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Debt be Damned

The U.S. National Debt is about to surge like never before, along with the rest of the entire planet’s gigantic pile of sovereign IOUs. America started with a $23.5 trillion debt before the Wuhan virus outbreak, with annual deficits running over a $1 trillion; and projected to be at least that amount for the next dozen years. But then, the stock market and economy crashed due to the catalyst of the COVID-19 pandemic, which pricked the massive bubble in junk bonds and equities that I have been warning about for years.

In addition to the automatic stabilizers that kick in during a recession, like unemployment insurance and food stamps, the Treasury is now buying commercial paper, suspending interest payments on student loans, and writing checks to small businesses. There are also various other bailouts and stimulus packages in the works; the IRS is allowing taxpayers a deferment for three months of up to $300 billion. Also, the government will soon be sending checks to nearly every American, the proposal is for at least $1,000 for each adult and $500 per child, per month—around $500 billion in total. Helicopter money is now coming, and both parties embrace it with alacrity. The total amount of stimulus proposed so far was reported by Bloomberg to be $1.3 trillion this year alone.

A global depression is now here, but the question is for how long. A small taste of the miserable data that is to come came from the Empire State Manufacturing Survey for the month of March. The index plummeted by the most in history to an incredible minus 21.5. Since the survey was taken, we have seen entire counties shut down, U.S. schools and corporations shuttered, and at least 50 major retailers are shutting their doors, and that number is growing daily. The retail sector employs a total of 15.7 million people. There will be about 3.5 million jobs that are predicted to be lost if this economic slowdown turns out to be like the average since WWII. However, it is clear this economic contraction will be nothing like the typical recession. Indeed, when was the last time a great portion of the world’s population was told to shelter in place. Around 67 million Americans think they will have trouble paying their credit card bills due to the coronavirus, according to WalletHub. And, nearly 80% of Americans are living paycheck to paycheck—we really need this virus to dissipate quickly, but the probability of that outcome is impossible to know.

To give you further insight as to how bad the unemployment numbers could get, let’s look at where the jobs are now. In the U.S., most of the jobs created since the Great Recession ended back in 2009 have been in the Leisure and Hospitality sectors. According to the BLS, there are nearly 17 million people employed in those two sectors alone. But now, a great deal of those doors have been closed. Many of these people are 1099 employees and have no access to unemployment insurance. Those that are W-2 employees will see a huge reduction of their income and may not see an immediate request to be rehired once the economy begins to recover.

This is because there will be a serious degradation of consumer and business’ balance sheets. Coming into this crisis, there was a record amount of household debt and a record amount of corporate debt both in nominal terms and as a percentage of GDP. There is now a significant shock to the incomes of the public and private sectors, while all the existing debt remains and new debt is being accumulated. Government assistance can help, but it will not make people 100% whole.

But now the major averages have crashed by over 30%, and the Russell 2000 is down just shy of 40% in one month. Not only are all of the gains made last year now gone but the market has given back all the gains made since January 2017. As an aside, I was wondering how all those C-suite geniuses feel that levered up their corporations in record proportions to buy back stocks at record highs? I also wonder what public or private pension fund will be solvent since there has been no money made in the last three years, and the Benchmark Treasury yield is 1%? These retirement funds need to make at least 7-8% each year to come close to satisfying their obligations.

To combat these issues, global governments are reacting with massive fiscal and monetary stimulus. We already mentioned what the U.S. Treasury is doing. Also, the Fed cut rates back to zero, is buying commercial paper, openly admitted to launching Q.E. 5, and massively expanded its REPO facility—which it was supposed to draw down to zero beginning in April. In sharp contrast, Mr. Powell’s balance sheet has now exploded to an all-time high of $4.7 trillion. The Fed may also start buying corporate debt very soon and announced unlimited Q.E. on Monday, March 23rd.

Wall Street now needs a 50% increase in stocks just to get back to where it was a month ago. That’s how the math works when you are down about 35%.

At the end of this crisis, we will have an even bigger mountain of debt, interest rates than are even further into the twilight zone and the seeds of runaway inflation that have been fertilized with a gigantic pile of poop from a massive herd of government-fattened brontosauruses.  That is the real crash still coming, which will occur after the market soars back to record highs on unprecedented money printing, interest rate manipulation, and debt-fueled stimuli. To be clear, the inflationary/insolvency crash of the bond market is dead ahead.

In the interim, we should continue to see wild swings in asset prices as the market struggles to reconcile with a temporary, yet brutal, depression that is being offset by Helicopter money. PPS models these cycles of inflation/deflation and growth/recession. That is your best chance to increase your standard of living, even during the increasing occasions when Wall Street burns.

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.”

Fed’s 3rd Mandate: Expanding Asset Bubbles

March 9, 2020

Wall Street hit a new all-time high on February 20th. It was supposed to be smooth sailing from there, riding along the global liquidity wave. But then, that wave crashed into what turned out to be the fastest correction from a new high in the history of the US stock market. Even though the fall was mild in comparison to the record-breaking bull run of the past few years, it was enough to frighten central planners to the core. Hence, we had further confirmation on Tuesday, March 3rd of what we already knew: our central bank has been fully corrupted and co-opted by Wall Street.

The Fed lowered rates by 50bps in an emergency meeting, even though its regularly scheduled meeting was just two weeks away–maybe Trump will now give Powell the Presidential Medal of Freedom. But someone should have informed the White House and the Fed that the 4th rate cut in a rate-cutting cycle has nearly always led to market panics. But to be clear, the only reason the Fed cut rates is that the stock market suffered a brief correction. It wasn’t a bear market or a recession. It wasn’t even runaway deflation or an outright recession scare, …but just an 8% fall in stock prices from an all-time bubble high at the time of its decision.

There can no longer be any doubt that the Fed has become a slave to markets. After years of manipulating interest rates lower, it now must do everything in its power to make sure borrowing costs never rise, asset prices never go down, and the massive pile of US debt (330% of GDP) never sees a recession. Otherwise, the default tsunami will engender the greater depression. However, central banks can’t hold off a recession forever, and they have ensured its inevitable arrival will lead to nothing short of perdition.

The global junk bond market started to freeze in late February, just like it did back in December 2018, which caused the major averages to plunge by 20-30% at that time–this is what Powell was pooping his pants about.

Nevertheless, the Fed now only has four rate cuts left before running out of ammo. Lowering borrowing costs isn’t a vaccine, but the Fed is simply panicked to keep stock prices from crashing any further.

The Coronavirus, it is an exogenous market event, not an endogenous market event. In other words, the selloff in stocks was not generated from a deteriorating macroeconomic function, such as spiking inflation, recession, or a full-blown liquidity crisis. Yet, it is now becoming one. Rate cuts do not ameliorate much of the effects of the disease. But investors should expect further rate cuts and additional QE in an effort to prop up markets.

So, where is all this artificial manipulation of interest rates, money supply, and asset prices leading us? I believe the penultimate liquidity wave is now upon us. Investors can expect Central Banks to print money like never before and fiscal policies to expand deficits in record proportions to combat the effects of the virus. But it won’t work. Just like every other attempt to provide a viable economy has failed since the Great Recession. This is because the equity and bond markets have become addicted to each artificial stimulus program. Government remedies of lowering rates and money printing are merely palliative in nature. That is, alleviating the symptoms while exacerbating the underlying economic rot, which consists of excessive debt and intractable asset bubbles. But now this second-to-last impulse from the Fed should land us back to a 0% Fed Funds Rate and in permanent QE just like the rest of the world.

Then, after another relatively brief period of ersatz market and economic growth, another cyclical plunge in economic growth and asset prices should ensue. The big difference this time around will be that global central banks will already be offering money for free and in great quantities—but primarily for banks; not for you and I.

Therefore, in response to the next crisis, central banks (in full cooperation with fiscal authorities) will be forced to pull the pin on the ultimate inflation grenade: UBI, MMT, and Helicopter money directly to the people, which should produce a period of intense stagflation globally such as never before seen. If you ever had any doubt about the stagflationary disaster that awaits this world, check out what the Bank Of Japan did on Monday. It purchased over a billion dollars’ worth of ETFs on that one day alone!

The key point here is that during a bond market crisis caused by inflation, global central banks will be completely impotent to do anything about it.

The liberal maniac central planners that run the world have concurrently embraced the vapid and specious philosophy of usurping markets in favor of price-fixing. Sadly, they no longer have much of a choice because bubbles have been forced up to the thermosphere and, therefore, a mild and truncated recession has become impossible. Instead, a protracted depression has become inevitable.

The economic data has already become rancid in China—the epicenter of COVID-19. China’s official Purchasing Managers’ Index fell to 35.7 in February from 50.0 in January. This was the greatest plunge on record. China’s services sector saw its worst month on record in February as well, the Caixin/Markit services Purchasing Managers’ Index plunged to 26.5 in February, from 51.8 in January. And passenger car sales fell 80%.

Investors should expect the global economic news flow in the next few months—at least—to head towards what we are seeing now in China. And S&P 500 earnings growth, which was already zero coming into the virus, to be sharply negative in Q2. Indeed, passive management has become a death sentence for your standard of living.

Permanently Addicted to Zero

February 25th 2020

In Fed Chair Jerome Powell’s appearance before Congress on February 11th, formerly known as The Humphrey-Hawkins testimony, he asserted that the U.S. economy was, “In a very good place” and “There’s nothing about this expansion that is unstable or unsustainable.” But compare Powell’s sophomoric declaration to what Charlie Munger, Vice-Chairman of Berkshire Hathaway and Warren Buffett’s longtime right-hand-man, had to say about the market and the economy, “I think there are lots of troubles coming…there’s too much-wretched excess.”

Mr. Powell’s comments rival in ignorance with that of former Fed Chair Bernanke’s claim that the sub-prime mort crisis was contained. That is until the Great Recession wiped out 50% of stock valuations and over 30% of the real estate market. And of course, don’t forget about Fed Chairs Yellen and Powell’s contention that their Quantitative Tightening program would be like watching paint dry and run harmlessly in the background on autopilot. At least that was their belief until the junk bond market disintegrated and stocks went into freefall in the fall of 2018. Therefore, it should not be a surprise at all that the Fed doesn’t recognize the greatest financial bubble in history: the worldwide bond market mania. Perhaps this is because central banks created it in the first place and therefore didn’t want to take ownership of it.

Mr. Powell also averred this gem in his latest testimony, “Low rates are not really a choice anymore; they are a fact of reality.” Credit must be given here for finally admitting the truth—albeit what was probably a slip of the tongue. The Fed is tacitly stating that keeping money at a virtually-free rate is now a mandatory condition for perpetuating asset bubbles and preventing mass defaults on the record-breaking level of corporate debt.

So, how can hoping interest rates never rise back to normal be a condition that is either stable or sustainable? Jay Powell must understand this is an untenable position to take. And, how stable can interest really be when the budget deficit for the first four months of fiscal 2020 has jumped to $389.2 billion? That is an increase of 25% over last year. The National Debt is now an incredible $23.3 trillion; it was “just” $9.1 trillion at the end of 2007. Total household debt increased by $193 billion in Q4 2019 and is now $14.15 trillion. This marks 22 consecutive quarterly increases, with total household debt now $1.5 trillion higher than 2007. That’s the good news. Corporate debt has exploded by over 52% since the Great Recession and is at a record percentage of GDP. Total U.S. debt now stands at about 330% of GDP. This ratio was 150% of the economy prior to severing the dollar’s tether to gold in 1971.

And, the total market capitalization of stocks as a percentage of GDP has soared by 50 percentage points since June 2007–another all-time record high. But what else would you expect when returns on cash are losing value when subtracting inflation.

The only way these debt and asset bubbles are manageable is if interest rates are artificially held down close to zero percent by central banks. Otherwise, the economy will collapse and cause the GDP denominator in these ratios to plunge, just as all of the debt in the numerator remains. In other words, these debt ratios, which are already daunting, will become absolutely nightmarish.

An economy that must lug along this tremendous debt burden encumbers its ability to grow. The Fed believes the only way to keep the credit markets open and keep the economy growing is by constantly lowering borrowing costs. However, it is now running out of room to lower interest rates—it only has 1.5% before it returns to zero. And, most of the major central banks around the world are already at zero. Therefore, without another round of massive fiscal stimulus, like we saw with Trump’s Tax Cuts and Jobs Act of 2017, the prospects of continuing to hold a recession in abeyance much longer are dwindling by the day. This is especially true given the appetite and ability to significantly cut taxes or increase spending–while annual deficits are already north of $1 trillion (5% of GDP)–is greatly attenuated.

Somehow Mr. Powell finds solace in these scary facts. He doesn’t understand that this bond bubble is international, and its bursting will wreak havoc across the globe. For example, the insolvent nation of Greece, which back in 2012 had its 10-year bond yielding a whopping 45%, has now seen its benchmark yield retreat to an all-time low of just 1% today. In fact, Greece is now issuing 13-week debt with a negative yield. This is especially concerning given that its Debt/GDP ratio has increased from 159% back in 2012, to 181% today. Mr. Powell should tremble while wondering what Greek bond yields would yield if the ECB ended Q.E. and stopped buying its debt. He’s unconcerned because the ECB, BOJ, and PBOC are all caught in the same trammel of ensuring money is free forever.

I’ll close with this piece of wisdom from Robert Kaplan, President of the Dallas Fed, in a paper he wrote about one year ago warning about the excesses in the corporate and government bond market:

“An elevated level of corporate debt, along with the high level of U.S. government debt, is likely to mean that the U.S. economy is much more interest-rate sensitive than it has been historically.”

I would have graded Mr. Kaplan’s paper with a “C” for using the word “likely” instead of “definitely” when referring to the economy’s addiction to low rates. However, ultimately, he gets an F- for not recognizing that it is, in fact, the fault of central bankers for getting caught in a trap of their own creation.

This is yet another admission by the Fed that interest rates can never be allowed to increase. Our central bank has now announced it is on hold forever. Therefore, it is not much longer before investors lose faith in fiat currencies, maintaining their value. And that is when the real crash will begin because a central can’t fix an inflation problem by promising to create more inflation.

In the meantime, each day that goes by, the madness grows larger, and the inevitable reconciliation process will become all the more severe.

 

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

 

Coronavirus Cure: Print More Money

February 10, 2020

A few days ago, the market was crashing on Coronavirus fears. But recently, the market has soared back based upon the hopes of a vaccine and some better than expected economic data in the US. The ADP January employment report showed that a net 291k jobs were created, and the ISM Services Index came in at a healthy 55.5. However, a couple of good data points doesn’t change the fact that US economic growth has contracted back to 2% trend growth and will absolutely become more anemic–at least in the short-term. This is because the measures needed to contain the virus are also GDP killers. I have no clue if the virus will become a pandemic or if it will fade away like the SARS and MERS viruses–without long-term economic damage. But, for the stock market to remain at record high valuations, nearly everything has to go perfectly. That is, the Fed has to keep pumping in money, and EPS growth must rebound sharply.

The government reported that real GDP increased by 2.1% in Q4 2018, and nominal GDP increased by 3.6%. Therefore, the BEA wants us to believe that inflation was running at an annual rate of just 1.5% in Q4 of last year. That sleight of hand caused the number to appear respectable. However, going forward, we see many corporations, some of the biggest in the world, warning about a big hit to earnings because of the ancillary effects of the virus-likee closing down many major cities in China. For example, the mighty Tesla stock dropped 21% intraday on February 5 on the announcement of Model 3 delivery delays in China. This is happening in the context of S&P 500 EPS growth that had already flatlined before the outbreak of the virus.

Looking forward to Q2, which is less than two months away, the market will have to deal with the reporting of some really bad economic data and earnings that will be much weaker than Q1. But not only this, it will also have to deal with the Fed’s withdrawal from the REPO market and QE 4. This means the most overvalued stock market in history is going to have to deal with anemic data and a crimp in the monetary hose at the same time.

The most important point is that stocks care much more about liquidity than economic data. With that said, the removal of the Fed’s latest monetary supports should, for a while at least, take a good chunk of air out of this equity bubble. Of course, another market crash will cause Fed Chair Powell to step back in to support stocks, but that will be in response to the chaos, and significant damage has been done. The sad truth is that central bank liquidity has become the paramount functioning mechanism for markets; 2018 proved this beyond a doubt.

In that year, both the ECB and Fed tried to exit—at least to a certain degree–their respective liquidity supports for the market and economy. ECB Chair Mario Draghi said in the summer of 2018:

“We anticipate that after September 2018…we will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018. “his feeling at the time was that the QE program had succeeded in its aim of putting inflation on target and fixed Europe’s economy and markets.

In December of 2018, The European Central Bank decided to formally end its 2.6 trillion euro ($2.95 trillion) bond purchase scheme. And, as we all know, the Fed was raising rates and selling off its balance sheet throughout 2018. But, by the end of the year, the liquidity in the junk bond market completely evaporated, and the US equity markets went into freefall. The European SPDR ETF lost nearly 25% during 2018, which will go down in history as the year central banks attempted to normalize monetary policies but failed miserably.

By the time the calendar flipped to 2019, the Fed informed investors that rate hikes were over and, incredibly for most on Wall Street, the march back to free money was in store. By August, the Fed was again cutting rates and then launched QE4 ( $60b per month of bond purchase on October 11). And, at the September 12, 2019 meeting, the Governing Council of the ECB decreased interest rates by ten basis points to -0.5% and restarted an asset purchase program of €20 billion per month. Central banks’ sojourn with normalization didn’t get far off the ground at all. In fact, the Bank of Japan didn’t even attempt it; and they are all now trapped into the never-ending monetary manipulation of markets.

Of course, we recently had another growth scare coming from China’s Wuhan province. The Coronavirus caused Beijing to close down its markets for several days, and when they reopened, the plunge was over 7% in one day. This brought the maniac money printers back in full force. President Xi announced a huge stimulus package to stop the carnage. The People’s Bank of China injected a total of 1.7 trillion yuan ($242 billion) through reverse repos on February 3rd and 4th alone, as the central bank sought to stabilize financial markets. This was the biggest stimulus ever in China. It seems central banks have found a cure for every evil in the world, even a global pandemic: Print More Money!

It was not at all a trend towards more positive economic data that stopped the bleeding — only the promise of a tsunami of new money to be thrown at the market. The faith in governments to borrow and print their way out of every negative event has never been more prevalent—in fact, it is off the charts. The need to prevent a bear market has never been more salient because asset prices have risen to a record percentage of GDP. In other words, the pumping up of asset bubbles and GDP growth have become inextricably linked now that the US market cap of equities as a percentage of GDP is at a record high of 155%.

The truth is that liquidity trumps fundamentals. However, the rush to paper over each problem doesn’t always arrive on time and with enough force. Remember the NASDAQ and Real Estate debacles where equities plunged for many quarters before the Fed’s rate cuts had its desired effect. Central banks will continue to print money with each stock market hissy fit until they no longer are able to do so. The only things that can stop them are if the junk bond market craters at the time when major central banks are already in QE and ZIRP—we are perilously close to that point now. More stimulus at that point just won’t solve the problem.

Or, when inflation begins to run intractable, and the entire fixed-income spectrum begins to revolt—you can never solve an inflation problem by printing more money. If yields are spiking due to the market’s fear of currency debasement, then more QE at that point will cause investors fears of runaway inflation to become completely verified.

It will be at that point where those passively-managed, buy and hold, and indexed investors will be in for a shock. However, having a model that measures the cycles of Inflation/Deflation and Growth/Recession will give investors a fighting chance to maintain their purchasing power through the coming chaos.

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.”

Trillion-Dollar Market Cap Club

January 28th, 2020

There are a handful of stocks in which institutions and individual investors have recently piled into.  This behavior is emblematic of all bull markets once they begin to hit the manic phase. Wall Street falls in love with a few high-growth darlings and takes their valuations up to the thermosphere.

If you add up the market capitalizations of just four stocks, Google (Alphabet), Apple, Microsoft, and Amazon, their combined worth exceeds $5 trillion. If you throw in Facebook, you get the top 5 biggest firms by market capitalization, and they compose an amazing 18% of the S&P 500. Another way of looking at this is that the market cap of a full 282 companies in the S&P 500 now equals the same as the top 5 behemoths.

Again, this is not dissimilar to what has occurred in past blow-off tops. Recall the NASDAQ internet craze in the late ’90s and the Nifty Fifty bubble mania of the late ’60s and early ’70s. In the 694 days between January 11th, 1973, and December 6th, 1974, the Dow Jones Industrial Average lost over 45% of its value, but many stocks in the Nifty Fifty fared much worse. The Dot.com disaster was even more dramatic. It caused 5 trillion dollars of equity to vanish and wiped-out nearly 80% of market value.

The Nifty 50 stocks were the fastest-growing companies on the planet in the latter half of the 1960s and became known as “one-decision” stocks. These were viable companies with real business models but became extremely over-priced and over-owned. Investors were lulled into the belief they could buy and hold this group of stocks forever. By 1972, the overall S&P 500 Index’s P/E stood at 19. However, the Nifty Fifty’s average P/E at that time was more than twice that at 42. When the inevitable crash arrived, stocks that were part of the Nifty Fifty fell much more than the overall market. For example, by the end of ’74, Xerox fell 71 percent, while Avon and Polaroid plunged by 86 percent and 91 percent, respectively.

The years 1994 to 2000 marked a period of massive growth in the adoption of the internet, leading to a massive bubble in equities surrounding this technological revolution. This fostered an environment where investors overlooked traditional metrics, such as the price-earnings ratio. During this period, the Nasdaq Composite Index rose 400%, as its PE ratio soared to 200.

It’s always the same story: near the end of a massive bull market, a relatively small number of stocks get taken to incredible heights by a public that is thirsty for some story to justify such lofty valuations that are far above fundamentals. This can be clearly proved by viewing the Market capitalization of the Wilshire 5000 as a percentage of GDP. Stock valuations have now reached at an all-time high. In fact, they are nearly twice as high as the historical average and even higher than the NASDAQ bubble peak!

Not only this, but there are a record number of IPOs that don’t make any money, and a near-record number of U.S. listed companies that are spewing red ink—just like in past bubble tops.

This particular iteration of a massive equity bubble has seen a huge turn towards passive investments and a surge of money going into ETFs.

A paper done by the Federal Reserve explains that passive funds in 2018 now account for 39 percent of the combined U.S. Mutual Fund and ETF assets under management, up from just 3 percent in 1995 and 14 percent in 2005. According to the paper, passive investing is pushing up the prices of index constituents and there is a risk that rising prices can lead to more indexed investing, and the resulting “index bubble” eventually could burst.

The Potential Problem with ETFs

This brings us to a potentially huge problem with the overall market. A study done by Factset shows that in some instances of the largest market cap stocks that are held within ETFs, they represent more than 30 days of the average daily trading volume of the individual security that is traded on the exchanges. This means, for example, if only 10% of ETF holders decide to sell the security on any given day, it will represent three times the entire volume that is traded on the NYSE. Therefore, what we have is a condition where investors have become overcrowded in a few positions–just like what has occurred in previous market tops. However, this time around the situation is compounded by an influx of new money that has piled into ETFs. These same investments have doubled down on the doomed strategy of piling into a handful of winners.

In 2008 there was just $700 billion invested in ETFs; today, there is just under $5 trillion. ETFs have greatly exacerbated market directions in the past. Their existence tends to propel bull markets higher but, on the flip side, they also have led to flash crashes. To fully understand the dangers associated with buying and holding ETFs—and the overall market in general, especially in a bear market–you have to understand the process of creation and redemption units and how Authorized Participants (AP) function.

APs are the only entities that are allowed to directly interact with an ETF provider in order to create and redeem units. During a bull market, an ETF often trades at a premium to the underlying securities held by the index it tracks. In this case, an AP can buy the individual shares on the index at a discount and exchange them for a new ETF that is trading in the market at a higher price and then sells the ETF in the market for a profit. This process is known as creation, which adds to the supply of ETFs. And, it perpetuates the bull run.

Conversely, during market panics, an ETF will often sell at a steep discount to the shares trading on the index. In this case, an AP can buy the ETF in the market and exchange it for the individual shares on the index from the provider that is trading at a higher price. The AP can then sell the individual shares on the open market. This process is called redemption, and it reduces the number of ETF units. However, this process has also exacerbated crashes in the past by adding more selling pressure on to the individual shares of the index, which in turn leads to more panic selling for the less liquid ETF market.

Who are these very few lucky and privileged Authorized Participants? You may have guessed it, large banks such as; JP Morgan, Goldman Sachs, and Morgan Stanley.

This is just one more reason that validates the necessity of having a process that identifies when the epoch bear market begins before one occurs…because the next bear market should be one that makes the Great Recession of 2008 seem benign in comparison.

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.”

Stocks Rise as Zombie Companies Proliferate

January 21, 2020

Share prices on the major US exchanges are hitting all-time highs at the same time that both the number and percentage of companies that do not make any money at all are rising.

According to the Wall Street Journal, the percentage of publicly-traded companies in the U.S. that have lost money over the past 12 months has jumped close to 40% of all listed corporations–its highest level since the NASDAQ bubble and outside of post-recession periods.

In fact, 74% of Initial Public Offerings in 2019 didn’t make any money as opposed to just 25% in 1990—matching the total of money-losing ventures that IPOED at the height of the 2000 Dotcom mania. The percentage of all listed companies that have lost money for the past three years in a row has surged close to 30%; this compares with just over 10% for the trailing three years in the late 1990s.

The insane behavior of markets can be blamed squarely on central banks and their zeal to perpetuate asset bubbles by forcing interest rates into the sub-basement of history. This, of course, causes savers to leap far out along the risk curve in search of a yield that is far greater than the asinine 2% inflation target from which the Fed has vastly eclipsed long ago.

This market insanity isn’t completely lost on those who occupy the C-suite in corporate America.

According to a recent survey of U.S. corporate CFOs done by Deloitte, 77% of respondents said stocks are overvalued, while just 4% said equities are undervalued. And, a full 97% of respondents say that an economic slowdown already has begun, or will start sometime in 2020.

Perhaps the reason why the Fed has the REPO market in the Intensive Care Unit is precisely because corporate bond prices are nearing the edge of a gigantic chasm. The Federal Reserve Bank of NY is so concerned about the liquidity of money markets that it had to add another $83.1 billion in temporary liquidity to financial markets on Thursday, Jan. 9th alone—adding to the pile of about a half-trillion dollars’ worth of fresh monetary expansion since mid-September of last year.

All this largesse offered by the Fed at record low rates has indeed led to its desired effect. Corporations rushed to sell $69 billion in investment-grade (IG) corporate debt during the first full week of 2020, the second-highest amount ever in a one-week period, according to Bank of America Securities. The rate on the ICE/Bank of America investment-grade corporate bond index has plunged to a paltry 2.87%, as investors chase risk in a desperate search for any kind of yield. The BBB tranche of IG debt, which is just one notch above junk and comprises 50% of all IG debt, is yielding just 3.18%. That record low yield is a full 300 bps lower than it was prior to the Great Recession.

The truth is, there’s a record amount of corporate debt, which has the lowest quality of composition and trades at the lowest yields ever. Around the world, there is a half-trillion dollars’ worth of negative-yielding corporate bonds that are held by individuals that hope to sell it at a higher price—and fast—because holding a bond to maturity that pays less than the principal guarantees a loss in nominal terms and with a much fatter minus sign attached to it when inflation is factored into the equation.

Nevertheless, corporate bond prices continue to climb along with share prices even though earnings growth has absconded. According to FactSet, the Q4 2019 S&P 500 y/y earnings will be negative 2%. If the Q4 earnings season turns out to be a negative number at all, it marks four straight quarters of y/y negative EPS growth. But, falling earnings doesn’t seem to matter to stock investors much at all when the Fed keeps the confetti machine blowing at full speed–and deteriorating credit quality of corporation doesn’t seem to faze them either.

While the stock market surges to new highs, the credit quality of the U.S. government is faltering as fast as corporate debt. The budget deficit reached $1.02 trillion for the 12-month calendar year ending in December. And, the deficit increased to $357 billion in the first three months of this fiscal year 2020 (Oct., Nov., and Dec.). This deficit is the largest in seven years. It was only higher during the aftermath of the Great Recession. But remember, this is supposed to be the best economy ever. However, it is not; and when the economy starts to contract the annual budget deficits should spike north of $2.5 trillion due to automatic economic stabilizers, just as corporate bond yields become completely unglued.

The continuation of this phony bull market and ersatz economy is predicated on borrowing costs staying at a record low levels forever. This is despite the fact that the level of debt is unsurpassed and growing higher each day. This is the same condition as the real estate bust of 2008: 1.5 trillion dollars’ worth of US Mortgage debt was owed by borrowers who couldn’t pay back the loans once home prices stopped rising and interest rates began to rise. Only this time around it is going to be much worse: over $5 trillion worth of corporate debt will most likely become insolvent once the economy stalls and zombie corporations get shut out of the credit markets due to spiking borrowing costs.

In the interim, it is ok to dance on top of these bubbles; but only if you have a robust model that gives enough warning ahead of time to sprint towards the extremely narrow emergency exit. Otherwise, you will buy and hold, and dollar cost average your account to penury. If you doubt, that just ask the Japanese in 1989 how holding on to stocks worked out.

Up until now, the day of reckoning has been held in abeyance by central banks’ willingness to drop borrowing costs to near nothing and by engaging in perpetual QE. But this strategy only works for a while. Now that money has been offered around the globe for virtually free and for a very long time, there isn’t much central banks can do to thwart the next recession outside of dropping money from helicopters (a.k.a. direct debt monetization or hyperinflation)–but that won’t happen until the next collapse is in full free-fall. Modeling this dynamic will be crucial for investors’ success.

 

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.”

Playing Taps For The Middle Class

January 13, 2020

It is not at all a mystery as to the cause of the wealth gap that exists between the very rich and the poor. Central bankers are the primary cause of this chasm that is eroding the foundation of the global middle class. The world’s poor are falling deeper into penury and at a faster pace, while the worlds richest are accelerating further ahead. To this point, the 500 wealthiest billionaires on Earth added $1.2 trillion to their fortunes in 2019, boosting their collective net worth by 25%, to $5.9 trillion.

In fact, Jamie Dimon, CEO of JP Morgan, made a quarter of a billion dollars in stock-based compensation in 2019. As a reminder, shares of JPM were plunging at the end of 2018; that is before the Fed stepped in with a promise to stop normalizing interest rates. And then, soon after, began cutting them and launching a bank-saving QE 4 program and REPO facility on top of it in order to make sure Mr. Dimon’s stock price would soar. Slashing interest rates hurts savers and retirees that rely on an income stream to exist, just as the Fed’s QE pushes up the prices for the things which the middle class relies on the most to exist (food, energy, clothing, shelter, medical and educational expenses).

Therefore, what we have is a condition where those who own the greatest share of assets, such as stocks, bonds, and real estate, are becoming more wealthy. Meanwhile, those that have to spend a greater percentage of their income on the basics of raising a family are falling further behind. The saddest part of this charade is that the Fed isn’t at all happy or content with the current pace of middle-class erosion. Instead, it actually wants to aggressively speed it up.

According to the Congressional Budget Office and Fortune.com, the incomes of the top 1% have increased by 242% since 1980, while the middle three quintiles have seen just 50% income growth in just under forty years. President Trump is correct; this is indeed the best economy ever–but unfortunately, only for the ultra-rich. Nearly 80% of Americans now live paycheck to paycheck. According to a survey done each year since 2014 by GOBankingRates, in 2019, 69% of respondents said they have less than $1,000 in a savings account, which compares with 58% in 2018.

According to the LA Times:  Adjusted for inflation, wages for the top 5% of earners rose from $50.46 an hour in 2000 to $63.10 in 2018, an increase of 25%. The median worker’s hourly wage, meanwhile, rose by just 7% over that period, to $18.80.

According to economics professor Gabriel Zucman in a paper he submitted to the NBER, the wealthiest 0.1% of Americans now hold the largest share of total household net worth than at any time since 1929. This just happens to coincide with the period just before the historic Wall Street stock market crash and the start of the Great Depression.

A study done in 2015 showed that America’s top 10% of wealth holders averaged more than nine times as much income as the bottom 90%. And Americans in the top 1% averaged over 40 times more income than the bottom 90%.

The richest 1% of the world’s population now holds over 50% of its wealth.

Perhaps it is not a coincidence either that the United States has lost 20% of its factory jobs since 2000. The chart below illustrates clearly how the Fed is pushing up asset prices far ahead of GDP…leaving the middles class in its wake.

Central banks are creating new money at an unprecedented pace and throwing it at the wealthiest part of the population—pushing asset bubbles ever higher and further away from economic reality. The Fed is turning a blind eye towards a middle class that is heading towards extinction.

Make no mistake about it…the level of fiscal and monetary insanity has jumped off the charts, along with the value of assets in relation to GDP. Global governments are now borrowing money at a record pace, which is adding more debt to the already insolvent and intractable existing pile. And, in order to keep all the bubbles afloat, central bankers have become trapped in a permanent condition of ZIRP and QE. What could possibly go wrong? Unfortunately, it will be nothing short of mass economic chaos when the bond market finally implodes. But this doesn’t have to be bad news for all investors. Having a process that navigates the crashes and booms will make all the difference in the world.

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.”

 

Farewell Paul Volcker Hello Monetary Madness

December 20, 2019

God bless Paul Volcker. He was truly a one of a kind central banker, and we probably won’t see another one like him ever again. It took his extreme bravery to crush the inflation caused by the monetary recklessness of Arthur Burns and the fiscal profligacy of Presidents Johnson & Nixon. Raising interest rates to 20% by March 1980 was wildly unpopular at the time. But in the end, it was what the nation needed and paved the way for a long period of economic stability and prosperity.

Back in 1971, the world fully had developed a new monetary “technology.” Governments learned that money need no longer be representative of prior efforts, or energy expended, or previous production, or have any real value whatsoever. It can be just created by a monetary magic wand; and done so without any baneful economic consequences.

This phony fiat money can, in the short-term, cause asset values to increase far above the relationship to underlying economic activity. And now, having fully shed the fettering constraints of paper dollars that are backed by gold, central banks have printed $22 trillion worth of confetti since the Great Recession to keep global asset bubbles in a perpetual bull market. Now, anyone whose brain has evolved beyond that of a Lemur understands that this can only be a temporary phenomenon–one where the ultimate consequences of delaying reality will be all the more devastating once they arrive.

This magic monetary wand is also being used to push borrowing costs down to record low levels—so much so, that some governments and corporations are now getting paid when they borrow. Therefore, it’s no wonder to those of us who live in reality that both the public and private sectors tend to pile on much more debt when both real and nominal interest rates are negative. Indeed, debt has been piling up at a record pace. Amazingly, central bankers find themselves in complete denial when it comes to this reality.

To this point, The U.S. budget deficit for the month of November was $209 billion and is running a deficit of $343 billion for just the first two months of fiscal 2020. And, we have the following three data points from my friend John Rubino at DollarCollapse.com:

  • Total US credit (financial and non-financial) jumped by $1.075 trillion in Q3 2019, the strongest quarterly gain since Q4 2007. The total is now $74.862 trillion, or 348% of GDP.
  • U.S. Mortgage Lending increased $185 billion, the strongest quarterly gain since Q4 2007.
  • M2 money supply surged by an unprecedented $1.044 trillion over the past year, or by 7.3%.

Not only this, but Morgan Stanley’s research shows that nearly 40% of the Investment Grade corporate bond market should actually be rated in the junk category based upon their debt to EBITA ratios. In fact, the entire corporate bond market has a record net debt to EBITA ratio. And, the total amount of US corporate debt now equals a record high 47% of GDP. In the third quarter of this year, US business debt eclipsed household debt for the first time since 1991.  And, according to Blackrock, global BBB debt, which is the lowest form of Investment Grade Debt, now makes up over 50% of the entire investment grade market versus only 17% in 2001.

Here is another fun fact: The IMF calculated that in the next financial crisis– if it is only half as severe as 2008–zombie corporate debt (which consists of companies that don’t have enough profits to cover the interest on existing debt) could increase to $19 trillion, or almost 40% of the total amount of corporate debt that exists in the developed world.

The problem should be clear even to the primates that govern our money supply. Global governments have already proven completely incapable of ever normalizing interest rates, and every moment they continue to force borrowing costs at the zero-bound level compels these corporations to pile on yet more debt. This means the corporate bond market is becoming increasingly more unstable, just as it also raises the level from which bond prices will collapse–when not if, the next recession arrives.

And speaking of recession, during the next economic contraction, the US national deficit should rise towards $3 trillion per year (15% of GDP) and that will add quickly to the National Debt, which is already at $23 trillion (106% of GDP). Meanwhile, while US Treasury issuance will be exploding in size, the $10 trillion worth of US corporate debt will also begin to implode. This means the Fed should be forced to purchase trillions of dollars in Treasury debt at the same time it has to print trillions more to support collapsing corporate bond prices.

That amount of phony fiat money creation would eclipse QEs 1,2,3, & the Fed’s currently denied QE 4 all put together. I wonder what name Jerome Powell will put on his non-QE 5 when the time arrives? If investors are unprepared to navigate the dynamics of depression and unprecedented stagflation, it could mean the end of their ability to sustain their standard of living. A totally different kind of investment strategy is needed during an explicit debt restructuring as opposed to one where the government pursues an inflationary default on its obligations. I believe governments will pursue both methods of default at different times. Determining when and how the government reneges on its obligations is crucial. That is what the Inflation/Deflation and Economic Cycle Model SM was built to do. Get prepared while you still have time.

Economic Tribulation is Coming, and Here is Why

December 16, 2019

The global fixed income market has reached such a manic state that junk bond yields now trade at a much lower rate than where investment-grade debt once stood. Investment-grade corporate debt yields were close to 6% prior to the Great Recession. However, Twitter just issued $700 million of eight-year bonds at a yield of just 3.875%. That is an insanely low rate even for investment-grade corporate debt. But, the credit rating on these bonds is BB+, which by the way, happens to be in the junk category.

One has to wonder how fragile the fixed income world has become when investors are tripping over each other to lock up money for eight years in a junk-rated company that is offering a yield only 1.5 percentage points above the current rate of inflation. And, in a company involved in the technology space, which is a sector that evolves extremely rapidly with a high extinction rate. Oh, and by the way, Twitter missed on both revenue and earnings in its last quarterly report. Nevertheless, this issue was so oversubscribed that the dollar amount for the offering was boosted by $100 million just days before coming to market.

The fixed income mania is even worse over in Euroland, where junk bonds are commonly issued with yields of just around 1.5%–and with some even getting paid to borrow money. And, it has become par for the course to find European investment-grade corporate debt that is yielding below zero.

The MSFM will not acknowledge the existence of a bond bubble. This is mind-boggling because the worldwide bubble in fixed income is the largest deformation of an asset value in the history of humankind. Bloomberg’s research indicates that the average yield on the 10-year US Treasury Note was 7.3% from the 1960s thru 2007. That yield now has a one handle in front of it. Wall Street explains away this abnormality by claiming low yields are justified because there is no inflation. However, the Bureau of Labor Statistics (BLS) clearly shows that year/year Core CPI is running at 2.3% and has been over 2% for nearly two years! Therefore, the low inflation lie promulgated by Wall Street can’t explain the condition of record-low interest rates. And, the fact that the US now has a debt to GDP ratio of 106%–the highest since immediately after WWII–doesn’t explain it either.

Negative 10-year bond yields in Europe and Japan can’t be explained by extraordinary fiscal prudence as well. The EU’s debt to GDP ratio stands at near 90%, which is 20 percentage points higher than it was when the Maastricht Treaty came into force in 1993, and Japan’s debt to GDP ratio is 240%, which is the highest on record.

Record low-interest rates should be a function of record low inflation rates and budget surpluses. But global governments get a failing grade on providing either. Not only this, but the future looks even bleaker. Central banks are promising even more inflation at the same time debt, and deficits are soaring.

After the great economic collapse of 2008, we have felt several tremors of the great rate earthquake that still lies ahead. In 2012 we saw the bond market blow up during the EU debt crisis. Rates spiked in most of Europe as bond investors became convinced that systemic sovereign debt defaults were coming. This caused the then head of the ECB, Mario Draghi, to promise to do whatever it takes to push rates lower. He promised to print trillions of euros and buy enough debt until investors became more inspired to front-run ECB bids rather than worry about defaults.

Then, in 2014, there was a big growth scare in China, which has been responsible for one-third of global growth. China launched a massive 10 trillion RMB infrastructure plan to stimulate its faltering economy. The US also deployed a tax cut and stimulus package that the CBO estimated would add nearly two-trillion dollars to the deficit over a decade. Things worked well for a while, with global fiscal and monetary stimulus running full throttle.

But then in late 2018, things all began to fall apart once again, as money market rates began to soar. The Fed had been raising interest rates and selling off its balance sheet. It raised the FFR only two and a half percentage points above the zero line and sold a few hundred billion dollars’ worth of its assets. That caused the stock market to plunge and the credit markets to freeze. Jerome Powell’s half-hearted attempt at normalization of monetary policy caused the entire phony economic construct to tumble.

This chart produced by Sprott Asset Management LP sprott.com illustrates how feeble the global attempt towards normalization really was and how central bankers have become ensnared in their own trap.

This proves the point: whatever semblance of normalcy that exists in the economy and markets is based upon the continuation of free money forever and the ability to keep interest rates from ever rising.

But for that to be the case, you must believe that the $14 trillion of central bank money printing (and that is just counting what has been done in the developed world) will never cause inflation to rise above central banks’ 2% target. And, you also must assume that the surging $250 trillion debt load will never give bond investors cause for concern over debt service costs even though that pile of debt is growing at a much faster pace than underlying growth.

The truth is Central Planners have gone all-in with their fiscal and monetary policies. In their zeal to keep the stock market in a perpetual bull market, they have borrowed and printed to the limit. Interest rates are now at or near zero throughout the developed world, and debt to GDP ratios have risen to the point where solvency is now becoming a real risk.

 

The future guarantees that the junk bond market will someday implode, and probably soon. Repo borrowing costs will soar, the liquidity in the junk bond market will evaporate and equity prices will begin to free-fall. However, since normalization has proved to be a pipe dream, as it has failed miserably whenever and wherever it has been even marginally attempted, policymakers are aware that they will be handcuffed during the next economic downturn. That is why central bankers have become petrified over each downtick in the stock market.

The clock is ticking down towards a period of unprecedented economic tribulation, and its catalyst will be the implosion of the global bond bubble. A recession will destroy the worldwide corporate bond market. But even though that is bad enough, intractable Inflation will destroy the entire global fixed income complex across the board. Modeling when this great reset will occur and capitalizing from it will make all the difference in the world for your standard of living.

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.”

Central Planners: Out of Room and Running Out of Time

December 9, 2019

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

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

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

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

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

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

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

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

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

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

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