Commentary

Peak Growth and Inflation

May 10, 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

Get Ready for the Fourth U.S. Central Bank

April 26, 2021

 We all should be aware that the current Federal Reserve of the United States is not America’s first central bank. In fact, we’ve had a few others before this current disastrous iteration came into existence in 1913. We hope and believe it won’t be long before this latest version goes away for good.

Our first central bank was founded in 1782 and was called The Bank of North America. Soon after, in 1791, The Bank of North America became The First Bank of the United States, chartered by Congress.  However, in 1811 its twenty-year charter expired and was not renewed.

Five years later, Congress chartered its successor called the Second Bank of the United States that lasted from 1816-1836. This Central Bank collapsed for the same reason the others did before it: they were, for the most part, filled with corruption and became progenitors of speculation and economic instability.

Our founding fathers could never imagine the extent the current U.S. central bank would eventually go to usurp the power from free markets and destroy the value of the dollar.

Why This Federal Reserve Should Soon Become Extinct

I was asked recently in an interview how sure I was that the stock market would crash. My answer was that it is virtually guaranteed to occur given that valuation of equities is–for the first time ever—over twice the level of GDP. And, this metric is a full 100 percentage points greater than it was just prior to the start of the Great Recession. The only question is whether the crash will just be of the 30% variety, or will it be a total wipeout of around 80%, like we witnessed at the end of the Dot.com era.

The next crisis should start sometime between the second half of ’21 through the end of ’22. The catalyst will be the same as it always is: a central bank that tightens its monetary policy because of the delusion that an economic crisis has ended, and it is time to normalize monetary policy. Alas, normalization is impossible precisely because debt and asset bubbles rely on ultra-low rates to survive—and those asset bubbles which exist today are without precedent. Once the monetary support is removed the stock and credit markets begin to melt down as the fuel (liquidity) for these bubbles evaporates.

I have no doubt that the Fed will respond to a 30% market crash with another massive liquidity infusion. However, this liquidity injection may not be as effective as it has been in the past. First off, if the selloff begins anytime between now and the end of next year, the option of significantly reducing the Fed Funds Rate (FFR) is a non-starter. The Fed usually needs at least 500 bps of interest rate relief to turn the markets and the economy around. But Mr. Powell will have no room to lower rates because the FFR will still be at zero percent. In fact, the FOMC’s latest Dot Plot predicts the liftoff from zero won’t be until 2024. And, the Fed’s consummation of its tapering program won’t take place until the middle of 2022. Hence, the Fed should already be engaged with its asset purchase program (QE) in some proportion until the second half of 2022. The central bank will already have its gas pedal essentially to the floor, so the impact from more easing from that level will be muted in comparison to other crises. In addition, with total US debt at a record 400% of GDP, there just isn’t the wiggle room for much more fiscal support without causing a backup in yields.

Most importantly, the Faith in central banking and their fiat currencies is already being shaken to the foundation. Back in the credit crisis of 2008, what was touted by then Fed Chair Ben Bernanke as a once-in-a-lifetime emergency monetary-easing policy has now turned into a perfunctory and ordinary plan of action. The Fed’s retreat to the zero-bound and forays into Quantitative Easing have become, sadly, a rather pedestrian function. This latest trip down the rabbit hole of free money and QE began in 2019–well before the COVID-19 pandemic began.

All previous ventures into QE and free money were greeted with much lower long-term interest rates. This is exactly what the Fed wanted and needed to happen. Lower borrowing costs across the yield curve helps to infuse the economy with new money and serves to re-inflate asset prices.

This tactic has been remarkably effective in the past because subdued inflation and confidence in our sovereign bond market were believed to be permanent economic features–perhaps due to the 40-year bull market in Treasuries. However, the Fed may not be so lucky during this next coming crisis. Our central bank has already printed $7 trillion since 2008 to re-inflate asset bubbles and to support banks’ balance sheets. And, our Nation’s debt now stands at 130% of GDP. Another massive and multi-trillion-dollar increase in the Fed’s balance sheet at this juncture may destroy any confidence remaining in U.S. Treasury solvency.

The Fed has gone so rogue that it is trying to destroy the evidence of its inflation and money printing crimes. Our central bank is no longer reporting its weekly money supply data. M1 & M2 appear to be going the way of M3, which the Fed stopped reporting back in 2006. This chart gives you a clue as to the real reason that our current central bank needs to hide the truth.

But we are not fooled, and neither should you. Investors are growing weary of having their retirement funds destroyed every few years when the Fed’s asset bubbles collapse. And, the perpetual near-zero return from banks is getting harder and harder for savers to overcome. If long-term Treasury yields respond to the next round of money printing by rising instead of falling, as they have done in the past, the next market crash won’t be kept in check easily. Indeed, both equities and fixed income could fall concurrently, which could turn a painful bear market into a complete meltdown—perhaps worse than ever before suffered for those investors that adhere to the buy-and-hold mentality.

This could be the catalyst that sends the current Federal Reserve into the dustbin of history. A free and independent population demands that its central bank shares those very same qualities. The next U.S. central bank must once again link its currency to gold instead of the foolish and corrupt whims of plutocrats and feckless politicians.

 

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.”

Freedom Fatality of the Fed

March 22nd 2021

In a recent interview, I referred to the Fed as a disgusting institution. I want to explain why I believe that to be the case, as I do not like to disparage anyone or any entity indiscriminately or capriciously—only when absolutely necessary. To be clear, central bankers may not be nefarious in nature, but their product is iniquitous.

Any entity whose very purpose for existence is to destroy markets is inherently disgusting and, in the end, one that ends up being evil.  At its core, the Fed is Robin-Hood in reverse, stealing from the poor by destroying their purchasing power to give to the rich by inflating their asset prices. The Fed, along with all central banks, are inherently freedom killers, middle-class eviscerators, and economic destabilizers, regardless of stated intentions. If that wasn’t bad enough, the problem now is that the Fed has usurped markets to the point of no return.

The Fed’s very mandate encompasses the unholy operation of obliterating price discovery in its paramount function of determining what money actually costs. This process should only be the purview of the free market.  Of course, the level of interest rates does indeed affect all other asset prices. But the Fed wasn’t content with just an indirect influence on asset prices. It eventually morphed from its initial focus on rescuing troubled banks to ensuring stable prices and full employment and then turning to its ultimate purpose of promoting perpetual bull markets in stocks, bonds, and real estate. But the Fed isn’t even satisfied with that, it is now actually also in the business of ensuring the U.S. embraces a government that promotes egalitarian socialist principles and rejects its capitalist roots.

This function is by no means exclusive to America. In fact, such views originated in socialist Europe and are clearly manifest in the European Central Bank.

How far from reality and embracing free markets is the ECB?

The President of the ECB, Madame Lagarde, is now claiming that financial conditions are tightening and putting the nascent recovery from the pandemic in jeopardy. The reason for her concern is interest rates…they are simply rising too quickly and are now too high, in her opinion. And the level of interest rates is of so much concern that the ECB wants to stem that rise in bond yields. What is the level of sovereign borrowing costs that are now being deemed detrimental to the European economy? Well, for examples, the Spanish 10-year note is 0.3%, and the German 10-year note is negative 0.35%. And, because of these “excessively-high” and “frightening” borrowing costs, the ECB is now front-end loading its 1.8-trillion-euro money-printing scheme. In other words, stepping up the pace of its short-term bond-buying, so more bonds are bought presently rather towards the proposed end of its QE program in March 2022.

This is a perfect example of how warped our fiat monetary system has become. Only in the delusional mind of a socialist central banker could negative borrowing costs be excessive. That’s negative in nominal terms; forget about after adjusting for inflation, which sends those already negative yields much lower.

What about Jerome Powell? For now, rising yields are just representative of a healthy economy. This view was reiterated to at the March FOMC meeting and press conference. We have a 1.7% 10-year Note today. But what about once that yield hits 2%+ later this spring or early summer? Will the credit markets continue to function normally; what about the crowded Emerging Markets and short dollar trades? My guess is they will falter as rates breach 2% and lead to an extreme tightening of financial conditions. This is shocking for investors to grasp: if the economy and markets can’t function with benchmark Treasury rates at 2%, what will happen once they normalize to 6-7%?

However, here’s the point: tight financial conditions are coming regardless of what the Fed does. It is unavoidable precisely because of the humongous extent and duration these borrowing costs have been manipulated.

There’s no end in sight for the trap our central bank is in. For without the massive and indiscriminate purchases of the Fed, our Treasury auctions would fail. Meaning, private buyers would only show up after a super spike in yields; but that would render the government insolvent, along with bonds across the entire fixed-income spectrum. To this point, the federal budget gap widened 68% in the first five months of the fiscal year. For the 12 months that ended in February, the deficit totaled $3.5 trillion, or 16.5% of GDP. This, I remind you, is while debt service costs are at a record low and some 500 bps below average. Under a free-market interest rate regime, the deficit would be closer to 35% of GDP! Hence, my conclusion regarding the nefarious trade of central banking is irrefutable.

Our bond market is now in revolt. The conundrum now is that the Fed must continue to print money at a record pace to keep asset bubbles from crashing. However, if central bankers keep monetizing debt in its reckless pursuit of higher inflation, the disruptive move higher in bond yields could become absolutely intractable and catastrophic for these same asset bubbles.

Later on this year, and into 2022, we will be looking at an economy and stock market that will be suffering from higher taxes, higher interest rates on a massively increased corporate and government debt burden, and much higher inflation. In addition, there will be a fiscal and monetary cliff of record proportions—the Fed’s announcement to end the record $120b per month QE program and the wearing off of $6 trillion worth of government stimulus handed out y/y from March 2020-March 2021. Also, the efficacy of the vaccines on COVID-19 variants will become manifest. We may be faced with the fact that we will be living with this virus, along with various restrictions and lockdowns even after the vaccines have been fully administered. God forbid this to happen, but we must remain vigilant.

Hence, even if the market survives this late spring early summer’s interest rate spike, we will still have to deal with the eventual reconciliation of these asset bubbles once the record-breaking fiscal and monetary cliff arrives. Investors would be wise to avoid the Deep State of Wall Street’s set-it-and-forget-it portfolios and instead actively manage these wild swings between inflation/growth and deflation/depression.

 

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.”

 

Bond Market Rocks the Richter Scale

March 5, 2021

The global sovereign bond market is fracturing, and its ramifications for asset prices cannot be overstated. Borrowing costs around this debt-disabled world are now surging. The long-awaited reality check for those that believed they could borrow and print with impunity has arrived. From the U.S., to Europe and across Asia, February witnessed the biggest surge in borrowing costs in years.

Thursday, February 25, 2021, was the worst 7-year Note Treasury auction in history. According to Reuters, the auction for $62 billion of 7-year notes by the U.S. Treasury witnessed demand that was the weakest ever, with a bid-to-cover ratio of 2.04, the lowest on record. Yields on the Benchmark Treasury yield surged by 26 bps at the high—to reach a year high of 1.61% intra-day–before settling at 1.53% at the close of trading.

What does the head of the Fed have to say about the move? Jerome Powell believes the volatility in bond yields is a healthy sign for the economy. Yet, out of the other side of his mouth is warning that nearly 30% of corporate bonds are now in “trouble.” The Federal Reserve and other bank regulators are warning that businesses impaired by Covid-19 are sitting on $1 trillion of debt and a high percentage of it is at risk of default—exactly 29.2% of lending was troubled in 2020, up from 13.5% in 2019, according to a report recently released by the Fed.

The average interest rate on U.S. Public Debt back in 2001 was 7%. Today, thanks to massive and unprecedented central bank intervention, it has plummeted to about 2%. Precisely because of the Fed’s manipulation of bond prices, the interest expense on that $27 trillion National debt was just $522 billion in 2020. If interest rates were to return to the normal level of 7%, the interest expense would soar to $1.9 trillion per year!

So, what pushed rates to record lows in the first place, and what conditions are necessary to keep them from surging much higher from here? There are three reasons for record-low bond yields. Number one: The Fed has been engaging in Q.E. at the record pace of $120 billion per month. It is in the process of purchasing $80 billion of Treasuries and $40 billion 0f M.B.S., which amounts to massive manipulation of bond prices. The second: The U.S. has experienced anemic G.D.P. growth. According to the B.E.A., real G.D.P. decreased 3.5 percent (from the 2019 annual level to the 2020 annual level), compared with an increase of 2.2 percent in 2019. Lower levels of growth push the flow of money towards fixed-income investments. And thirdly, inflation must be quiescent, for it is the bane of the bond market. The B.L.S. indicates that year-over-year C.P.I. increased by just 1.3% at the end of last year, which is well below where the Fed would like inflation to be. If either one of these conditions changes, rates will spike along with interest payments on the debt.

The problem, as far as the future direction of interest rates is concerned, is that all three conditions are now heading the other way. The rates of C.P.I. and G.D.P. growth are about to surge on an annual basis in the next few months due to last year’s virus-related base effects. Adding to this upward pressure on rates, the Biden administration could soon sign into law the $1.9 trillion COVID Relief Package. If approved by the Senate, the bill will include $400 in enhanced unemployment checks as well as $1,400 stimulus checks for most families. And, an expansion of the child tax credit to give families up to $3,600 per child. This huge amount of new debt issuance will once again be all monetized by the Fed.

Adding further fuel to the surging growth and inflation dynamic is the continued roll-out of the vaccines, along with the warmer spring weather, which should serve to steepen the downward trend in Wuhan-related hospitalizations and deaths that is already in place. This will lead to a reopening of the economy and cause a surge in Leisure and Hospitality sector hiring.

These factors should also cause Wall Street’s bond vigilantes to become dreadfully afraid of the inevitable tapering of the Jerome Powell’s asset purchase program. After all, the Fed is comprised mostly of Phillips Curve devotees; and the surging Non-farm Payroll reports coming in the late spring and early summer should awaken them from their slumber. The end of central bank rate manipulation should cause the average interest rate on debt service payments to spike higher. If the Fed were to be forced to abruptly end Q.E. and raise rates, that spike could–at least temporarily–rise towards that average rate of 7% seen in 2001.

Just how damaging could that be for this overleveraged economy? Our national debt now stands at $28 trillion, and last year’s annual deficit was a daunting $3.1 trillion.  But now, President Biden’s $1.9 trillion COVID Relief package is just the start of 2021 spending plans. D.C. will then quickly turn to another multi-trillion-dollar infrastructure deal before the ink on this latest round of stimulus checks is dry. Alas, the C.B.O. already predicts the deficit for fiscal 2021 to be $2.3 trillion. Sadly, this is before, and such new government “stimulus” plans become law. It is inconceivable that the market for our government debt could function normally if our annual deficit climbs towards 35-40% of G.D.P. This will be especially true if the Fed is forced to fight inflation instead of continuing to supply its massive and price-insensitive bid for Treasuries.

Of course, we are only talking about government debt here. Spiking rates on the record amount of corporate debt, along with the real estate and equity market bubbles, will be absolutely devastating.

This brings us to one Annie Lowrey, staff writer for The Atlantic and author of the book “Give People Money.” I mention her because she is a torch carrier for the Modern Monetary Theory movement and is an apologist for Universal Basic Income. Regrettably, this is now something our government is fully embracing. Her claim is that the government can send people checks with impunity because inflation has not been a problem for a generation, and so most have no memory of it. Really? Just because most have no memory of inflation doesn’t mean it can’t exist. Hence, she concludes we should not be worrying about a problem that we simply do not have. Well, to that, I say the Titanic didn’t have a problem with ice burgs for a while either.

Ms. Lowrey must not know about surging home prices that are once again pricing out first-time home buyers. She is also blind to skyrocketing stock values that are at all-time high valuations and bond prices which have reached the thermosphere. Indeed, asset price inflation has become intractable. And now, consumer price inflation is about to follow. This is precisely because MMT and U.B.I. are becoming entrenched in the economy and putting money directly in the hands of those same consumers; but without a commensurate rise in the productive capacity of the economy.

What this all means for the markets and the economy is clear: we will be experiencing chaotic swings between inflation and deflation with increasing intensity over time.

My friend John Rubino put the current state of affairs succinctly:

“So here we are “Capital D” Depression if governments rein in their spending and borrowing, and a spike in interest rates followed by a Depression if governments continue on their present course.”

The bond market is already starting to crack, and the numbers hit on the Richter scale are rising. For those looking to offset equity risk by holding bonds…well, you are in for a shock. That 60/40 portfolio strategy may have worked fairly well for the past forty years. But fixed income will not act as a ballast for your investments when both equities and bonds are in a bubble and headed for a crash. In contrast, it is a recipe for disaster. Active management to navigate these inflation booms and deflationary busts is now 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.”

When Will the Party End?

February 2, 2021

I’d like to explain why these already-stretched markets could crash by the start of the 3rd quarter. I’ve been warning over the past month, or about, that my Inflation/Deflation and Economic Cycle Model SM is forecasting a potential crash in equities around the start of Q3 this year. Of course, this timing could change and I would only take action in the portfolio if the Model validates this forecast to be correct. Nevertheless, here’s why the bubble we are currently riding higher in the portfolio could burst around that time.

During the late Q2 early Q3 timeframe the following macroeconomic conditions will be occurring:

  1. The second derivative of y/y growth and inflation will be surging.
  2. As a direct consequence, Bond yields will be surging
  3. Whatever tax increases to pay for the Biden administration’s stimulus packages should have been passed.
  4. The next trillion-dollar COVID stimulus package will be months in the rear-view mirror and the $900 billion package signed by Trump in late December will be even further behind.
  5. The chatter around Fed tapering its $120 billion per month bond purchase program will then reach a crescendo. Just look how the market sold off today on just a routine Fed meeting—one without the spiking inflation yet to come. By the way, Mr. Powell reinforced his record-breaking easy monetary policy.
  6. Finally, the COVID vaccines will be close to reaching maximum distribution and their genuine efficacy and effect on the economy will then be known. If the vaccines work anywhere near as advertised, Powell indicated in his press conference today that it would be a strong catalyst towards normalizing monetary policy. Hence, the economy will then realize its maximum re-opening status–thus, putting further upward pressure on interest rates.

To sum up: we will have higher taxes, much higher interest rates and rapidly rising inflation. All this will occur at the same time the market will be worrying about front-running the Fed’s exit from record manipulation of bond and stock prices. There will be immense pressure on the Fed to cut back on monetary stimulus at exactly the wrong time: the cyclical peak of economic growth. Indeed, the ROC in growth will be on the precipice of rapidly falling during late Q3 and Q4 because of waning fiscal stimulus, the threat of reduced monetary stimulus and interest rates that are becoming intractable.

This will leave Mr. Powell with a huge problem. If the stock and bond prices are already crashing due to inflation (while the Fed Funds Rate is already at 0% and QE is at a record high rate, then the Fed won’t be automatically able to save the day by instituting more QE and rate cuts. While it is true that a central banker can easily fix a bear market caused by recession and deflation–simply by pledging to create more inflation–it cannot easily arrest a bear market if it is caused by spiking rates and inflation through the process of printing more money.

Powell may be rendered powerless to stop the market from plunging precipitously. It may only be in the wake of the carnage of a deflationary depression that Powell’s move to buy stocks has any real benefit. Only then will his printing press become effective. Alas, that will be way too late for those who suffered going over the cliff and the multiple years you have to wait to make up the loss. PPS is ready to protect our gains and profit from the coming gargantuan reconciliation of asset prices. In contrast, the deep state of Wall Street will buy and hold your retirement account into the abyss.

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 Coming Bitcoin Crash

January 29, 2021

Bitcoin, or as I like to call it BitCON or S*H**T coin, is not gold 2.0. What makes gold valuable is its extreme rarity, its beauty, and its quality of being virtually indestructible. Bitcoin enjoys none of these traits.

Of course, Bitcoin is not in the least bit beautiful. This is because its private key consisting of 64 electronic letters and numbers are invisible to the naked eye. And, even if you could glimpse a view of one under a very powerful microscope, they turn out to be not very pretty at all. BTC aren’t exactly indestructible in practice either—I’ll explain that misconception too, as this is where the justification for BTC’s obscene valuation completely falls apart. Also, as it turns out BTC is not in actuality scarce because it is in reality part of a group of commodities that have an infinite supply.

While the number of BTC is limited to an eventual 21 million units, and therefore technically rare, it is also a fact that there are an unlimited number of cryptocurrencies that can be created. These “currencies” perform the same primary function of moving a “coin” along a block chain whose transactions are decentralized, immutable and anonymous. In other words, the worth of each existing cryptocurrency gets diluted every time a new one comes into existence; and this function is perpetual. It is as if geologists were constantly finding new elements within the earth’s crust that held the same qualities as gold. While the quantity of gold would not be increasing, the value of each existing ounce above ground would plummet.

Most importantly, while BTC is indeed nearly impossible to eradicate by governments, these same governments can rather easily relegate all cryptocurrencies to the dark web; thus, greatly suppressing its valuation. The truth is governments don’t like to lose control over their currencies—they will never allow it to happen. They do not tolerate tax cheats very well; nor do they like money launderers; or promoting commerce in illicit activities. Needless to say, not all users of BTC engage in such activities. But no one can deny such things take place and the decentralized nature of cryptocurrencies attracts those who traffic in these behaviors. Hence, governments will eventually end up regulating cryptocurrencies by declaring commerce in them illegal and outlawing the exchanges, along with all of Wall Street’s investment products associated with it. Their liquidity would then vanish overnight along with all price transparency. This in turn will wipeout most of its value.

Here then lies the conundrum: BTC, et al, now needs to be regulated by government and accepted by Wall Street in order to justify its ridiculous price. However, once cryptos become regulated and taxed they lose their essential characteristics of being decentralized, the transactions are no longer immutable, nor are they anonymous. Indeed, all trading in BTC can be easily viewed by the relevant authorities. Therefore, those who engage in these transactions expose themselves to having their cryptocurrencies confiscated; making its very purpose for existence annulled. In other words, worthless. BTC will then return to the dark corners of the internet where few venture to go. There will no longer be mass acceptance of BTC and its price must then crash to reflect its extremely limited use. That won’t be anywhere near $40,000 per unit; but probably closer to the three-digit zone.

 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 Threshold Keeps Dropping

January 25, 2021

Initial Jobless claims totaled 900,000 for the week ending January 16th, after shedding 965,000 in the week prior. These numbers are over four times greater than they were a year ago. I find this to be not only sad but also remarkable in that we are still losing close to one million jobs per week a year after the Wuhan virus first broke out. More signs of economic stress were found in the December Retail Sales report. Sales dropped 0.7% last month, and the data for November was revised down to show a decline of 1.4%, instead of the 1.1% previously reported. Figures such as these illustrate just how fragile the economy still is, which will automatically put upward pressure on the level of outstanding debt. And, gives the new Administration impetus to pass more and bigger fiscal stimulus packages. That’s really bad news for any of us left that still care about debt and deficits.

The US budget deficit is up 60.7% in only the first three months of the budget year. The amount of annual red ink so far in fiscal 2021 was a record-breaking $572.9 billion, which is $216.3 billion higher than the same October-December period a year ago. Remarkably, we are living in the good old days of fiscal rectitude when compared to what lies ahead.

President Obama took a full eight years to add $9 trillion to the outstanding debt load. The MAGA President accomplished this baleful deed in only four.  Now, Joe Biden indicates his opening salvo for spending will be a $1.9 trillion COVID relief package, which will quickly be followed up by another two-trillion-dollar economic spending deal. It took over two hundred years’ worth of US history to accumulate $1 trillion in National debt. We did 4x that amount in the past 12 months alone, with the promise of trillions more in debt already on the way. Safe to say, there is no home for the party of fiscal and monetary conservatives any longer. Libertarians have become ostracized pariahs. The Tea Party went extinct moments after its birth.

This brings us to the Vice-Chair of the Fed, Richard Clarida, who said on an interview with CNBC recently that the Fed won’t raise interest rates until there exists a 2% rate of inflation for an entire year. Not only this, but former Vice-Chair Alan Blinder said in a recent Bloomberg interview that there would be “smooth cooperation between the Treasury and Fed.” Aren’t you relieved? So much for the separation between the Treasury and Fed. Treasury Secretary Janet Yellen will work well with the current holder of her former position (Fed Chair Powell) to ensure the purchasing power of your savings will get destroyed at an even faster pace than it is already.

Our Nation’s debt to GDP ratio has now climbed above 130%. More importantly, that debt has surged to equal 800% of our entire federal annual revenue. We have basically become an insolvent nation with annual deficits that mimic a banana republic. They are adding 15% of GDP per year to the whole insolvent dung heap. This record amount of debt will soon be held in the context of rapidly rising inflation due to the Fed’s monetization of direct government payments to the private sector. All this will be taking place at the same time the market will become concerned that the indiscriminate buyer of $120 billion of debt each month (the Fed) must someday soon begin removing its bid for these bonds. Perhaps, this will occur not so much due to any fear of inflation on the part of the Fed—central banks are now completely enamored with the idea of higher inflation—but rather because of the bond market’s reaction to inflation. Spiking yields will lead to a stampede of front-runners to try and sell ahead of the Fed and crashing bond prices.

The problem here is that each Fed-induced boom/bust cycle has served to addict the economy and market to lower and lower interest rates. The historical average Fed Funds Rate (FFR) has been about 5.5%. However, it only took a 5.25% FFR in June of 2006 to collapse the real estate market and the entire global economy. The FFR was still 25 bps below average, but that was too high to sustain the housing bubble and its related debt. Likewise, in December 2018, the FFR was inched back to just 2.5%. Nevertheless, that lower rate was enough to crash the REPO and stock market–pushing the Fed once again into retreat on its rate hiking cycle. This was true even though that rate was far less than half its average.

The simple truth was, asset-price valuations had soared to a level that only made sense in an environment of ultra-low interest rates. It’s the same for debt, which had climbed to a level that was untenable without near-zero servicing costs.

Today, the level of debt and asset prices have broken all previous records and valuation metrics. Therefore, it makes sense to assume that the level of interest rates necessary to topple the market and economy is much lower than the previous high-water mark of 2.5%. The Total market to GDP at the end of 2018 was “just” 123%. Today it sits at a perilously close to 200%. Similarly, Total Non-financial Debt was 260% at the end of 2018. This ratio now stands at 310%. This combination of record debt, which sits on top of a historic equity bubble, ensures that the Fed’s next foray into normalizing interest rates won’t last very long before the entire artificial edifice comes crashing down once again. This is especially true given the fact that the current rate of QE ($120 billion per month) is 50% greater than it has ever been before.

The fact is, Mr. Powell and his cohort of counterfeiters will never be able to normalize interest rates—not even remotely close. Forget about raising rates; they most likely will not even be able to exit QE this time around without cratering the markets. The only saving grace for investors will be to eschew the deep state of Wall Street’s mantra of passively holding a diversified portfolio of stocks and bonds. Rather, they must actively manage these cycles between inflation and deflation. This has become especially imperative because each progressive boom/bust cycle is becoming more destabilizing and pernicious.

 

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.”

 

 

Taper Nervous Breakdown

January 4, 2021

The next time the Fed reduces its bond purchase program the market reaction should be more like a nervous breakdown rather than just a tantrum.

First let’s review a bit of the historical histrionics surrounding the initial Taper Tantrum. Back in September 2012, the Fed’s Quantitative Easing program was running at the level of $85 billion per month. The asset purchase program consisted of both Mortgage-Backed Securities and Treasuries. Then, in December 2012, Fed Chair Ben Bernanke expanded his massive QE 3 scheme by making its duration unlimited. But by May 2013, the time had finally arrived to start discussing the tapering of its asset purchases. And in December of that year Tapering officially began; with QE ending by October 2014. Of course, the Fed would be back in the QE game six years later. But at the time, the overwhelming consensus thinking was that the 100-year economic storm had passed and we would never witness such extraordinary actions by our central bank ever again.

While the S&P 500 did drop by 5% in just a few weeks after Bernanke first discussed reducing asset purchases, the carnage was much worse in the sovereign debt market. In May 2013, after just a mere suggestion of an imminent reduction in bond purchases, panic spread throughout global bond markets. The 10-year U.S. Treasury took it especially hard, sending bond prices plunging. The Benchmark yield gained 140 basis points between May and early September 2013. According to PIMCO, the yield on the 10-year Note was 1.94% on May 13th, the day before Bernanke’s testimony. But less than four months later that yield surged to 3.34%.

As bad as that Tantrum was, there are three reasons why the next Taper Tantrum should make the previous markets’ hissy fit look like a state of tranquility.

The first difference is that the Fed is now buying $120 billion worth of assets each month instead of the $85 billion during QE 3. It was buying MBS and Treasuries during the runup to the last Taper Tantrum. But now, the Fed is not only buying those same types of assets, it has thrown in for the first-time ever new types of debt including municipal and corporate bonds—even junk-rated debt—with its current QE 4 program. This humongous market distortion has forced bond yields much lower than they were seven years ago. Back in the Taper Tantrum days, the thought that there could ever be negative yielding sovereign debt was absurd. Today, there is nearly $20 trillion worth of debt that offers a yield less than zero percent. Treasury bond yields are also at a record low—some one hundred basis points less than what existed in 2013. With bond yields so low, it simply means the potential energy stored up behind interest rate normalization will be all the more violent; with the rate of change causing G-LOC.

The second reason why the next tantrum will be worse than before is that equities are in a much bigger bubble today. The price to sales ratio of the S&P 500 back in March of 2000 (the previous peak of stock market valuation) was 2.1; and this metric was just 1.3 prior to the Taper Tantrum. Today, it is at an all-time record high ratio of 2.7. The other most important and revealing valuation metric is the total market cap to GDP ratio. The total market cap of the Wilshire 5000 to GDP was 1.4 at the March 2000 peak. This ratio was just about 1.0 in the Taper Tantrum days. However, it is now over 1.85. Therefore, the stock market is not only at a much higher valuation than at any other time in history, it is immensely greater than its 2013 levels. How bad could it get? For those investors who bought the NASDAQ at its peak; the ensuing plunge was over 80% and you would have to wait 15 years to break even in nominal terms. When adjusting for inflation the waiting time was even longer.

Both the Dot.com crash and Taper Tantrum were the result of the Fed taking away the punch bowl. Jerome Powell tacitly admitted during his December press conference that the continuation of near-zero borrowing costs is the only thing keeping the stock market bubble from bursting. Hence, it is imperative to avoid making the mistake of buying and holding stocks at these levels once the Fed starts draining its liquidity.

Finally, there is now a record amount of total debt that is clinging precariously to the Fed’s artificially-induced low yields. The more debt there is outstanding in relation to the underlying economy, the more unstable the economy becomes–and the more damaging its eventual reconciliation will be. The National debt to GDP ratio now stands at 128%. It was “just” 100% in 2013 and a mere 57% in March of 2000. Most importantly, the ratio of Total Non-financial Business Debt to GDP is both daunting and ludicrous. Back in the lofty days of the Internet Bubble, this ratio reached 67%. But it declined to 42% during the days leading up to the Taper Tantrum. Today, Total Non-financial Business Debt has soared to become a full 82% of the overall economy (sources: Z.1, World Bank). There is now a record amount of high-yield corporate debt outstanding and that yield is the lowest in history. And remember, the Fed wasn’t buying junk bonds back in 2013.

The common catalyst for previous bubble explosions has been a central bank that has removed its massive and indiscriminate bid for the bonds it buys. For it is exactly that process which indirectly inflates those asset bubbles to begin with. It is a rapidly rising rate of inflation, as measured by the Core PCE Price Index, which will prompt the Fed into reversing its easy monetary policy stance. But that is probably still a long way off.

It is certain that the coming wipeout will bring the Fed back into the monetary manipulation game once again. This next iteration will be in record size and scope—just like the previous ones before it. But that decision will be subsequent the coming chaos. And after all, what investor really wants to suffer another 80% setback in their retirement plans if they don’t have to? This is why it’s now more important than ever to reject the buy-and-hold propaganda that is spewed out from the deep state of Wall Street.

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

 

Inflation Blinders

December 31st, 2020

While the Fed is desperately trying to ignite the spark of inflation, the wildfire it created rages uncontrolled. The conflagration can be easily spotted when looking at asset prices. But remember, the Fed doesn’t count surging asset prices as inflation. Indeed, encouraging bubbles has become a primary function of central banks.   Hence, it removes those prices from all of its meaningless and warped inflation calculations.

For examples: the 19 commodities in the CRB Index have surged by 54% since the April low. Nothing to worry about here, this makes the fed happy. Real estate prices are in an echo bubble from the crash of 2008. Homeowners with mortgages, representing about 63% of all properties, have seen their equity increase by 10.8% in the past year, according to CoreLogic. Again, that’s great news for existing homeowners—especially those that speculate in real estate and own multiple properties. And, it’s the best news for banks that own MBS and derive their income from making new loans.

Unfortunately, these institutions are once again making loans to people who have little chance of paying them back—but we’ll worry about that when the next crisis emerges and the government will have to bail them out again. Of course, it’s terrible news for renters and first-time home buyers. However, Mr. Powell isn’t concerned about the middle class nearly as much as he is about pumping up the financial services industry.

Then we have the stock market. The Median PE ratio of the S&P 500 is now 30.8. The Historical Median PE ratio is just 17.3. According to Ned Davis Research, the stock market would have to correct by 43.8% just to get back to a normal valuation–not to the point of undervalued or cheap you understand–just back to average. I’ll remind you that markets tend to overcorrect to the downside, not just stop at fair value.

Don’t forget about the Fed’s most preferred bubble…bond prices. Fixed income has been taken up to the thermosphere across the board. Bringing yields down on US treasuries bills to 0%. And, Junk bond yields to provide 300bps below what Treasury yields normally offered.

There has been a 700% increase in the fed’s balance sheet in the past dozen years. To be perfectly precise, that $6.4 trillion increase in base money supply is the root of all inflation. M2 money supply is up a record 25% this year. One consequence of the Fed’s actions has been a 14% fall in the USD since April, which was during the initial breakout of COVID-19. Mr. Powell is printing money at the pace of one trillion four hundred forty billion dollars per year. He promised at the December FOMC meeting and press conference to keep up this rate of counterfeiting up until the unemployment rate plunges and core PCE climbs above 2% in a sustainable manner. He also now believes racism and climate change are under the auspices of monetary policy.

But the truth is, low inflation is a delusion of the Fed. Its newly created money goes primarily into asset prices where inflation now runs rampant.

Why are asset prices rising far ahead of core PCE inflation? The sad truth is most of the increase in base money supply cannot be lent out to consumers and businesses because they are already saturated in debt. So, the inflation created hangs around Wall Street. But, in the wake of the next crisis, that money supply boom should not only become manifest on Wall Street; but pervade throughout the economy. This is because the Treasury and Fed will cooperate to directly send money to consumers and small businesses rather than just hand it out to big banks. We saw this happen earlier this year and it should be come standard operating procedure in the near future.

The Jan. 5th runoff election in Georgia is key because it could grease the skids towards runaway stagflation if the Democrats win both senate seats. In either outcome, however, the destination towards Universal Basic Income and MMT is inexorable.

Here’s how dire the situation really is: The U.S. government’s deficit in the first two months of this fiscal budget year ran 25.1% higher than the same period a year ago. The total was $429.3 billion; and yes, that’s nearly one half trillion dollars in just two freaking months. All of which must be, and will be, monetized by the fed with alacrity. These types of banana republic numbers are evident even before we have the ultimate crash, which will be brought on by the coming bond market implosion due to insolvency and inflation.

When you predicate GDP growth on the back of asset bubbles the economy becomes addicted to the practice. Hence, the fed becomes trapped in its never-ending support of these same asset bubbles. For if it was to ever stop manipulating money supply and remove its indiscriminate bid for bonds, interest rates would soar and the bubbles will all crash. Thus, wiping out whatever anemic and unsustainable growth that was created.

This is why buying and holding a basket of stocks and bonds can no longer work. In fact, it could destroy your retirement. In contrast, actively managing your money in a way that seeks to own the correct assets during bull markets and seeks to protect and profit during a bear market has become crucial.

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.”

Take the Under on 2021 GDP

December 28, 2020

 Wall Street is universally bullish on the economy and stock market for 2021. For example, Morgan Stanley is on record predicting the U.S. economy will expand by 5.9% next year. The stock market has front-run this optimism. The most important valuation metric, total market cap to GDP, currently stands at an unprecedented 185%. This absurd valuation only makes sense if investors believe corporate profits will skyrocket next year. No other bull market in history even comes close to this historic distortion between the price of stocks and the underlying economy.

But, let’s take a moment to unpack this theory of a booming economy next year. To accomplish this, we fist have to look back to what occurred during 2020.  The outbreak of the Wuhan Virus shut the economy down for most of the first half of this year. But, after falling by a seasonally adjust annual rate of 31.7% in Q2, the economy rebounded sharply in the second half. Hence, the overall U.S. economy is projected to contract by about 3.5% for all of 2020. Don’t forget that the unemployment rate is still highly elevated and there are still many issues with small businesses that can’t access the capital markets. Hence, what have now is a highly bifurcated economy with some big winners and many huge losers.

2020 was mar by a tremendous divergence in economic sectors. There was a crash in the leisure and hospitality sectors, but a boom in home improvement, e-commerce and the financial services industries. Most importantly, the reason why the entire economy didn’t crash throughout all of 2020 was because the government borrowed and printed $3 trillion and handed it out to Wall Street, small businesses and individuals—with another $900 billion ready for dissemination in a couple of weeks. Therefore, for the most part, consumers simply switched from going out to eat, jumping on planes and booking hotel rooms; to ordering electronic gadgets online, refurbishing their homes and gambling on Wall Street.

So now, assuming the vaccines all work as advertised (that’s a big assumption indeed), consumers will once again start taking vacations and making dinner reservations. However, this activity will be drawn from the money that was erstwhile being spent on home improvement and work-from-home office gear. The point here is there will not be another $4 trillion is stimulus doled out in 2021—not if Republican Senator Mitch McConnell has anything to say about it. And, if the virus appears to become tractable by mid-year, the Fed may begin to reduce its record and unsustainable pace of $120 billion in QE per month.

If the above proves true, there is no way the U.S. economy will be in the 6% GDP boom that is predicted by Wall Street next year. At best, it should return to the rather pedestrian 2.2% year-over-year growth rate experienced between December 2019 and December 2020. And, that is assuming the scars from a humongous increase in debt across the board vanish quickly. It also must be the case that the 10 million jobs lost since the pandemic began will come roaring back. And, the crippled retail sector, which includes 1 out of every 6 restaurants that have permanently closed their doors, won’t become a drag on the economy either. The truth is, Wall Street’s soaring EPS postulate, which will cause a melt-up of stocks in 2021, is a farce.

And, as I already mentioned, the jury is still out on how these vaccines will perform. The news about a more virulent strain of COVID-19 puts a salient question of the table: how will theses new MRNA vaccines deal with a COVID-19 virus that mutates more than the measles; but yet slightly less than the influenza virus?

Nevertheless, the most prominent risk in the near future is that the Fed begins to retreat on its monetary support. Of course, Mr. Powell won’t raise interest rates until at least 2023. However, the eventual dialing back of QE could cause havoc in markets.

The Fed Chair stated the following at his December FOMC press conference:

When asked about the markets extraordinarily-high asset valuations and if it was a bubble, he replied, “That’s maybe not as relevant in a world where we think the 10-year Treasury is going to be lower than it’s been historically from a return perspective.”

And, when asked about the solvency of the U.S. Treasury Powell stated, “I think the question is we’ve always looked at debt to GDP and we’re very high by that measure. By some other measures, we’re actually not that high. In particular, you can look at the real interest rate payments, the amount of what does it cost. And from that standpoint, if you sort of take real interest costs of the federal deficit and divide that by GDP, we’re actually on a more sustainable fiscal path, if you look at it through those eyes.”

The translations for these statements are that Mr. Powell has tacitly acknowledged we can only remain a solvent nation as long as the Treasury can borrow money for virtually free and the stock market bubble can only remain inflated as long as the Fed keeps buying enough junk bonds to keep interest rates at all-time record lows.

Rising interest rates will eventually torpedo this bull market. That time will arrive whenever, or if ever, normalization of our economy returns. Meaning, nominal GDP rises to somewhere in the neighborhood of 5% (2.5% inflation + 2.5% real growth). Of course, we could also get there by having inflation rising much higher than real growth, which is a much more likely outcome. At that point, the benchmark US Treasury Note should yield at least the same as nominal growth. However, after remaining at record low levels for most of the last dozen years, absolute carnage will arise from borrowing costs that begin to surge by hundreds of basis points across the sovereign yield curve–with much more damage occurring in corporate debt market–especially junk bonds. This will cause the economy and markets to tank.

The Fed’s gradual exit from its manipulation of the bond market will once again cause panic on Wall Street.  But panic is something reserved for those who rely on the deep state of Wall Street for advice. Only those without a data-driven process do that. In sharp contrast, we will closely monitor the pertinent components of the IDEC Model for the timing to sprint towards the very narrow exit door. And then get short this massive equity bubble to protect and profit from its collapse. It’s the only sane thing to do.

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.”