

All this debt is putting upward pressure on rates, and inflation targeting are adding salt to the wound. Core Consumer Price Index (CPI) is now up 2.4% year over year and is well above the Fed’s asinine 2% inflation target. We have debt levels surging in both the public and private sector, and yet interest rates are so low that in 1/3 of the developed world it actually costs you money if you want to lend your savings to the government. And, annual deficits in the US have officially eclipsed $1 trillion and are projected to grow even bigger as far as the eye can see. This begs the question: If a 1% Fed Fund Rate (FFR) helped create the housing bubble that brought down the global financial system a decade ago, what could possibly go wrong with having a decade’s worth of ZIRP–and even NIRP–that have now created a triumvirate of record asset bubbles existing concurrently for the first time in history?

Over the past week, the European Central Bank (ECB), the Fed, and the Bank of Japan (BOJ) met. What all three central banks have in common, other than being extremely dangerous and incredibly clueless, is they all are cutting interest rates at this time when borrowing costs are already at their lowest in history. This is causing a massive amount of new debt to be taken on, and at the same time all three major central banks are in a panic to get inflation higher. Meanwhile, the tenuous and massive asset bubbles they have created are ready to implode.

The salient questions are whether their cuts will be done quickly enough to turn the economy around and if there is enough room to cut rates no matter how fast they come? The base case scenario is that central banks will fail to stem the gravitational forces of deflation until they resort to some form of helicopter money. Think Universal Basic Income (UBI) and Modern Monetary Theory (MMT). But how will we know if this is correct? The Pento Portfolio Strategies’ Inflation/Deflation and Economic Cycle Model is not only designed to predict these outcomes by measuring changes in fiscal and monetary policies but also verifies these assumptions by monitoring the 20 model components that include yield curve dynamics, credit spreads, and other market-based metrics. This includes the liquidity of money markets.

And speaking of money markets, the Repo market is not functioning normally at this time. People should be concerned about this because it is an early warning signal for a liquidity crisis; just like the signal, it sent back in 2007. The Repo market consists of overnight secured lending between banks. This rate is influenced by the Fed Funds Rate (FFR). The Fed’s target rate is now 1.75%–2.00%; yet the Effective Fed Funds Rate (the actual rate banks exchange their assets for cash) spiked above the high-end of the Feds target. The spiking Repo rate for collateralized lending helped push the FFR up, which is unsecured borrowing between banks. This means there are certain financial organizations out there that are seriously hurting for cash. Otherwise, they would never need to pay 8% over the current borrowing rates targeted by the Fed.

The spike in the EFFR caused the fed to print nearly $300 billion to date and inject that liquidity it into the money markets to bring down rates. As of this writing, they have decided to continue these Repo operations thru October 10th. Overnight injections are temporary fixes, and the fed might soon realize that it needs to inject a form of more sustainable liquidity. In other words, the Fed may return to QE and permanently start to increase its balance sheet once again, Jerome Powell even hinted at returning to QE in his September press conference. This is true despite the fact that it just ended the draining of its balance sheet in August. You remember the QT program; the one that was supposed to be on autopilot and would be like watching paint dry?

Despite the claims from virtually everyone on Wall Street, and their lackeys in the media, the spike in Repo and Fed Funds borrowing costs clearly shows that banks do not at all have the liquidity cushion that has been advertised. If banks are short of cash now, which caused Repo funding costs to spike to about 10%, just imagine what is going to happen when the $5.4 trillion junk bond, BBB and Collateralized Loan Obligation (CLO) market becomes distressed! As mentioned already, the last time this happened was in 2007, and it coincided with the top of the stock market and presaged the collapse of the entire global financial system one year later.

Whether or not this follows the same pattern as the Great Recession is unknown at this point. But our model is built to map this cycle correctly and protect and profit from whatever occurs. Having a tested model is a far better strategy for investors than to be fully invested in a passively and blindly managed basket of stocks and bonds no matter what.

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.”

More Wall Street Propaganda

September 9, 2019

 One of the best examples of Wall Street’s propaganda machine at work is its willingness to dismiss recessionary signals. The inverted yield curve is a perfect example. Case in point, look at the story that was put out on Market Watch dated November 27th, 2006—exactly one year before the Great Recession officially began, the stock market started its decline of more than half and the global economy started to collapse.

Here’s how some on Wall Street and the Fed described what was happening on the precipice of the global financial crisis regarding the inversion of the yield curve at that time: “Bernanke, and his predecessor Alan Greenspan, have attributed the inverted yield curve to a ‘global savings glut’ that has sparked fervid demand for Treasuries and U.S. corporate bonds. Economists have noted that this buying spree is inconsistent with the possibility of a looming recession. In the past inverted yield curves have been harbingers of recession, but a number of economists, including Federal Reserve Chairman Ben Bernanke, do not think this is the case in the present instance.”

A few years earlier, Alan Greenspan told Congress during his annual testimony on November 2005 that he:

“Would hesitate to read into the actual downward tilt of the yield curve as meaning necessarily as it invariably meant 30 or 40 years ago. This used to be one of the most accurate measures we used to have to indicate when a recession was about to occur. It has lost its capability of doing so in recent years.”

In 2006, his successor Ben Bernanke appeared to be even more confident that the flat yield curve was caused by the “significant increase in the global supply of savings” and nothing to say about the faltering economy. In his March 2006 speech to the Economic Club of NY Bernanke stated he “would not interpret the currently very flat yield curve as indicating a significant economic slowdown”  instead he bloviated on about four other anomalies adding to the demand for US long term debt that was putting downward pressure on the long end of the curve. First and foremost, among his excuses was strong international demand for US debt. Perhaps it was his indifference to the curve inversion that caused him to assure investors in May of 2007 in a speech given at the Federal Reserve Bank of Chicago,

“Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited.”

In other words, he wanted investors to ignore the yield curve inversion because in the Fed’s infinite wisdom everything was just fine.

The first lady Chair of the Federal Reserve, Janet Yellen, is now taking her turn assuring investors of the yield curve’s irrelevance; explaining very recently on a Fox Business Network interview dated August 14th, 2019:

“Historically, [the yield curve inversion] has been a pretty good signal of recession and I think that’s when markets pay attention to it, but I would really urge that on this occasion it may be a less good signal.”

And, turning to the current dictator of monetary policy, Jerome Powell, he said in his March of 2018 news conference that while the inverted yield curve has had its prescience in the past,

“but a lot of that was just situations in which inflation was allowed to get out of control, and the Fed had to tighten, and that put the economy into a recession.  That’s really not the situation we’re in now.”

The Fed and Wall Street are great at concocting stories to claim that it is different this time. One of their favorite and reliable false narratives is that an inverted yield curve is not a harbinger of recession. Well, this time is most likely not at all different, despite the fact that a never-ending parade of gurus come on financial news networks and explain why this time the yield curve inversion is irrelevant.

What is the major point here? Besides the fact that central bankers and Wall Street Shills never learn their lessons, it is that an inverted yield curve is not some exogenous event that is coincidently linked to recessions. It is always a sign of a slowing global economy and the imminent collapse of unstable asset bubbles that were built on cheap credit. This is because an inverted yield curve causes credit to shut down. When the difference between where banks can borrow funds (short end of the curve) and what income their assets can generate (long end of the curve) shrinks towards zero, the incentive to lend money erodes. And, since the slowing economy dramatically increases the risk of loan defaults, lending institutions become much more reticent to extend new credit at low margins to those that have higher potential to default. The result is a significant reduction in the amount of money created; the same money that fuels these asset bubbles and the overleveraged economy.

Therefore, the inverted yield curve isn’t different this time, and the countdown to recession and equity market collapse has begun. An official recession has always occurred in less than two years after the initial inversion. And in 60% of those inversions since 1955, the stock market topped out just three months after the date of that first inversion, according to BOAML. It should be noted that the spread between the Fed Funds Rate and the 10-year Note has already been negative for the past four months. Indeed, the August report from the ISM proved that the manufacturing recession in the US has officially arrived.

The sad truth is there’s a record amount of debt extant in the world that sits on top of a massive global bond bubble. From which central banks—because of their love affair with ZIRP and even NIRP–have almost no room left to remediate a recession and market collapse. That is, other than the full deployment of massive helicopter money—where new money is created by governments and central banks and then handed out directly to the private sector. What could possibly go wrong with that?

This is why a static buy and hold, or dollar-cost averaging investment strategy isn’t working any longer. You have to know what sector of stocks to own and when it is time to short stocks or bonds; or both. Such are the consequences of having both fixed income and equities in a record-breaking bubble together for the first time in history.

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 Central Banks’ Time Machine is Broken

September 3, 2019

Last week we wrote about how global central banks have created an economic time machine by forcing $17 trillion worth of bond yields below zero percent, which is now 30% of the entire developed world’s supply. Now it’s time to explain how the time machine they have built has broken down.

In parts of the developed world, individuals are now being incentivized to consume their savings today rather than being rewarded for deferring consumption tomorrow. In effect, time has been flipped upside down. These same central bankers then broke that time machine by guaranteeing investors they will never cease printing money until inflation has been firmly and permanently inculcated into the economy.

They have printed $22 trillion worth of new credit in search of this goal since 2008. This figure is still growing by the day. But by doing so, they have destroyed Capitalism. Freedom is dying; not by some Red Army but by central banks.

The savings and investment dynamic, which is the backbone of capitalism, only functions when savings gets rewarded. No sane person would defer consumption today in order to be assured that they will be able to consume less of it tomorrow. Without savings, there can be no investment, and without investment, there can be no productivity. And since productivity accounts for half of GDP, without it there will be a massive reduction of the goods and services available to absorb the increased money supply that is being created. This will serve to significantly increase the rate of inflation.

That is where the time machine breaks down. Owning negative-yielding debt can only make a modicum of sense in the context of unbridled deflation because it would make real yields positive. However, owning negative-yielding debt—that guarantees losses if held to maturity– while the rate of inflation is positive and is being forced yet higher by central banks, is untenable and the apogee of irrationality.

According to Bank of America Merrill Lynch, Investment grade Corporate debt outside of the US now totals $27.8T, with the yield on that debt of just 0.11%. And there is $1 trillion worth of corporate debt now with a negative yield. The central banks’ goal of inflation targeting ensures the destruction of capitalism and will lead to an economic collapse such as never before witnessed.

This process can be best viewed by the fact that the German government just sold 869 million euros of 30-year bonds with a negative yield for the first time in its history. However, the problem was it tried to dump 2 billion euros of 30-year sovereign debt and was only able to get off 43% of the offering—that is known is a failed auction and offers proof that the central bank time machine is broken. Only the European Central Bank (ECB) could accept negative rates regardless of where real yields are. However, investors can’t accept negative yields when the average year over year Consumer Price Index (CPI) in the European Union (EU) has increased by 1.6% in the past 12 months. Since nominal rates are negative and real rates are even further below zero, the chance of an absolute global bond market revolt is rising dramatically by the day.

Turning to the U.S., the core rate on CPI increased by 2.2% year over year in July and has been above 2% for the past 17 months. While nominal Treasuries still provide a historically minuscule nominal yield, the real yield on such debt is negative across the entire curve. A negative real yield in the U.S. doesn’t make sense in the context of a Fed that wants to push inflation sustainably above 2%. This is especially true given the solvency concerns associated with owning Treasuries. The U.S. faces trillion-dollar annual deficits indefinitely, and the national debt now stands at $22.5 trillion, which is 105% of GDP and 661% of federal revenue.

Indeed, the entire globe has become debt disabled and dependent upon interest rates that are perpetually decreasing. Global debt has soared to $250 trillion (a record 320% of GDP).  Central banks have increased the base money supply by $22 trillion in the past decade in order to make this debt load appear solvent. What governments don’t understand is once that 633% increase in global money supply begins to catch fire, inflation will start to run intractable. This means the collapse of the global bond market is inevitable.

The sad truth is that there is almost nothing central banks can now do now except pursue hyperinflation by using Modern Monetary Theory (MMT) and Universal Basic Income (UBI). In other words, helicopter money to keep asset prices and the global economy from collapsing. The reason: consumers, businesses and governments have become so saturated with debt that reducing interest rates no longer boosts consumption. Consumers cannot afford the principal at any interest rate—not even slightly less than zero. And that, by the way, is where most central banks are already.

This broken time machine is showing up in the data. It has pushed the Cass Freight Index, which measures North American rail and truck volumes, down 0.8% in July from the prior month marking its eighth month of declines and a drop of nearly 6% from a year ago.

According to the IHS Markit’s Flash US PMI report, the Manufacturing PMI dropped below the 50 mark for the first time in almost a decade in August and the Services PMI in the same period slumped to 50.9 from 53 in July.

Last Thursday the Bureau of Labor Statistics (BLS) revised its count for net new jobs created in 2018 and thru March of 2019. The result was an overstatement of jobs by 501,000 employees. It was the largest revision since 2009.

So, let’s sum up all this dysfunction in case you are still not aware:

  • Global growth has stagnated, and there is a manufacturing recession worldwide.
  • The US manufacturing sector is contracting, and the service sector is approaching that same condition, according to IHS Markit data for August.
  • Year over year S&P 500 EPS growth has crashed to the flat line, according to Factset
  • The best recession predictor, which is the spread between the Fed Funds Rate and the 10-year Note, has been inverted for the past four months.
  • The trade war with China is intensifying, and the yuan is dropping precipitously.
  • Aggregate global debt has soared by over $70 trillion since 2008
  • Central banks have printed $22 trillion in the past decade to keep all of this insolvent debt from crashing.
  • But now, central banks have reached their limit to lower borrowing costs, and the economy has reached a debt–saturated condition.
  • The savings and investment dynamic is going extinct thanks to the broken central bank time machine.
  • That same broken time machine is leading to a bond market supernova.

Between August 1st thru October 30th, we are in what I call an economic dead-zone –three months where there will be most likely only one 25 bps rate cut from the Fed and the trade war is slated to rapidly intensify. That 25-basis point reduction isn’t nearly enough to revert the plunging yield curve or to placate an apprehensive Wall Street. This is a period of time where there is a significant chance for a major decline in stocks.

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.”