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Transitory Inflation Debate

June 14, 2021

Inflation is running white-hot right now, and the reason is clear. It is because the Treasury poured $6 trillion into the economy between March of 2020 to March of 2021. That amounts to nearly $50,000 per US family in the name of pandemic relief. According to David Stockman, the government’s largess was equal to 7.5 times the $800 billion of economic growth lost due to the various lockdowns and restrictions—both self-imposed or mandated. This time around the money wasn’t just sent to Wall Street, as it was in the wake of the Great Financial Crisis of 2008. Covid-19 was a perfect excuse to deploy Modern Monetary Theory (MMT) directly to state and local governments, consumers, and businesses as well.

In other words, the government didn’t just re-liquefy the banking system and then maybe hope consumers would receive some of the monetary crumbs as an ancillary consequence. The various virus-related rescue packages circumvented banks and pushed funds directly to the mass population. Paying people to lay fallow while at the same time giving them money to actually increase their consumption habits is a perfect recipe for rapidly rising Consumer Price Inflation. However, such a feat cannot be duplicated anytime soon without destroying the US dollar and the full faith and credit in our sovereign bond market.

As far as the stock market is concerned, you can’t drive the proverbial investment vehicle while looking in the rearview mirror. It’s always the next macroeconomic condition for which investors need to prepare for, as the current state of affairs is always priced-in. Accelerating rates of growth and inflation should prove to be transitory because they have been based on the artificial measures of fiscal and monetary carpet bombs.

However, the experiment with MMT is in the process of ending…for the time being. September 4th will mark the end of the $300 per week in enhanced unemployment subsidies. These erstwhile employees will have to head back to work, many for less pay. But they will be producing goods and services, which will be key towards relieving supply shortages and reducing bottlenecks that tend to increase prices. Not only this, but 41 million people have to start paying student loans once again come October 1st. Americans now owe about $1.7 trillion of student debt, more than twice the size of their credit-card liabilities, according to Bloomberg. And, over the course of this fall, mortgages and rent forbearance ends. Meaning, consumers must soon resume paying their greatest monthly expense–thus, vastly reducing their discretionary spending.

Hence, the US economy is about to go over a massive fiscal cliff; and the monetary cliff is just as deep. Indeed, the plunge has already begun. First, the Fed will end up having reduced the annual growth in its balance sheet to around $1.5 trillion for all of 2021, from $3.2 trillion in debt that was monetized during all of 2020.

Second, Mr. Powell announced on June 2nd that the fed would begin to sell $13.7 billion of its corporate bonds and ETF holdings. Now admittedly, this is a very small fraction of the total $10 trillion corporate debt market. But it’s the psychology of markets that matter. Back in March 2020, the Fed said it would purchase an unlimited number of Treasuries and MBS, as well as buying corporate bonds and ETFs for the first time in its history. Wall Street became completely aware that the Fed was going to create a bull market in prices across the entire fixed-income spectrum. And predictably, investors began to front-run the central bank’s indiscriminate and infinite bids.

Therefore, it didn’t matter that Mr. Powell only had to purchase $13.7 billion of corporate debt. The Fed went all-in on its backstop for bonds, and everyone became aware it would not let these prices drop. In fact, it eventually sent bond prices and yields to the twilight zone.

For instance, the yield on CCC corporate debt, which is the junkiest of junk-rated corporate debt and only one notch above “D” for default, is just 7%. That yield is the lowest in history and more than 700 bps points below their long-term average. This is one of the many illustrations why the next time QE ends, and interest rates rise, the results will be disastrous.

 

If you want to know why the stock market has stalled out over the past couple of months, your reason is the fiscal and monetary juice that has supported asset prices, and the economy has started to wane. This will cause a period of disinflation to emerge very soon, requiring investors to own the asset classes and sectors that benefit under such a regime — such as dividend payers that tend to increase their payout. However, the disinflation could turn into a very destabilizing deflationary environment next year. Hence, the next opportunity to make a significant amount of money in the stock market could very well be to short it, as equity prices begin their toboggan ride down the slide.

No one can be sure when this will happen. It could occur during the course of the official tapering of asset purchases. Or, even perhaps once the rate hiking cycle commences. In either case, the fuse has already been lit on the next deflationary recession/depression, which should fracture the equity market deeper and harder than any other time in history when it arrives.

Fed’s Tools are Broken

June 7, 2021

The U.S. central bank has metastasized from an institution that was originally designed to assist distressed banks, to one that believes its purview now includes perpetuating asset bubbles, fighting global warming and reconciling racial inequities. Another distortion of the original purpose of the Fed is that its mandate has changed from providing stable prices and full employment, to creating an inflation rate above 2% for a period of time equivalent to the duration it was below that level.

But the members of the FOMC claim there is nothing to fear if inflation were to ever grow too hot because it has the tools to bring it under control. In other words, when necessary, the FOMC can not only stop QE but it can raise rates aggressively enough to vanquish inflation without destroying the markets and economy along the way. Let’s see just how true this contention really is.

But before we get to how “successful” the fed will be to tame inflation, a funny thing happened on the way to achieve its 2% goal. Our central bank focuses on the incredibly distorted core rate of inflation found in the Personal Consumption Expenditures Price Index. But meanwhile, prices are surging in the real world. For instance, headline PCE inflation increased by 3.65% year over year in April. And even in the fed’s preferred metric, prices jumped by 3.1% y/y. Not only this, but a slightly less massaged reading of inflation, which can be found in the headline CPI metric, had prices rising by 4.2% y/y.

If you want an even more accurate view of the current rate of inflation just look at home prices, which are up 21% y/y, according to Redfin data. Also, the 19 commodities in the CRB Index have soared by over 60% in the past 12 months. Safe to say, the actual rate of inflation is already far above the Fed’s inane 2% target.

These absurd inflation rates were brought about by paying citizens $6 trillion between 3/20-3/21 to lay fallow at home and not produce goods and services. Hence, creating supply shortages; and a huge void to absorb the massive liquidity wave. Therefore, the rate of inflation has already climbed to a point that is dramatically destabilizing to the economy. This is the conundrum for our Treasury and Fed: keep printing money and cause inflation to run intractable, which will destroy the stock market and the economy. Or, stop monetizing debt and let the gravitational forces of deflation implode the gargantuan asset bubbles. Given the history of the Fed, it is clear Mr. Powell will soon try to once again convince investors that the U.S. economy has healed and it’s time to normalize monetary policy.

Most in government and on Wall Street claim that the Treasury can slowly and innocuously reduce its spending while the Fed gradually stops printing money. However, this is virtually impossible because of the massive amount of debt taken on since the start of the global pandemic and the mind-boggling level of asset prices–which are predicated on free and continuous money printing.

Twenty percent of the largest U.S. corporations are in the zombie category (meaning they don’t earn enough money to even pay interest on outstanding debt). Those big businesses are carrying some $2.6 trillion in debt, according to Barron’s. Once the free-money spigot is turned off, massive bankruptcies will emerge. The asset bubbles in junk bonds, real estate and equities have been built on top of that risk-free-rate of zero percent. Take it away and the game ends in catastrophe.

History is clear regarding this dynamic. In the year 2000—the peak of the NASDAQ bubble–the Fed Funds Rate (FFR) was 6.5%. It was reduced to 1% by June 2003, in order to help ease the pain of the imploding stock market. But by June 2006, the Fed promised the crisis was over and had the FFR back to a lower high of 5.25%.

However, Mr. Bernanke had it all wrong. Bringing interest rates close to the average rate caused the housing market to crash. In the wake of the Great Financial Crisis, the FFR was taken to zero percent by December 2008—it was the first time in history that money became almost free.

Of course, the members of the FOMC are very slow learners. The Fed was once again assuring a weary consumer that the once in a hundred-year storm had passed, and the current Fed-Head Jerome Powell finished the job started by Janet Yellen when he took rates to another lower high of just 2.5% in 2018. Nevertheless, a crash in the equity market in the fall of 2018, plus a REPO market crisis in the summer of 2019 caused the Fed to cut rates three times, to 1.75% by October of that same year. Unsurprisingly, the global Pandemic eventually put the FFR back to zero percent, but it was already on its way there before the advent of COVID-19.

Money printing, debt accumulation and asset bubbles have become the fragile foundation for which this current economy is built. Therefore, the notion that the Fed can end its $120 billion per month QE program and gradually raise interest rates back anywhere close to the normal level of 5-6% is ridiculous. Indeed, it would be shocking if it could get rates close to the previous high of 2.5%–the new lower high on the FFR is probably below one percent given the massive increase in the number of insolvent companies and unsustainable level of equity valuations.

Forget about 2% core PCE inflation. Intractable inflation is acutely manifest in asset prices right now! However, the government and many businesses can only pretend to be solvent while borrowing costs are close to zero. Take the free money away and the whole system goes belly-up.

For proof, just think about the following three key data points. For proof, just look at the following three key charts.

 

If the Fed couldn’t normalize rates before, how could it possibly come close to doing so now?

The truth is any real effort to tighten monetary policy back to the previous old high of 2.5% will cause the credit markets to freeze once again, which should cause a more intense market crash than the other previous attempts to normalize borrowing costs. Nevertheless, Mr. Powell will soon lead the average investor down this predictably perilous path toward perdition. The question is, what happens when consumers and investors reach the epiphany that the Fed’s tools for the purpose of taming inflation have now become broken?

 

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.”

 

Biden’s Tax Increases Won’t Just Impact the Rich

May 10, 2021

 

In March, President Biden signed into law the American Families Plan. His hopes are to grow the middle class, expand the benefits of economic growth to all Americans, and leave the United States more competitive. These ambitious spending plans will come at a cost of $1.8 trillion in new federal spending on education and family programs. Furthermore, in Biden’s eyes, the best way to fund these programs and tax perks, is by increasing taxes on the wealthy. Upon closer examination, these tax increases will have impacts far more reaching than the wealthy.

Draft tax bills were proposed in March. Floating out there now is the HR2286, the Sensible Taxation and Equity Promotion Act (STEP Act), the Ultra-Millionaire Tax Act and the For the 99.5% Act.

 

Key takeaways from these proposals are to:

  • Raise the top marginal income tax rate from 37 percent to 39.6 percent, which would apply to income over $452,700 for single and head of household filers and $509,300 for joint filers. However, these higher taxes could hurt the creation of new business and returns on private investment, which are a major source of funding for new drug discoveries and technology innovation.

 

  • Tax long-term capital gains as ordinary income for taxpayers with taxable income above $1 million, resulting in a top marginal rate of 43.4 percent when including the new top marginal rate of 39.6 percent and the 3.8 percent Net Investment Income Tax (NIIT). This could result in many Americans simply postponing the sale of stocks and other investments.

 

  • Tax unrealized gains at death for unrealized gains above $1 million ($2 million for joint filers, plus current law capital gains exclusion of $250,000/$500,000 for primary residences).

 

  • Elimination of a “stepped-up” basis when a person inherits a capital asset. This is where the asset’s basis is increased to the property’s fair market value at the date of the previous owner’s death. Then, if the person who inherits the property sells it immediately, there won’t be any capital gains tax. Biden’s administration claims taxes on inherited family farms and small businesses won’t go up as long as heirs continue to run the farm or business. In reality, heirs may not want to continue to operate and are forced to sell to cover taxes.

 

  • Apply the 3.8 percent NIIT to active pass-through business with income above $400,000, end the preferred treatment of carried interest, and make permanent the 2017 tax law’s limitation on excess losses that applies to non-corporate income. Also, capping 1031 Like-Kind Exchanges at $500,000 in deferred capital gains. The majority of 1031 exchanges are done by those in sole proprietorships or S corporations. The proposed 1031 exchange limit would then trickle down to small businesses renting. Consequently, landlords will inevitably charge more rent to absorb the extra taxes.

 

  • Raise the corporate tax rate from 21% to 28%. This will be passed on to customers by raising prices and to workers by slowing wage growth.

 

  • $80 billion over a decade to beef up the Internal Revenue Service (IRS) to increase tax compliance and collections.

 

Tax Foundation General Equilibrium models suggest that the American Families Plan Tax Provisions will reduce Gross Domestic Product, Gross National Product, Capital Stock, the Wage Rate and Full-Time Equivalent Jobs.

Gross Domestic Product is the product of Labor force growth + Productivity. According to the Census Bureau, U.S. population growth is the lowest since 1930’s. And, we now have the lowest birthrate since 1979. All that leaves us with is our ability to increase the output per worker (productivity).

The proposals have a long way to go before becoming law, but it is important to begin the planning process and to be aware of the far-reaching ramifications if enacted. The cost of these taxes will certainly extend beyond the wealthy.

 

 

Jenifer Pento, CPA

Tax and Accounting Advisor

Pento Portfolio Strategies

www.pentoport.com

jpento@pentoport.com

O (732) 772-9500

C (732) 207-6090

F   (732) 275-8232

 

Peak Growth and Inflation

May 10, 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

Get Ready for the Fourth U.S. Central Bank

April 26, 2021

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

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

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

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

Why This Federal Reserve Should Soon Become Extinct

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

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

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

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

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

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

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

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

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

 

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

Freedom Fatality of the Fed

March 22nd 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

Bond Market Rocks the Richter Scale

March 5, 2021

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

New Jersey “Exit Tax” – The Truth Behind the Confusion

The term “exit tax” has generated much confusion among New Jersey residents selling their homes to move out of the state. While it is often thought that this is a tax imposed when you sell property in New Jersey and change your domicile, this is an invalid statement. It is not an additional tax, but merely a pre-payment of potential income tax due from the sale of the home.
P.L. 2004, Chapter 55 became effective August 1, 2004 and was enacted to ensure that the state would collect income tax from nonresident sellers on the resulting gains from sales of property. This tax payment is collected at closing and is a required condition to recording the deed.
  • Form GIT/REP-3 is used by resident taxpayers — and by nonresident taxpayers claiming one of the recognized exemptions — to claim an exemption from withholding at the time of sale. The form contains 14 exemption choices, called “Seller’s Assurances.” The first exemption is for resident taxpayers who will be paying the tax on their Resident NJ 1040 Gross Income Tax return. Exemptions 2 through 14 can be used by residents or nonresidents.
  • Form GIT/REP-1 or GIT/REP-2 is used by nonresident taxpayers with no qualifying exemptions.
The estimated Gross Income Tax due is calculated by multiplying the gain on sale or transfer by the highest rate of tax (10.75%) or 2% of the sales price, whichever is higher. The pre-payment is recorded on the taxpayer’s NJ Nonresident Return and treated as a prepayment of tax. If there is an overpayment of tax (due to, e.g., there not being a taxable gain on the sale of the residence) the “exit tax” transforms to the “exit refund” whereby the
overpayment will be refunded.
The seller is considered a nonresident unless a new residence has been established in New Jersey. Part-year residents are considered nonresidents.
Observation: Bear in mind that for federal income tax purposes, homeowners may be able to exclude the gain on the disposition of a home from income under IRC Sec. 121, which states that the taxpayer must own and occupy the property as a principal residence for two of the five years immediately before the sale. However, the ownership and occupancy need not be concurrent. The law permits a maximum gain exclusion of $250,000 ($500,000 for certain
married taxpayers). Generally, this exclusion can only be claimed once every two years. A reduced exclusion is available to anyone who does not meet these requirements because of a change in place of employment, health or certain unforeseen circumstances. Unlike under former law, the gain on the sale of a house is now permanently excluded, rather than deferred, and a taxpayer doesn’t have to purchase a replacement home to exclude the gain. New Jersey follows federal tax law and if there is any amount taxable for federal purposes, it
will also be taxable for New Jersey purposes.
The New Jersey “Exit Tax” can be misleading, but still needs to be taken into consideration if you plan on selling your home and leaving the state. Additionally, New Jersey imposes a Realty Transfer Fee and both New Jersey and New York enforce the mansion tax, which I’ll address in an upcoming blog. An understanding of what is required at closing and knowing the financial impact will avoid surprises at tax time.

When Will the Party End?

February 2, 2021

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

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

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

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

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

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

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

 

The Coming Bitcoin Crash

January 29, 2021

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

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

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

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

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

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