Latest Commentary

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.”

The Central Bank Time Machine

August 23, 2019

 We are now witnessing the death throes of the free market. The massive and record-breaking global debt overhang, which is now $250 trillion (330% of GDP), demands a deflationary deleveraging depression to occur; as a wave of defaults eliminates much of that untenable debt overhang. The vestiges of the free market are trying to accomplish this task, which is both healthy and necessary in the long term—no matter how destructive it may seem during the process. Just like a forest fire is sometimes necessary to clear away the dead brush in order to promote viable new growth. However, the “firemen” of today (central banks) are no longer in the business of containing wildfires, but instead proactively flooding the forest with a deluge of water to the point of destroying all life.

In point of fact, the free market is no longer being allowed to function. Communism has destroyed capitalism, as the vital savings and investment dynamic has been obliterated. Central banks have decided that savers deserve no return on their so-called risk-free investments and have hence forced into existence humongous bubbles in junk bonds and equity markets worldwide. They have destroyed the savings and investment dynamic and turned time backward.

This explains why market volatility has spiked. Markets want and need to correct the absurd valuations found in fixed income and risk assets, but governments constantly step in to try and reverse these gravitational forces. The result is wild swings in global markets that have neither completely crashed nor meaningfully advanced in the past 20 months. For example, the S&P 500 is virtually unchanged during this timeframe yet has experienced a few sharp selloffs and a 20% correction in between.

Every time market forces begin to take over, some government announces a fiscal stimulus package and/or a particular central bank announces a proposal to print yet more money. Nevertheless, we are quickly approaching the point where insolvent governments can no longer stimulate growth by adding to their pile of debt, and central banks are approaching the limit on their ability to reduce debt service costs and how much new credit they can create without destroying the confidence in fiat currencies. Thus, busting through their asinine 2% inflation target.

Measuring the steps that governments and central banks are willing to take and the effectiveness of such stimuli will be the key to understanding the inflation/deflation and growth dynamic that is essential to making money.

So how is the US economy doing now? Despite a relatively strong retail sales report for July and low unemployment claims, the general trend of the US economy is towards slowing. The all-important Aggregate Hours Worked index is a measurement of the total number of workers times the average hours in a workweek. Despite the 2,162,000 of net new jobs created for all private-sector employees from 7/2018-7/2019, the Index for aggregate weekly hours was unchanged at 111.9 during that period. This is because the average workweek for July 2018 was 34.5 hours; that figure has dropped to 34.3 for July 2019. Not coincidentally, there are now a record number of individuals that are holding more than one job. Not only this, but the 3-month rolling average for net new jobs created in July of last year was 237k; it plunged to 139k net new jobs created for the three-month average ending July 2019.

The Treasury Department said federal spending in July was $371 billion, up 23% from the same month in 2018. The fiscal-year-to-date deficit was $867 billion, compared with $684 billion last year at this time—with two months still left in fiscal 2019. Servicing costs for this current fiscal year’s National Debt are almost a half-trillion dollars ($497 billion through July) –and will be higher than 2018′s record $523 billion once this fiscal year ends in October. This calls attention to President Trump’s Twitter feed. He posted this doozy on August 8th, “As your president, one would think I would be thrilled with our very strong dollar. I am not!” Trump wants a weaker dollar, and the Fed wants more inflation. Once achieved, those record borrowing costs will explode higher.

The NY fed announced that consumer debt is now $1.5 trillion higher than 2008. Total Consumer Debt is at a record $13.9 trillion.

The disease of ZIRP, insolvency, and asset bubbles has infected the entire globe. Something is indeed rotten in the state of Denmark, and it is their mortgage market. Denmark is now offering mortgages with negative interest rates. Borrowers can now end up paying back less of the principal they paid on the home. They pay no interest and get paid to borrow.

Yet still, stock market carnival barkers claim they can find no market distortions or signs of excess leverage anywhere in the system. Well, why not start with the fact that the major global central banks alone have printed $22 trillion since 2008. They have created the biggest bubble in the history of planet earth known as the sovereign debt bubble. This has distorted asset prices across the board and set the table for the obliteration of the global economy upon its bursting. Such bubbles have become so large and precarious that governments are in a panic to create a perpetual state of ever-rising inflation to keep them from crashing.

But eventually, these bubbles always burst because bubbles by nature are never static. They are massively unstable and must either grow or explode. There isn’t a better reason for bond prices to collapse other than inflation. And the inflation “success” of central banks would be a great catalyst. The fact the fed wants more inflation, yet already has achieved a 2.2% y/y core CPI reading in July, is unnerving, to say the least. Once inflation begins to run hot–and that $22 trillion of new dry tinder catches fire–bond yields will start to soar. At that point there is nothing central banks can do. If they were to stop printing money the only bid for negative-yielding debt gets removed and bond yields will spike in an unprecedently destructive manner. Alternatively, they can keep on printing and watch hyperinflation obliterate the economy. That is the unavoidable outcome of creating a 633% increase in the supply of base money since 2008.

The other scenario is if the US economy joins the rest of the world and slips into a recession. This would cause the spread between Treasuries and Junk bonds to surge; cutting off the supply of new credit for most companies rated BBB or less. By the way, there is over $1 trillion worth of corporate debt that now has a negative yield.

Whether it is recession or inflation or both, the salient point is that bond yields are not destined to just slowly drift a few basis points higher in an innocuous fashion. Yields have become so enormously distorted that an explosion higher is virtually assured to occur. After all, if you own a sovereign or corporate bond with a negative yield and your central bank is forced to pull the plug on its bid prices will collapse with lightning speed. Likewise, junk bond prices in the US will crater the moment it becomes clear that zombie companies will soon be going belly-up. High-yield debt would then spike from the record low 5-8% range to the 14%-22% range; just as it did in the past two recessions. That is, at least until the Fed decides it is necessary to start directly purchasing Junk bonds.

Indeed, what central bankers have created is sort of a time machine. They have reversed the clock when it comes to the time value of money. The cost of money should normally increase alongside the solvency and inflation risks as we go through time. However, the growing mountain of negative-yielding debt has flipped time upside down; where savers lose more money as time passes. In other words, they can consume 100% of their savings today; or instead, choose to defer that instant gratification and be assured to lose a portion of that ability tomorrow.

In closing, you know Wall Street loves to say that gold is a bad investment because it doesn’t have a yield and it cost you money to store it. Well, you know what else doesn’t have a yield and costs you money to store it: Sovereign debt–27% of the developed world’s total global supply now has a negative yield. And that trillion-dollar pile of negative-yielding corporate debt is surging by the day.

This is why the buy and hold strategy of investing has become so dangerous and deadly for your financial wellbeing. Investors must have an active strategy that adapts to both deflationary collapses and stagflation cycles in markets.

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.”

From Opium Wars to Currency Wars

August 19, 2019

In 1842 the Qing dynasty surrendered Hong Kong to the British Empire following the First Opium War. Then, in 1898, the British pledged to cede it back to China after 100 years had passed. Excluding the period of Japanese occupation during the Second World War, Hong Kong remained under British rule until its peaceful handover to the Chinese in 1997. This transition was structured by the Sino–British Joint Declaration, which guaranteed Hong Kong would remain a capitalist economy and have its own currency and separate legal system until the year 2047. This rubric was known as “One Country Two Systems.”

Regrettably, the current conflict between Hong Kong and the mainland was inevitable because the people of Hong Kong have a long history of thinking of themselves as a part of a western-style democracy—one that has been prospering for 177 years–and would never easily relinquish their freedoms. The salient question now is will China send the People’s Liberation Army into Hong Kong to quell protestors that were originally incensed about a “fugitives bill.” This bill would allow Hong Kong citizens to be extradited to China. President Trump has already indicated that he is behind President Xi. And, with American/Sino relations at a low point, the time may be ripe for China to expedite the complete annexation of Hong Kong both territorially and systemically.

Until very recently, Hong Kong has enjoyed its quasi-independence from mainland China, growing economically both as a manufacturing hub and one of the financial capitals of the world. But, unhappiness with the proposed extradition bill has led to civil unrest. Hong Kong’s chief executive, Carrie Lam, agreed to suspend the bill but not remove it entirely. That has simply reminded the people of their eventual fate.  The truth is it was never going to be possible for the 7.4 million free citizens of Hong Kong to change the way that the communist autocratic regime controls 1.4 billion mainland Chinese.

Gordan Chang author of “The Coming Collapse of China,” believes revolution is on the horizon for China; starting with Hong Kong. And these seeds of revolution have already begun. On Monday, August 5th, defying Beijing, seven districts in Hong Kong participated in a general strike, leading to the cancellation of hundreds of flights and the eventual shut down of the main airport. A quarter of the entire population of Hong Kong has now taken to the streets.

The civil unrest in China has also started to impact the value of its currency–the yuan broke below the important level of 7 yuan to the dollar.

China’s central bank suggested that the depreciation was in response to Mr. Trump’s decision to extend punitive tariffs to the entire value of China’s exports. However, China is not manipulating its currency lower as Trump would suggest. Rather, China is desperately trying to keep it from crashing.

Hayman Capital’s Kyle Bass believes that if the Chinese yuan were to trade freely, it could be looking at as much as a 30% – 40% devaluation. The Chinese government is working hard to prevent a free-fall currency collapse. And it’s unclear if the 7-yuan breach was a test to see if markets would allow the yuan to devalue slightly without experiencing massive capital flight out of China.

Because China now has both a fiscal and current account deficit, it is in desperate need of US dollars for trade and debt repayments.

And the truth is large Chinese commercial banks have become even more dependent on dollar-denominated debt. The Bank of China’s annual report showed the total amount of dollar debt stood at 2.21 trillion yuan ($314 billion) at the end of 2018, up 12% on the year. However, as dollar debt has increased, dollar assets remained unchanged at 1.67 trillion yuan, bringing the dollar-debt to dollar-asset gap up 81% to 536.5 billion yuan.

However, despite China’s woes, many market pundits believe that China’s over $3 trillion in foreign currency reserves leaves both China and its currency out of danger. But those pundits may be surprised to know that it’s not just China skeptics that question the potency of China’s foreign reserves. According to the IMF, China’s reserves have been below the recommended levels since 2017. Despite its substantial foreign reserves, which have surged by 430% from 2004 to 2015, money supply and short-term debt have increased even faster; growing 860% and 780% respectively, over the same period.

China’s total debt has skyrocketed to $40 trillion (over 300% of GDP), from around just $2 trillion back in 2000. Not surprisingly, the amount of bad loans has increased alongside the pace of state-directed unproductive debt. Official data shows that the amount of non-performing commercial loans (NPLs) has recently reached 2.16 trillion yuan—a 16-year high. This number is still a very low percentage of total loans outstanding, but that is because the government ameliorates the default process by papering over most of those NPLs. The PBOC may be forced to soon print 10’s of trillions of yuan to bail out its faltering banking system, which would send the value of its currency plunging from its current precarious position.

If the pace of yuan decline were to continue, it would force China’s major trading partners to devalue along with the yuan–or risk an export-led recession. Thus, putting a tremendous strain on the ability of these countries to carry their tremendous amount of dollar=based debt.

The trade war is increasing the difficulty of keeping the Chinese economy and currency levitated.  According to the Nikkei Asian review, more than 50 multinationals from Apple to Nintendo to Dell are working on relocating their manufacturing bases out of China to escape the punitive tariffs placed by the United States. With the large outflow of economic activity, China is going to have a harder time feigning its illusory 6% growth rate.

Any Pentonomics follower knows I have maintained for some time that China’s economy is built on an enormous debt bubble that will one day burst. Europe, Japan, and the US share much the same fate. This will have hugely negative ramifications for the global economy. China looks like it is now a gentle gust of wind from having its entire house of cards blow.

The Red nation is now having to fight three wars simultaneously; a trade with the United States; amalgamating the freedom-loving citizens of Hong Kong into the communist dictatorship of the mainland; and, a currency crisis that would destabilize the eastern bloc nations and take the developed western world down with it.

Investors need to factor in the natural progression of the dynamics between China, Hong Kong, and the free world. That is; from Opium wars to currency wars, to military wars. China has labeled the protestors as terrorists that must be severely punished “without leniency, without mercy.” This war might not be confined to China and its territories much longer. The political, economic, and military tensions between China and the West are intensifying rapidly.

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.”

An Ounce of Prevention is NOT Worth a Quarter Point of Cure

August 5, 2019

With Inflation hovering around 2% and the level of unemployment at historic lows, the Fed is fully attaining its prescribed dual mandate of full employment and stable prices (now defined as 2% inflation rate). Given this, one would think Jerome Powell was enjoying his summer, vacationing, taking long walks on the beach or lounging by the pool delighting in his success as Fed Chair.

But ironically, Fed officials saw the need to panic into a quarter-point rate cut on and also decided to end QT on July 31st. Why you ask?  Fed officials appear to be channeling Benjamin Franklin’s wisdom that “an ounce of prevention is worth a pound of cure.” Jerome Powell has been twitter bullied by Trump to “make the fed great again” –so he’s now playing offense.

In fact, former Minneapolis Federal Reserve President Narayana Kocherlakota went as far to say that he believes it will be at least 3-5 years of an easy monetary policy before the fed can even consider raising rates again. And our Fed isn’t the only central bank looking to add both defensive and offensive stimulus. The People’s Bank of China has eased lending conditions. And Australia, India, New Zealand, and Russia have recently injected fresh stimulus into their economies.

Of course, there is also the European Central Bank (ECB) President Mario Draghi, who is poised to spring into action in September, despite a current deposit rate of -0.4%. Draghi actually believes that negative interest rates equate to borrowing costs that are still too high and that making them even more negative is the panacea for EU and its insolvent banking system.

The Eurozone economy is circling the drain, and Draghi noted recently that, “This outlook is getting worse and worse… in manufacturing, especially, and it’s getting worse and worse in those countries where manufacturing is very important.” Analysts are predicting that GDP in the Eurozone for the second quarter flatlined at about .2% and they are forecasting the third quarter will come in about the same.

All this bad news is taking its toll, as German businesses are said to be the most pessimistic in a decade. The second-quarter figures are set to show a contraction in Italy and possibly Germany with Spain and France looking only slightly better.

All this “worse and worse” news is leading the ECB to signal they are willing to do more and more of “whatever it takes.” Of course, it’s going to be interesting to see where these new measures leave Deutsche Bank–one of Europe’s most prominent banks– whose stock has plummeted 77% over the past few years on the back of negative interest rates.

Still, there is an expectation that before Draghi hands over the switches of this economic train wreck to the current IMF Director, Christine Lagarde, he will first put the euro printing presses into overdrive.

Mr. Draghi, who leaves office in October, has never once raised interest rates throughout his eight-year tenure. His successor is believed to be even more dovish. She’s scheduled to start on Nov. 1, the same day as a no-deal Brexit occurs, which could lead to increased market turmoil.

But will more negative interest rates resolve the imbalances in world economies and markets? If past performance is an indicator of future success, the answer is no!

Negative rates haven’t worked out that well for the Eurozone. Mario Draghi was able to end QE in December of 2018; but that illusion of heading towards normalcy has now been shattered, as the ECB prepares for a further balance sheet expansion.

The nation of Japan could never entertain any such delusions. It is more proof that endless QE and negative interest rates are not the salve for an economic malaise. The Bank of Japan (BOJ) never tried to get rates above 0% and could not even begin to taper its QE program. Japan has enjoyed negative rates since early 2016 going out a full ten years on its sovereign bonds. However, the real economy has completely stagnated. Japan’s GDP measured in dollars in 2016 was $4.92 trillion. At the end of 2018, it was $4.971 trillion…a gain of a measly 0.9%.

There is a stark warning for those who use Japan as an example of an economy that can exist just fine on low rates, high debt levels, and no growth for a long period of time without any profound consequences to its economy. What they fail to grasp is that Japan’s stock and real estate market collapsed in 1989, and the Nikkei Dow is still down 50% from those levels reached three decades ago. Hence, the Japanification of the globe may well be fully underway, but a crash in asset prices is an integral part of that condition. Therefore, a debt-disabled, low-growth, negative-rate world can indeed exist for a very long time. But the US market will not trade at 150% of GDP if it becomes well accepted by investors that economic growth has permanently entered into a state of profound illness.

The real damaging effect of all this money printing is the inequity it is breeding in the United States and around the world. Central banks have been printing money to keep assets prices in a permanent bubble. But this asset price inflation has created a huge wealth gap that continues to broaden.

Think about real estate in some of our big cities–the owners of real estate in the boroughs of Manhattan and Brooklyn have seen the price of real estate triple the rate of inflation over the past 10 years, according to The Douglas Elliman Market report. Meanwhile, rents in Manhattan have exploded on average of 55% during this time; while wages have stagnated.

 

It is becoming apparent that ever-easier monetary policies are approaching their limits—simply because the developed world’s central banks have virtually run out of room to boost demand by reducing borrowing costs. The consequence of which is the confidence in central banks is eroding as fast as the middle class is approaching extinction.

Mr. Powell may think an ounce of prevention is worth a pound of cure. But, because of central banks’ proclivity to lean on artificially-low rates to boost asset prices and GDP for the past few decades, only a few ounces are now available–where a ton of easing is needed to keep the bubbles afloat.

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 Fed is Further Fueling the Bond Bubble

July 29, 2019

Let’s dive right into why lowering interest rates at this point in the cycle will not provide much of a boost to the faltering global economy and may not be much help to the stock market either. The simple truth is that asset prices are far too overvalued and debt levels far too onerous for a few rate cuts—for which Wall Street has already priced into the market–to make much of a difference. The European Central Bank (ECB), Bank of Japan (BOJ), and Fed don’t have room left any longer to play the same trick they have played since 1987. Namely, whenever there has been a hiccup in the stock market or the economy, they drop borrowing costs by at least 5%. But now there is zero room left in Europe and Japan, and just over 2% here in the US to reduce borrowing costs.

The proof can be found in the real estate market. By persistently forcing interest rates down, the Fed has engendered another bubble in home prices that has simply pushed them far above the affordability level for first-time buyers. Existing Home sales are down 2.2% from the year-ago period in June. Permits to build more homes, meanwhile, sank 6.1% month/month in June and were also about 7% lower compared to the same month last year. However, the 30-year fixed mortgage rate dropped to about 3.75% during the month of June, from a peak of 4.94% last November, according to data from mortgage finance agency Freddie Mac. This is proof that what the housing market needs to attract new buyers is much lower prices, not a few basis points lower in mortgage rates.

I want to share with you some disturbing data that was published by the highly respected personal finance company called Wallet Hub that doesn’t offer much hope for the immediate future regarding the affordability, or lack thereof, for first-time home buyers. Today, about one in nine individuals between the ages of 16 and 24 are neither working nor attending school. And, more than 70% of these young adults are ineligible to join the U.S. military because they fail academic, moral, or health qualifications.

Turning to the health of US corporations and the broader economy, a good barometer can be found in the railroad industrial giant CSX. The company reported earnings recently that missed on both the top and bottom line. And here’s what the CEO had to say about the condition of the economy:

“Both global and U.S. economic conditions have been unusual this year, to say the least, and have impacted our volumes. You see it every week in our reported carloads,” Chief Executive James Foote said on a conference call following the earnings report. “The present economic backdrop is one of the most puzzling I have experienced in my career.” Mr. Foote’s career in the railroad industry is over 40 years. The stock plummeted 12% on the news in one day.

While the data on Retail Sales was a bit better than some of the gloom coming from corporate earnings reports for Q2, GDP growth still dropped from 3.1% in Q1, to just 2.1% this quarter.

Regrettably, the data on global GDP growth is much worse. Auto sales in the European Union (EU) dropped by 7.9% in June from the same month a year ago. And exports from Singapore fell for the 4th month in a row and were down an astonishing 17.3% in June from the same month in 2018. The nation’s exports of electronics plummeted by 31.9% year/year. Germany’s manufacturing sector worsened in July with goods producer performance falling to its lowest level in seven years.

I want to highlight some comments made in a recent interview by one of the Fed’s chief lovers of counterfeiting, Charles Evans, President of the Chicago Fed. It is crucial to understand to what degree these central planners are hell-bent on destroying the middle class in favor of Wall Street. Mr. Evans was very clear that having an inflation rate that is even a few basis points below its asinine 2% target must be “rectified” as soon as possible and for a very long time. In other words, some members of the FOMC believe inflation must be forced well above 2% for many years to make up for the years the Core PCE Index spent below 2%. Core PCE Inflation is the Fed’s preferred metric for measuring inflation and is by far the lowest measure concocted by the government. Nevertheless, because this measurement of inflation is a measly three tenths below target, the FOMC may be panicking towards the zero-bound level once again.

The world’s central bankers have redefined stable prices as a 2% annual rate of inflation. Mr. Evans now says, “We need to go above 2% at some point or else I’m worried that [investors will think] that 2% certainly looked like a ceiling didn’t it” In other words, the Fed thinks it is imperative to empirically demonstrate to everyone that it can bring inflation above 2% “with confidence”.

The truth behind why the Fed is so concerned about maintaining a 2% inflation target is that it knows banks’ assets are in a bubble and the financialization of the economy requires that the central bank keep asset prices from ever correcting. This is because the bubbles are so big that an innocuous burst is no longer possible. Even a small decline in asset prices could quickly spiral into a crash and take the entire economy down with it.

Despite the perennial “better than expected” game Wall Street loves to play, year over year earnings growth has been pitiful. BASF, FAST, TXT, NFLX, CSX and CAT are just some of the tape bombs that we have seen. In some cases, their shares plunged by double digits just seconds after the new release. CAT dropped by 5% after missing on earnings and revenue and lowered guidance. There have been a plethora of industrials and transportation companies whose terrible earnings show how weak the global economy has become. Indeed, not all earnings have been bad and most, as they always do, have beat lowered expectations. But the truth is that global growth is slowing—the IMF recently lowered its growth forecast again; this time to the lowest level since 2009. For now, it may be the case that Wall Street doesn’t care because the Fed is expected to cut rates and force more people to chase in an unhedged fashion further into this dangerous bubble.

But it will take a massive stimulus package from the Fed, ECB, BOJ, and PBOC to push the economy from disinflation to stagflation, which may levitate asset prices a bit longer. The sad truth is that such fiscal and monetary madness is definitely on its way at some point. We’ll learn more about this on July 31st after the FOMC’s rate decision. Perhaps a 50-bps rate cut and the end of the Quantitative Tightening (QT) would do the trick. But that will just severely weaken the foundation for the market and economy, just as it intensifies the inflation central banks have been so aggressively trying to construct.

The problem with the global economy does not stem from borrowing costs that are too high. In fact, interest rates are already at an all-time low. Therefore, lowering interest rates cannot at all fix the economy. It will just create more imbalances and further undermine what’s left of the middle class.  And eventually, ensure the coming interest rates shock will obliterate the stock bubble that has been built on free money.

What the World Doesn’t Need Now is Lower Rates

July 22, 2019

The Q2 earnings season is upon us and the risks to the rally that started after the worst December on record at the close of last year is in serious jeopardy. We received a glimpse of this with some of the current companies that have reported. For example, to understand how dangerous this earnings reporting season can be, take a look at what one of the largest US multinational firms had to say recently after it reported earnings. The Minnesota-based Fastenal, which is the largest fastener distributor in North America, reported worse-than-expected second-quarter earnings and revenue. Shares of Fastenal promptly tanked more than 4%. But what the management said about the quarter was very interesting. The company said in its press release that its strategy to raise prices to offset tariffs placed to date on products sourced from China were not sufficient to also counter general inflation in the marketplace.

In fact, companies that collect more than half their sales outside the U.S. are expected to see a 9.3% slump in second-quarter earnings, according to FactSet estimates. This quarter’s earnings overall are expected to drop by 2.3%–making it the second quarter in a row of declining EPS growth.

What I find most interesting is that we have a capital spending slowdown, a global manufacturing recession, global GDP grinding downward, US Q2 growth falling to about 1.5% from the 3% level seen last year, and an S&P 500 earnings recession. All of this is happening in the context of asset prices that are at all-time high valuations and are clinging precariously to a worldwide fixed income bubble that is destined to go supernova and obliterate asset prices.

I’ve gone on record indicating that the daggers for the bubble on Wall Street and the global bond market are inflation and recession. A recession would blow up the $5.4 Trillion worth of BBB, Junk and Collateralized Loan markets; And rising rates of inflation would leave the entire fixed-income spectrum in tatters.

But what happens if you get both occurring at the same time? What if we see the return of stagflation? What if rates undergo a massive spike due to global central bank insanity and their inability to ever come even close to normalizing interest rates; and then you also have a recession that causes multiple trillions of dollars’ worth of bonds to default? The answer is, yields would soar like a surface to air missile from the currently insane level of low rates that could only make sense in the twilight zone.

How insanely-low are interest rates you ask? There are now Junk bonds in Europe that have a negative yield, Austria recently issued a one-hundred-year bond with a yield of just 1.2%, And, almost every single country in Northern Europe and the nation of Japan have sovereign bonds with a negative yield– some of which going out ten years in duration!

Therefore, because rates have been forced down by central banks to such an insane level, a gradual normalization that is fairly innocuous for markets is virtually impossible to occur. What is more probable is a violent interest rate shock like we have never before seen; especially if we end up in an environment of stagflation that causes yields to jump by 100s of bps very quickly and destroys the global equity markets with catastrophic expediency. Speaking about the insanity of low yields, the Treasury Department recently stated the deficit grew 23% from October 2018 through June, for a total Fiscal ’19 Deficit of $747 billion with one quarter of the year still left. Annual deficits near $1 trillion are happening outside of a recession. During an economic contraction, deficits should surge towards $2.5-$3 trillion.

The global bond market suffers from a plethora of insolvent corporations and sovereigns that are issuing debt with yields that offer less than zero percent. The day of reckoning may not be imminent, but you must be fully prepared for its eventuality. It is possible to profit from it, but if you don’t anticipate its occurrence, the economic consequences will be severe.

But central banks and governments are unconcerned about these asset bubbles. Incredibly, they are printing and borrow more money. To this end, we should all be aware that the Fed no longer has a dual mandate consisting of stable prices and full employment. The Fed’s primary concern is to try and levitate asset bubbles. After all, Trump says this is the best economy ever and even members of the FOMC assent that underlying growth is very strong. The unemployment rate is at a record low, and the CPI for all items less food and energy rose 2.1 percent over the last 12 months. So, core inflation is over the Fed’s asinine target, and the jobs market is very strong at this time; initial unemployment claims are at a 50-year low.

Why then would Powell indicate during his latest testimony before congress that a rate-cutting cycle will begin later this month?  The truth is the economy is very fragile precisely because it has become 100% dependent upon perpetual asset bubbles. Powell became aware of this when stocks plunged in Q4 of last year and the Junk Bond market completely shut down. The truth is that Powell, and his merry band of counterfeiters, have become absolutely petrified about a recession because they know that it will implode the entire corporate bond market…turning an average run of the mill recession into a depression in short order.

Therefore, he will now run to the printing press at the slightest hint of a downturn. But the chances are high that a 25-basis point rate cut won’t be enough to bail out the global economy.  Nor will several more like it do the trick. It should take 100s of bps and a return to QE to push prices higher.

Are we supposed to believe that central banks are going to make this all ok by easing monetary policy further from here? After all, they have already forced $13 trillion worth of sovereign debt below zero, and the European Central Bank and the Bank of Japan already have negative rates and have been at that level for years. And the Fed only has 225bps of rate cuts available, when it usually has needed 500bps or more.

Perhaps central bankers can manage to force a few more drinks down the hatch in order to delay the inevitable hangover. But that just makes the eventual collapse all the more severe.

 

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 Fed Easing Turn Out Like ’95 or ‘07?

July 15, 2019

 You should completely understand that the market is dangerously overvalued and that global economic growth has slowed to a crawl along with S&P 500 earnings. However, you must also be wondering when the massive overhang of unprecedented debt levels, artificial market manipulations, and the anemic economy will finally shock Wall Street to a brutal reality.

Artificially-low bond yields are prolonging the life of this terminally-ill market. In fact, record-low borrowing costs have been the lynchpin for perpetuating the illusion. Therefore, what will finally pull the plug on this market’s life support system is spiking corporate bond yields, which will manifest from the bursting of the $5.4 trillion BBB, Junk bond and leveraged loan markets. And, for that to occur, you will first need an outright US recession and/or a bonafide inflation scare.

We already have a manufacturing recession abroad and a contraction in the US, as illustrated in the new orders data from the June the ISM report. Wall Street is now starting to understand that there will be virtually zero earnings growth for the S&P 500 for the entirety of 2019. However, what is holding up the high-yield market and, consequently, equity prices now is the view that the Fed’s new rate cutting path will allow this ersatz economy a bit of a reprieve by taking interest rates back to zero and thus suppressing junk-bond yields as well.

The answer to the question regarding when stock prices will crash back toward a fair valuation hinges upon whether or not the Fed’s return trip back to free money will be enough to levitate asset prices and the economy a bit longer. Therefore, you must determine if Jerome Powell’s quick retreat on monetary policy will be like the rate cutting exercise that occurred in 1995, or will it be more like the 2001 and 2007 FFR cutting cycle, which turned out to be far too late to save stocks.

Those three economic cycles all experienced a flat or inverted yield curve with rapidly decelerating economic growth; similar to what we find today. But unlike the relatively innocuous period of ’95, the ’01 & ’07 cycles proved that the rate cuts implemented were not nearly enough to avert a brutal stock market collapse.

Let’s look at a bit of history. After first having raised the Fed Fund Rate (FFR) by 300 bps leading up to the middle of the 1990s, the Fed then began cutting rates by February of 1995. It ended its three 25 bps rate cutting cycle by January 1996. The total amount of 75 bps of rate reductions were enough to not only steepen the yield curve and propel the economy out of its two-quarter growth recession but also launched the S&P 500 on an epoch five-year run of 140% by the year 2000. Of course, Wall Street would love for you to believe that Jerome Powell’s new-found dovishness will lead to a similar result.

In sharp contrast to what occurred nearly a quarter century ago, the Fed’s last two attempts to pull the economy out of a nose-dive ended in disaster.

The Fed began to raise interest rates in June of 1999 in an effort to put a damp cloth on the red-hot NASDAQ bubble. By May of 2000, it had undergone a total of 175 bps worth of rate hikes. Mr. Greenspan then began to lower rates in January of 2001 and finally ended his rate cutting cycle in June of 2003 after he reduced the FFR by a whopping 550 bps. Nevertheless, those rate cuts were not enough to save equity prices.  By the fall of 2002, Greenspan had already lowered the FFR by a total of 525 bps, but that didn’t stop the NASDAQ from losing 78% of its value by that time and for investors to see $5 trillion worth of their assets obliterated.

It was a similar situation regarding what occurred during the Great Recession. Chairs Greenspan and Bernanke collaborated to raise the FFR by 425 bps from June of 2003 thru June of 2006. Ben Bernanke then began cutting rates in September of 2007 with an oversized 50 bps reduction right off the bat. He then, in a rather aggressive manner, took rates to virtually zero percent by December of 2008. In other words, he slashed rates to a record low level and by a total of 525 bps, and it only took him one year and three months to do it! However, even that wasn’t enough to keep the stock and housing bubbles from crashing. By March of 2009, the Dow Jones had shed 54% of its value, and home prices plunged by 33%  on a national basis.

Again, this begs the crucial and salient question: will the hoped-for rate cutting cycle, which Jerome Powell indicated at his testimony before Congress on July 10th will probably begin on July 31st, be enough to keep the record equity bubble from imploding? Of course, nobody knows for sure, but there is a strategy to help us accurately model the answer.

First off, the rate cutting cycle in the mid-nineties was abetted by the massive productivity boom engendered by the advent of the internet. There is no such productivity phenomenon of commensurate capacity evident today. In addition, China was on the cusp of bringing 200 million of its population into the middle class by taking on $38 trillion in new debt. The building of that giant pile of debt was responsible for creating 1/3rd of global growth and cannot be duplicated again. Indeed, global growth today is careening towards the flat line rather than being on the cusp of a major expansion.

Not only this but the debt burden in 1995 pales in comparison to that of 2008 and 2019. Total Public and Private US debt as a percent of GDP was just 260% in 1995. However, by the year 2008, it had surged to 390% of GDP, and that figure still stands at 365% today. That is over 100 percentage points higher than it was in ’95.

Another comparison to view is the amount of overvaluation in the stock market between periods. In 1995 the total market cap of equities to GDP was around 70%. But by 2000, it shot up to 148% of GDP. That figure was 110% at the end of 2007 and has now climbed all the way back to 146% today.  The bottom line is the economy is much more fragile today than it was in 1995.

But perhaps even more important than the overvaluation of equities and the massive debt burden the economy must endure is the fact that the Fed could only raise the FFR to 2.25% before stocks began to falter during this last hiking cycle. Therefore, it can only cut rates nine times before returning to the zero-bound range. In each of the previous three rate-cutting cycles, the Fed had plenty of dry powder. In fact, in ’95 it had 600 bps, in 2000 it had 650 bps, and in 2008 it had 525 bps of rate cuts available to deploy.

Also, when looking at the effective number of rate hikes the Fed has engaged in during this latest tightening cycle, you get approximately the equivalent of 625 bps of hiking since 2014. This would include the wind-down of $85 billion in QE, 225 bps of nominal FFR hikes, and the $700 billion QT program – which for the first time in U.S. history saw a tremendous amount of base money destroyed. That amount of monetary tightening is absolutely extraordinary.

The unavoidable conclusion is that the efforts from Mr. Powell will not be nearly enough to thwart the market from its well-deserved day of reckoning.

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.”