Pentonomics

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.”

Land Mines

December 14, 2020

When the market cap of equities reaches 183% of GDP and government bonds yield near 0%, or even less overseas, the notion that one can just buy and hold a balanced portfolio is extremely dangerous. The minefield is not packed with IEDs; it is actually replete with tactical nukes.

One of those land mines would be the failure to keep the government open and pass more stimulus. I have no special insight here, except D.C. is famous for brinkmanship but always opts to spend more money in the end. Another problem would be the failure to have a peaceful transfer of power come January 20th. Also, the failure of vaccines to prove to be safe, effective and long lasting would blow the whole recovery mantra sky high.

But by far the most dangerous mine to watch out for would be the failure of the Fed to cap long term interest rates. The Fed could make a move towards this action when it meets on December 16th. Let’s assume that the vaccines work and the rate of inflation and growth begins to accelerate significantly come the 2nd quarter of next year—bade effects make that easier. At the same time, the Fed could then start reducing its purchases of corporate, municipal, and Treasury bonds. Hence, there would be a very good chance that rates would become absolutely unglued, sending bond prices cratering and yields soaring.

To get a better understanding of how greatly distorted and far into the twilight zone yields have gone, you have to understand that the average yield on the ten-year note from the 1960’s until 2000, which is before the Fed started to embrace ZIRP; was north of 7%. That yield is now well below 1%. And, this is despite an avalanche of additional debt that has brought the ratio of debt to GDP from below 40% in the 1960’s, to 128% today. What we have now created is a Treasury that is issuing debt at all-time record-low yields yet at the same time is also bankrupt. To make matters worse, we have for the first time in history a Fed that is targeting higher inflation, which is the bane of all fixed income. Indeed, the worlds’ central bankers are all aggressively seeking higher inflation in the context of $18 trillion worth of negative-yielding sovereign debt.

In order to accomplish this nefarious inflation task, the Fed is creating new money at the never-before-seen rate of $120 billion each and every month and has sent MZM money supply soaring by over 20% y/y. M2 is up an eyepopping 25%. Hence, nominal long-term treasuries have an incredible amount of room to soar. That’s guaranteed to eventually happen either due to inflation or insolvency, or probably both.

But even in the immediate future, rates could rise 225 bps just based on the view that economic growth will normalize in 2021. Don’t forget; the benchmark Treasury yield was over 3.25% as late as the fall of 2018. It’s not just government debt that’s in a bubble. Now, junk bond yields are at a record low 4.6%! And, real corporate bond yields have just turned negative—meaning, after inflation is factored in you lose money. This is why the Fed is all in and completely trapped. It owns the entire treasury, corporate, municipal, and junk bond markets through the process of direct purchases. If it ever were to stop, bond prices would plunge, and yields would skyrocket; taking down the real estate and stock markets along for the ride.

The notion that rates can gradually rise innocuously as the economy heals is pure Wall Street propaganda. It wasn’t the case in 2018 during the unwinding of the Fed’s balance sheet, which sent the Russell 2000 plunging by 30% in a matter of weeks. And it certainly isn’t the case now that junk bond yields are trading at a record low spread to Treasuries. These bonds that are issued by zombie corporations that will crater in price once Treasury yields begin to normalize.

In fact, the coming scenario could look a lot like what happened in 1987.

On Monday, October 18, 1987, the Dow Jones Industrial Average lost 22% in one day. There are many theories as to why the crash occurred, but the simple truth is that the panic stemmed from a sharp rise in interest rates and inflation.

Rising interest rates 33 years ago were a direct result of surging inflation. The year 1987 started out with very benign inflation. Consumer Price Inflation in January of that year showed that prices were up just 1.4% from the year-ago period. However, CPI inflation surged to an annual increase of 4.4% by October. Rapidly rising inflation put fear back in the minds of the bond vigilantes, who remembered vividly how the former Fed Chairman, Paul Volcker, had to raise the Fed Funds Rate to nearly 20% in order to vanquish inflation just six years prior. The worry was that the new Chairman, Alan Greenspan, would soon be forced to follow in his predecessor’s footsteps and start aggressively raising the Funds Rate. That fear helped send the Ten-Year Note yield surging from just above 7%, in January 1987, to over 10.2%, the week before Black Monday.

The stock market had soared by 22% in the 12 months prior to the crash of ’87. In similar fashion, the current market is setting record highs this year despite a global pandemic. Of course, the market is significantly overvalued today as compared to 1987. The Total market cap of equities to GDP was an incredible 120 percentage points lower on Black Monday than it is currently.

Therefore, since interest rates are dramatically lower and debt is significantly higher today than during 1987, it seems logical to conclude that the earnings of corporations, and indeed the economy itself, are in far more unsustainable conditions.

To be honest, nobody is exactly sure how 2021 will turn out. But the interest rate reality check is real, and we are headed firmly in that direction. Here at PPS, we always seek to not only protect but profit from all cyclical and secular bear markets. The deep state of Wall St. is either ignorant or unaware of the minefield. But you should be keenly aware.

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.”

 

Pre-COVID Economy Wasn’t All That Great

December 1, 2020

The stock market and economy appear to be doing ok for the moment, as the incredibly dangerous bubble inflates further. This optimism is predicated on a plethora of COVID-19 Vaccines, projected to bring the economy back to its pre-COVID state of health. However, the problem with this line of thinking is that 2019 was anything but normal and healthy. It was a messy combination of a Fed slashing interest rates and re-imposing QE in order to achieve a rather mundane GDP growth rate of just 2.2%. The truth is, the pre-virus economic construct was built on Silly Sand—erected on top of asset bubbles, artificial interest rates, and an avalanche of new debt issuance.

Not only will a return to “normalcy” merely bring us back to an anemic and non-viable economy, I want to highlight three things I’m watching out for during 2021 that could upend the economy and markets.

The first one is the Fiscal cliff. There are 12 million people who will lose their unemployment checks come the end of December unless D.C. manages to reach a compromise on fiscal stimulus. In addition, The CARES ACT enabled renters to defer their payments throughout most of 2020. Fourteen million renters will lose their forbearance measures at the end of the year.

Add to this the 2.7 million homeowners who were granted mortgage forbearance during this year but will have to start making payments again once the calendar turns. That means 28.7 million people will suffer from losing their unemployment assistance and/or having to pay 3/4’s of a year’s worth of rent/mortgage payments starting in January. Americans also have $1.7 trillion in student debt. The CARES Act suspended those payments, waived the accumulation of interest, and halted collection of defaulted debt until the end of the year.

The Fed’s coronavirus lending programs are also set to expire at the end of this year, including the Main Street Lending Program for small- to mid-size businesses and the Municipal Liquidity Facility, which backstops the debt market for state and local governments.

That’s the fiscal cliff approaching quickly. But CNBS loves to talk about the high consumer savings rate. However, that is an aggregate number. And it is only the case because the government handed out $3 trillion in stimulus checks and at the same time made it possible for consumers to defer student loan, rent, and mortgage payments. Needless to say, I’ll be watching what happens on Capitol Hill in the next few weeks very closely.

The second thing on my radar is the vaccine’s effectiveness. Starting in the spring, the hype surrounding the vaccine will end, and we will begin to know the true answers to several questions: is the vaccine as effective as advertised? Will enough people even take it? is it really safe? And, will the virus mutate, making the vaccine ineffective after just a few months? Wall Street is convinced all will go well—hopefully, that will be the case. However, there is asymmetric room on the downside with these vaccines.

Finally, the third concern could creep in towards the end of next year. If all goes well in D.C. and with the vaccine and the economy, the Fed should begin to significantly taper its QE program and support of the entire bond market (including treasuries, munis, and junk bonds). This should lead to a significant back up in yields and could cause panic in equities just like the it did in the fall of 2018 when stocks suffered a 20% free-fall. The removal of the Fed’s backstops would be a disaster for the market and the economy.

How can I be sure, you ask? The Wall Street Journal reported that 40% of all listed companies now make no money at all, and 20% of shares traded on an exchange belong to the category of zombies—companies that don’t make enough revenue to handle even the interest on existing debt after paying basic expenses. These zombies have taken on a tremendous amount of new debt to carry them through the pandemic. How much debt? Over one trillion—which is an increase of 270% in just over the past year for these zombies. Their debt now totals nearly $1.4 trillion, up from $378 billion last year. But yet–thanks to the Fed–these companies’ borrowing costs are at a record low. Then, you must add into that the scars of all those existing businesses that have survived the pandemic, which still isn’t quite over yet, having to lug around an increase of what should be about a $3 trillion of new debt on top of the record $17.5 trillion total non-financial business already outstanding. What you end up with is a business sector that is left with a gigantic addiction problem to perpetually low borrowing costs that must remain in place forever.

I believe towards the middle of next year reality could creep back into markets. The vaccine will help shift spending habits to restaurants, hotels, and airlines. But that spending will be taken from what was spent on home improvements and tech gadgets this year. Hence, the idea of a robust rebound could sputter and falter by the third quarter of 2021. Or, the Fed could kill the market just like it did in 2018 by threatening to begin normalizing monetary policy.

This is why I’ll be monitoring very closely the changes to fiscal and monetary policies in the new year. Once yields mean revert–and one day you can be 100% sure they will (either due to inflation, insolvency, or both) –the party will end, and the ensuing depression will be like nothing ever seen before.

Now, I don’t know how any of those three dynamics will turn out. Neither does anyone else by the way. But, having a data and math-driven model that allows us to actively navigate these dangerous waters is essential right now and becoming even more crucial as we approach the eventual 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.”

 

 

Evolution of the Fed

The evolution of humankind supposedly goes something like this: From a void and through a series of serendipitous happenstances arose; galaxies, the Earthly Primordial ooze, Bacteria, Monkeys, and eventually homo sapiens (wise man). The evolution of the Fed is deserving of equal derision, but with a much worse outcome.

Back in 1913, the Federal Reserve Act gave birth to the Federal Reserve System. The law gave power to the central bank to become a lender of last resort to financial institutions. If a bank found itself in trouble, it could approach the discount window and exchange 100% guaranteed government debt for Fed credit at a deep discount. This process defined the majority of the Fed’s role for decades to follow.

However, during this process, two watershed events occurred in 1933 and 1971. Executive order 6102 from FDR, which confiscated gold from private hands, helped pave the way for Nixon’s ending of the Bretton Woods System in 1971. These two acts served the goal of completely separating the government’s money from gold and giving it the ability to create new money by fiat.

Then, in 1978 the Full Employment and Balanced Growth Act (A.K.A.as the Humphrey–Hawkins Act) was signed into law. Congress mandated the Fed to pursue a level of maximum employment under the context of stable prices. The Fed’s fiat money was no longer relegated to help banks that fell on hard times. Now, the central bank was charged with printing money until the unemployment rate went so low that it began to engender unstable prices.

But that was just the start of heading down the rabbit hole. From 1987 thru 2000, an unofficial—but nonetheless real—mandate came into being. The Fed was put in charge of keeping stock prices from falling precipitously under the guise of claiming that any bear market would automatically lead to rising unemployment. Hence, it was to ensure a bull market would never end.

Of course, since both stocks and real estate are assets, this line of thinking would also apply to home values if they ever were to fall into harm’s way. Unsurprisingly, in 2008 the Fed stampeded to the rescue of real estate prices that had begun to collapse. It could not prevent residential properties from eventually falling by over 30%. However, it could ensure they would not drop any further, nor would they stay low for very long.

In 2017 the Fed officially changed the definition of stable prices to mean 2% inflation. But since that new goal wasn’t found to be quite good enough to keep asset bubbles afloat, in 2020, it officially changed its 2% inflation target to make that a minimum level. The definition of stable prices was now to mean Consumer Price Inflation must rise above 2% for some time to make up for the duration it was below that level. This process is officially known as Symmetric Targeting.

But the Fed’s incursion on freedom and usurpation of the free market didn’t stop there. In the wake of the Wuhan virus, Mr. Powell is officially now supporting both investment grade and junk-rated corporate debt.

It seems the Fed believes it has the “tools” to cure any hiccup in either the economy or markets. Incredibly, it is now in the business of curing pandemics with its open-ended printing of anti-viral fiat currency. The trouble is that it’s therapeutic $120 billion per month counterfeiting scheme turns out to be worse than the disease when it comes to the destruction of the middle class.

The immediate future of Fed’s evolution is just as dire as its past mutations. The government is looking to impose another baleful mandate on the Fed: racial equality. That’s right! There appears to be no limit to what counterfeiting can achieve. We already know the Fed believes it can prevent recessions, create permanent bull markets, and combat viruses. And now, it may soon seek to solve past racial injustices. The Fed has moved a very far distance away from its original charter of being a temporary lender of last resort.

The Democrats introduced a bill this past summer called, The Federal Reserve Racial and Economic Equity Act. If passed, the law would require the central bank to take actions that “minimizes and eliminates racial disparities in employment, wages, wealth, and access to affordable credit.”

If the Senate turns over to the Democrats after the election in Georgia on January 5th, then the Racial and Economic Equality Act should soon thereafter become law, and Universal Bill Income for all will be adopted. Of course, the majority of the Fed’s helicopter money would be doled out to non-white communities.

Hence, Mr. Powel may soon be mandated to keep printing money until an egalitarian society becomes manifest. As mentioned, the main problem here is that the Fed’s money printing hits the poor and minorities the hardest because they are the most affected by rising consumer prices and are the least beneficiaries from rising asset prices. Therefore, the gap between the races will widen instead of close, which will only force the Fed to print even more money to compensate for the problem they are exacerbating.

The evolution of central bankers proves the term “wise man” should seldom be used to describe the individuals that sit on the FOMC.

Sayonara U.S.A.

The Japanese word for goodbye is Sayonara. But it doesn’t just mean goodbye, it means goodbye forever. Unfortunately, that is what our country is doing to American Capitalism.

In the quixotic fantasy world of Keynesian economics, the more money a government borrows and prints the healthier the economy will become. Those who adhere to this philosophy also believe such profligacy comes without any negative economic consequences in the long run. This specious dogma contends that it is ok for a government to dig further into a big deficit hole during a recession because massive public spending will help the economy to climb out faster. And then, a government can cut spending in the good times, which leads to big budget surpluses.

The trouble with this theory is the time never arrives to bring the scales into balance. Case in point, during the pre-pandemic year 2019, the U.S. had a deficit that was equal to 5% of GDP—one of the worst figures since WWII. This deficit occurred during a time which was purported to be one of the best economies in history.  Today, there are negotiations for yet another “stimulus” package after having already spending $3 trillion (15% of GDP) earlier this year. Speaker Pelosi and the Democrats want to spend another $2.2 trillion and Republican President Trump says, “I would like to see a bigger stimulus package, frankly, than either the democrats or Republicans are offering.”

Unsurprisingly, Wall Street is also once again clamoring for another shot of heroin because all those trillions of dollars that were distributed in the spring and summer have already been spent. It seems both parties are ignorant of both history and real economics. The salient point must be stressed that no government has ever engendered a viable economy through the process of piling yet more debt on an already bankrupt pile. And no, having its central bank monetize the whole stinking dung heap is not a panacea.

We already know how this story turns out. A paragon for this experiment of unfettered fiscal and monetary profligacy in the nation of Japan.

Japan’s debt to GDP ratio is projected to rise to 250% by the end of 2020.

The Bank of Japan’s Balance Sheet has skyrocketed since 2000, as the BOJ has been compelled to frenetically purchase half of all JGBs (Japanese Government Bonds).

 

Meanwhile, all Japan’s borrowing (a quadrillion yen outstanding) and money printing has not moved the needle on the nation’s GDP.

Japan’s major equity Benchmark (Nikkei Dow) has endured three major crashes since the year 2000. The Index has only managed to increase about 15% from the start of the new millennia; and yet is still down 40% since 1989.

The conclusion from Japan’s experience is clear. Massive fiscal and monetary stimulus does not at all boost GDP in the long run. In contrast, in rots the economy to its core. Although it can provide for a small gain in stock prices, it also comes with major crashes along the way. And ultimately, it can lead to intractable inflation and economic Armageddon.

Turing back to the U.S., Jerome Powell said this gem in a speech given on October 6th, “The US federal budget is on an unsustainable path, has been for some time, but this is not the time to give priority to those concerns.” Powell also stated that the risks of overdoing stimulus are smaller than the dangers of not borrowing much more money right now—all of which will be printed by him with alacrity. That’s tantamount to a doctor prescribing for a morbidly obese man with late stage heart disease to shove down boxes of fried Oreos rolled in pig lard until he feels well enough to begin the diet.

So, what economic benefit did the U.S. get for borrowing well over $3 trillion in new debt during fiscal 2020 and having it all monetized by the Fed’s printing press—an endeavor that has brought the National debt to a daunting $27 trillion? Oh, and by the way, the Nation’s total debt both public and private has now surged to $78 trillion, or a record 390% of GDP (for comparison, it was 350% at the start of the Great Recession)—ah the good old days! Well, it will generate a projected GDP loss of about 4% this year and has turned out a measly 5% gain in the S&P 500.

This begs a question for all those geniuses in government: if government borrowing and spending equates to higher GDP growth, then why is it that the debt to GDP ratio perpetually climbs? Exactly when are those Keynesian multipliers supposed to kick in?

This is what the U.S. will get for turning all Japanese…an anemic economy, an equity market that limps forward, and a nearly extinct middle class. According to a recent report on the Japanese experience since its bubble burst in 1989 by Oxford Economics professor Shigeto Nagai, “The share of low-income households has been rising at the expense of middle-income groups in a process of secular income decline across percentiles.” In other words, poverty is rising in Japan across all classes with the country’s middle class suffering the brunt. The U.S. is also preparing to enter into a secular period of Japanese style lost decades with the middle class eroding away. The poorest 50% of all Americans, about 165 million people, collectively owned about $2.08 trillion in wealth in the second quarter of 2020, according to Federal Reserve, that’s less than the net worth of our 59 richest billionaires, according to Bloomberg data sighted in the NY Post.

The Fed and D.C. are trying to squeeze more air into the gargantuan equity bubble, which is exacerbating these trends. A bubble that has grown to the most massively distorted proportion ever witnessed in economic history.

All insolvent governments eventually collapse.  Our nation has also become addicted to asset bubbles, free money, and artificially-low interest rates. Indeed, the entire developed world is positioning itself for an interest rate death spiral of unprecedented proportions.

Expediting this perdition will be a move to state-sponsored digital currencies. Bloomberg reported on October 9th that the BOJ has started to experiment with cryptocurrencies; joining Russia and China in this endeavor. And sorry, it is not Bitcoin. It will be a blockchain based currency that is completely controlled by the government of Japan. The primary reason for this is clear: Central banks are preparing to usurp all control of money from the private sector. Meaning, governments will impose profoundly negative interest rates on savers in an attempt to keep asset bubbles growing. However, to accomplish this nefarious task central bankers will need to ensure the public cannot take their money out of the banking system. Hence, investors will need to be on high alert for government blockchains and intractable inflations across the developed world in the future.

This means the saddest part of all is that the Japanification of the U.S. is actually the best outcome we can now hope for. The more likely eventuality will be the utter economic devastation coming from the implosion of the international bond market due to artificially produced record-low interest rates on insolvent sovereign debt that will slam into intractable inflation.

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.”

Three Big Lies in One Small Press Conference

September 28, 2020

During the FOMC’s September press conference, Fed Head Jerome Powell managed to communicate three big lies in the space of an hour. The fact that bile spews from the mouth of a central banker isn’t all so surprising. However, having to suffer through three humongous untruths in about an hour was remarkable—even for the Fed.

Mr. Powell was asked by a reporter why the US economy needed an inflation rate of 2% to function properly, and why Americans would now need to have their savings depreciated to some degree above 2% for an extended duration.

So here was lie number one: Powell’s specious reasoning behind wanting higher inflation is that it would engender higher interest rates, which would then allow the Fed room to lower rates whenever a recession inevitably arrives. This means the Fed is oblivious to another zero figure to match its 0% return forced upon savers. There’s zero evidence, either historically or logically, that an economy needs a sustainable 2% + rate of inflation on the Core PCE Price Index to function properly.

Regardless… let’s leave aside the insanity behind wanting to pursue inflation just so there is room to lower rates once the recession arrives—a recession that is always facilitated by its monetary largess in the first place. It is far from the truth behind the Fed’s real motivation. The actual purpose behind its stated goal to create a condition of permanently rising inflation is to pump up asset prices into a perpetually-expanding bubble. This condition has now become necessary in order to ensure Wall Street and banks get bailed out of what would otherwise be a condition of insolvency.

The second lie was that the Fed would continue to buy Treasuries and MBS equal to a pace of at least $120 billion each month. However, this is clearly not been the truth—at least not of late. If Powell was indeed adding $120 billion to his balance sheet each month, it would have increased by $360 billion, instead of being static over the past three months.

As to why the Fed Head would mislead regarding the recent pace of increase in asset purchases is unclear. What is very clear, however, is that he will not reach his newly-raised inflation target by simply claiming he is monetizing debt at a record pace. The balance sheet did skyrocket from March thru June by over $3 trillion. But over the past quarter of a year, the balance sheet has gone nowhere. Indeed, what the Fed really needs is the unholy cooperation of Treasury with a Universal Basic Income guarantee to get consumer inflation to really pick up the pace. Thankfully, that is not happening yet.

The third, and perhaps biggest lie, was that the Fed’s massive increase in its balance sheet, which did occur over the past dozen years, did not lead to any asset bubbles. Powell was asked directly in the press conference if the Fed’s QE programs and zero interest rate policy (ZIRP) put into place the dangerous conditions of asset price inflation and financial instability. His response was that the Fed’s seven years of ZIRP and $6.2 trillion in QE was “notable for the lack of the emergence of some sort of a financial bubble.” He continued, “I don’t know that the connection between asset purchases and financial stability is a particularly tight one.” Really?

The S&P 500 now trades at a trailing price to earnings ratio of 27.2, which is closing in on double its historical average of 16, according to data from Refinitiv. Not only this, but the all-important Total Market Cap to GDP Ratio has now surged to an incredible 175%, which is far above its historical average and even dwarfs the previous high of 145% set in March of 2000 just before the NASDAQ lost 83% of its value.

In reality, Powell knows his statements are a fallacy because the overvalued and unstable stock market fell apart in the late summer of 2018 when the Fed was undergoing a half-hearted attempt to normalize interest rates and pare down the size of its balance sheet by just a few hundred billion dollars. This is, of course, after blowing it up by multiple trillions over the past dozen years.

But it’s not just the stock market that is in a massive bubble. The economy is also in one as well. Data put out by the Federal Reserve show that total non-financial debt in the US increased at an annualized rate of 25.27% in Q2, –shattering all known records! That debt explosion was primarily due to a 58.86% surge in Federal Government debt and a 14.02% jump in business debt. And no, this humongous debt binge wasn’t even close to being commensurate with a rise in our phony GDP. Business debt is now 83% of GDP, whereas it was just about 60% at the peak of the NASDAQ bubble. Government debt was 40% in the year 2000, but now it is well above 100%.

Of course, record-low borrowing costs (provided by the Fed) compels businesses to take on more debt and enables the Treasury to also issue bonds at the central bank’s falsified interest rates. Mr. Powell appears to be ignorant of these conditions. And if the Fed remains blissfully unaware, how then can it assume responsibility?

Nevertheless, the Fed’s unstable economy and stock market bubble was on full display in the past few weeks. Tech stocks of the FAANG variety, which Wall Street has overcrowded into with unprecedented measure, were obliterated. Take AAPL, for example; it crashed by nearly 20% from the start of September. The mighty Google (Alphabet) plunged by 18%. And, even the S&P 500 hit an air pocket that saw a 3-day plunge of nearly 8% at the start of this month.

Hence, the value of having an actively managed strategy that is built on a solid model was again illustrated.

It is abundantly clear that the economy and markets are in massive bubbles. While the high-frequency components of the Inflation/Deflation and Economic Cycle model are not flashing red at this time (it’s just amber at this moment), our leading components do indicate we may be heading in that direction. The pending election chaos, along with a massive fiscal and monetary cliff, could be paving the way to even greater volatility. If you are still invested in a passively managed and long-only portfolio, the time to act is now.

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

 

Overvalued Stocks Head into the Bunker

September 14th 2020

 The overvaluation of stocks relative to the economy has placed them in such rarefied space that the market is subject to dramatic and sudden air pockets. Our Inflation Deflation and Economic Cycle model is built to identify both cyclical and secular bear markets and protect and profit from them.

However, what it cannot do, nor can anyone else, is anticipate every short-term selloff in stocks. While the IDEC strategy protects and profits from bear markets, it also tends to soften the blow from short-term selloffs and prevents us from panicking at the bottom of every brief correction. This was the case in the latest plunge that started on September 3rd and lasted just three brutal days.

Having said that, I am very concerned about the market right now and heading into the election. The reasons are as follows: While it is true that the Fed is indeed stuck at the 0% bound for many years, it is also true that its balance sheet has stopped increasing at the multiple trillion-dollar torrid pace seen earlier this year. In fact, it has not only just plateaued; it has actually begun to shrink. The balance sheet has decreased by $100 billion in the past 3 months.

Another reason for caution is the upcoming vote this November 3rd. There is a good chance it could be marked by election-related chaos such as this nation has ever seen before. The normal peaceful transfer of power, which has been a hallmark of this country, is in huge jeopardy this time around because both parties will claim election malfeasance. If Mr. Trump loses the election, he has already stated that he may not accept the results due to massive mail-in ballot fraud. And, if Mr. Biden loses the election, the radical left, which is already taking over cities and burning them down, may light many more of them on fire due to its view that Russia has corrupted the results once again. In either case, the election seems to be a dead heat, and this nation appears to be moving closer and closer to civil war on both racial and economic fronts. The surging wealth gap is primarily to blame for this, and the Fed is primarily responsible for its creation and expansion.

In addition, the massive fiscal cliff that I have been warning about has arrived. The $3 trillion that was borrowed by the government and printed by the Fed has been exhausted. No further Paycheck Protection Program grants/loans have been approved, and those that have been disseminated have been spent. There are no more $1,000 checks per adult and $500 checks per child in helicopter money arriving any longer. The CARES ACT enhanced unemployment funds are dry. And, the Lost Wages Assistance program authorized by President Trump using FEMA dollars, which paid a $300-a-week federal supplement to unemployment benefits, will end by mid-September.

Wall Street has one hope to propel the bubble higher; it is clinging to the much-anticipated and greatly-hyped vaccine that is supposed to arrive (conveniently) on November 1st. Of course, a vaccine would be wonderful news for the world. However, it does not at all mean the Wuhan virus will cease to be an issue immediately before election day. In contrast, the vaccine will herald at the beginning of the long process of hopefully eradicating the virus from humans. And it will also mark the start of when some very tough questions begin to get answered. For example: How effective is the vaccine, and how safe will it be? We received a wakeup call on that front on Tuesday, when AstraZeneca’s vaccine trial was halted due to safety concerns. Other concerns revolve around how fast a vaccine will get distributed to the general public–the initial FDA approval will only be for Emergency Use Authorization. And, what percent of people end up taking a vaccine that was developed at hyper-warp speed? Nobody knows the exact answers to those questions at this time, but what is known for sure is that the pandemic will be an issue well into the first half of 2021–at the very least.

What will also be an issue are the scars left behind…scars that Wall Street is completely blind to. Mainly, there are the growth and productivity-killing aspects associated with an economy that must now lug around an additional $3.3 trillion in National debt and a $3 trillion run-rate of new business debt. Keep in mind the level of business debt was already at a record relative to the economy before the pandemic surfaced. And now it has vastly increased the number of zombie corporations alive, whose current business model is to feed off of the Fed’s free money to satisfy debt service needs.  And most regrettably, there is the number of people who have become permanently unemployed due to COVID-19. According to the August NFP report, the permanently-unemployed rolls soared by 534,000 to reach 3.4 million — the highest level since 2013. This figure has jumped by a cumulative 2.1 million people since February. As of August 11th, there are about 155,000 total business closures reported on Yelp since March 1st. About 91,000 of the closures are permanent. These are the businesses that have closed entirely, but countless more are suffering from revenue and earnings shocks, which is causing them to lay off employees at the rate of about 1 million per week.

The Predictive components of our IDEC Model are signaling the economy is heading into the macroeconomic conditions of disinflation and recession. This should be the case for awhile unless and until we get another massive fiscal package from D.C. The market-driven components are also starting to confirm the economy’s direction is going south. However, it is too early to get net-short until the high-frequency components give us a similar signal. We will continue to try and proactively protect your assets, instead of getting passively slaughtered like the rest of Wall Street is set up to suffer once again.

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.”