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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.”

 

Priced for Perfection

The stock market has now priced in a perfect resolution for all of its erstwhile perils. Wall Street Shills would have you believe that since the Fed has turned dovish, it will always be able to push stocks higher. The trade war is about to reach a peaceful conclusion, and that will be enough to fix all that ails the global economy. A no-deal Brexit is off the table, and a smooth transition out of the EU will occur. Peace will soon break out in Hong Kong, and its troubled economy will have no contagious global economic effects. And, there will be a sharp rebound in Earnings Per Share (EPS) growth from the current earnings recession because…well…just because we need one.

However, beneath the surface of this economic charade, the carcass is rotting, and the stink can be smelled by anyone who isn’t willingly holding their nose. To this point, the leveraged loan market, which consists of loans made to highly indebted and barely solvent entities, has seen an increase of 100% since 2007, according to the Bank for International Settlements.

There is about $16 trillion worth of U.S. business debt, about 1/3rd of which is comprised of leveraged loans and bonds that are rated junk. Half of the bonds that are in the category of Investment Grade have a rating that is BBB, which is just one level above junk. If that isn’t scary enough, dealers are willing to hold in inventory $12 billion of these types of loans, according to Bloomberg.

The salient question is: what will happen come the next recession when panicked holders try to sell trillions of dollars’ worth of distressed debt to a market that currently provides liquidity for just .075% of the market?

The Conference Board’s Leading Economic Index declined for a third consecutive month in October, and its six-month growth rate turned negative for the first time since May 2016. Meanwhile, Washington D.C. is mired in self-destruct mode. There is still no passage of a phase one trade deal even though one was announced on Oct. 11th with much fanfare. No passage of the USMCA trade deal, even though it has been sitting on Nancy Pelosi’s desk for a year. No passage of a budget deal, and so, the government is forced to fund operations by passing continuing resolutions (CR). This C.R. that was just passed only funds the government until Dec. 20th.

Maybe we should be happy that Washington is broken because when it works, all they can agree on is how to spend a lot more money. To this point, October government spending hit a record $380 billion, which led to a 34% jump in the year over year deficit and caused $134.5 billion worth of red ink to be spilled in one month. The U.S. is mired in permanent QE, is posting trillion-dollar deficits without end, has waring political parties, and operates its government without a budget. We are sadly looking more like a banana republic every day.

Investors have placed their faith in a Fed that has continuously proven its incompetence. Former Fed Chair Janet Yellen avowed not too long ago that there would not be another financial crisis in our lifetimes. However, she is now warning, “… the odds of a recession are higher than normal and at a level that frankly I am not comfortable with,” she was quoted saying this at the World Business Forum on Nov. 21st. What I find most disturbing about her comments made was what she said about retirees and savers. Yellen actually bemoaned the fact that people are forced to save money in the bank and get nothing for doing so. In fact, she was actually concerned that they are getting penalized for doing the right thing and falling further behind inflation. What!?

Ms. Yellen raised interest rates just 50 bps in her total four-year tenure at the Fed. But only now she is worried about savers and the Fed’s role in fostering the wealth gap? But what she has not, and cannot admit to, is how bad the next recession is going to be. While she did allude to the fact that central banks no longer have room to lower borrowing costs, she fails to understand that her willingness to keep offering free money for many years likely means her recession prediction is really a depression forecast. This is based on the record debt levels and historical asset bubbles that have been engendered by the Fed’s actions.

As the march towards global recession proceeds onward, the composite EU Purchasing Managers Index (PMI) for both manufacturing and services released last Friday fell to 50.3 from 50.6. Orders fell for the third straight month, and employment growth also slowed. The Australia, UK, and Japan PMIs all show these economies are still contracting. The Official NBS Manufacturing PMI in China fell to 49.3 in October, from the previous month’s 49.8. Any reading below 50 shows economic contraction. The only slightly better news was found in the U.S. flash services sector purchasing managers index in November. It rose to 51.6 from 50.6 but still is indicative of an economy that is barely growing. Even the “Better than expected” Durable Goods orders being pumped on financial news networks isn’t the real story. While the headline month over month reading for October climbed by 0.6%, the year over year number declined by 0.7%. And, the important Core Capital Goods New Orders figure fell by 0.8% YoY. Falling capital goods means business is not investing in productive assets and GDP growth will indeed suffer as a result.

Wall Street shills keep wishing for a turn in the global economy in 2020 because a booming rebound has already been priced into equities. But the only turn we are getting so far is one to the downside. That is going to be really bad news for the buy and hold crowd.

I want to close with a bit of central bank hypocrisy. The following is an excerpt from a paper published by two economists at the St. Louis Fed, Scott A. Wolla and Kaitlyn Frerking. They warned about the potential dangers involved when a nation’s central bank buys its own debt.

“A solution some countries with high levels of unsustainable debt have tried is printing money. In this scenario, the government borrows money by issuing bonds and then orders the central bank to buy those bonds by creating (printing) money. History has taught us, however, that this type of policy leads to extremely high rates of inflation (hyperinflation) and often ends in economic ruin.”

The paper published this month never acknowledges that this is exactly what the Fed has done and continues to do to this day. Not just a little bit but in a big way. The Fed has already permanently monetized nearly $4 trillion worth of debt, and it is just getting started down this pernicious path. This strategy is a page taken from the how-to-be-a-banana-republic playbook and has been repackaged by some far-left politicians and Sudo-economists and renamed as the Modern Monetary Theory (MMT). MMT is just a euphemism for debt monetization. Nevertheless, no matter what you call it, creating new money from nothing to purchase government debt has never worked in the history of economics and has always led to economic ruin.

There will be times when debt will be explicitly restructured (deflation) and other secular periods consisting of inflationary defaults (MMT, QE, Helicopter Money, or whatever name Jerome Powell is willing to put on it.

Investors need to model these dynamics to make sure they are on the correct side of the cycle, depending upon how the government is defaulting on this debt.

 

Fed Can’t See the Bubbles Through the Lather

November 12, 2019

Recently, there has been a parade of central bankers along with their lackeys on Wall Street coming on the financial news networks and desperately trying to convince investors that there are no bubbles extant in the world today. Indeed, the Fed sees no economic or market imbalances anywhere that should give perma-bulls cause for concern. You can listen to Jerome Powell’s upbeat assessment of the situation in his own words during the latest FOMC press conference here. The Fed Chair did, however, manage to acknowledge that corporate debt levels are in fact a bit on the high side. But he added that “we have been monitoring it carefully and taken appropriate steps.” By taking appropriate steps to reduce debt levels Powell must mean slashing interest rates and going back into QE. The problem with that strategy being that is exactly what caused the debt binge and overleveraged condition of corporations in the first place.

Global central banks have abrogated the free market and are in the practice of repealing the business cycle and ensuring stocks are in a permanent bull market. Massive and unrelenting money printing is the “tool” that they use. The good old USA had its central bank cut rates to 0% by the end of 2008 to combat the Great Recession; and that paved the way for the EU to join the free-money parade by 2016. In fact, the Band of Japan had already been at the zero-bound range years before. This means much of the developed world has been giving money away gratis for the better part of a decade.

And now central banks actually want you to believe that multiple years’ worth of global ZIRP has somehow left asset prices devoid of any significant distortions. All is normal here, or so we are told. So, I thought it would be prudent to shed some light on a few of those glaring imbalances that should be obvious to all except a debased central banker. To be blind to them screams of incompetence or mendacity–or both.

Forty percent of Europe’s investment grade corporate debt offers a negative yield and there are at this time $15 trillion worth of sovereign debt globally with a negative yield as well. The valuation of equities in the U.S. is now for the first time ever 1.5 times its phony and free-money-goosed GDP. Yet, at the same time S&P 500 margins and earnings are shrinking. The U.S. has increased its business debt by 60% since the Great Recession–it now totals $16 trillion, which is an all-time high in nominal terms and as a percent of GDP. Much of this debt has been used to buy back stock and reduce share counts to boost EPS. Corporate buybacks, which were illegal in the U.S. before 1982, will breach $1 trillion this year. As far as the Fed is concerned, issuing a record amount of debt to buy back stocks at record high valuations is just fine.

According to the BIS, 12% of businesses in the developed world have become zombies–having to issue new debt just to pay the interest on existing debt—this figure is also at a record. The average interest rate on the U.S. 10-year Treasury Note prior to the Great Recession was about 7%. Today, this rate is a lowly 1.8%.

It appears central banks are completely oblivious to the global bond bubble even though they are its very progenitor. For further examples, back in the European debt crisis of 2012, the borrowing costs for the insolvent countries known as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) shot up to the thermosphere. The Greek 10-year Note hit a yield of 40% and caused the economy to crash under the weight of its mountain of debt and skyrocketing servicing costs. This led to an explicit and partial debt default of its obligations and a humongous European Central Bank bond-buying program that promised “to do whatever it takes” to bring down yields. The Greek 10-year yield is now just 1.6%, even though the country’s National debt to GDP ratio has actually increased from 159% in 2012, to just under 200% today. How can this be? The answer is, Greek debt is once again in a gargantuan bubble, but this time around it is now and forever on the life support of ECB counterfeiting. It is the same story in Portugal. Its 10-year Note yield shot up to an untenable 16% in 2012. But through the magic of the printing press it is now just under 0.25%. As incredible as that rate is, it exists even though Portugal’s National debt to GDP ratio is still over 120%; just about the same level it was back in 2012 when the market caused its rate to skyrocket.

The U.S. deficit increased by 26% y/y and is now $1 trillion per annum. The annual deficits are projected by the CBO to be at least $1.2 trillion for the next decade. That is, if everything goes perfectly fine in the economy and rates stay at historic lows–and there is never another recession. For Mr. Powell and company, all this is viewed as being completely normal.

In addition, history has proved throughout the centuries that once an economy has more than a 90% total debt to GDP ratio, its economic growth becomes impaired. The total in the U.S. is now 330%, in the EU it is 450%, and Japan has over 600% total debt to GDP. How did the entire developed world become so debt-disabled? The answer is simple: artificial interest rates provided by central banks have incentivized, facilitated and enabled governments to issue massive amounts of debt with impunity. Again, according to central bankers there is nothing to see here.

These are just a  few of the many examples of market distortions arising from central banks artificially pushing yields into the sub-basement of history. Now they have destroyed the market-based pricing of fixed income and equities across the globe. These markets have now become wards of the state forever and ever amen.

The sad truth is that the entire artificial and tenuous construct of markets is predicated on interest rates that perpetually fall and never increase. As long as this baneful dynamic is in place, asset bubbles grow bigger, and debt levels rise. Thus, making the economy increasingly more dependent on lower and lower interest rates. The problem is most central banks have already arrived at the zero-bound range and/or are in various stages of QE. Even the horrific Fed only has one and half percentage points from running out of ammo to reduce borrowing costs and is already printing $60 billion per month in QE. And yes, that is exactly what it should be called. Hence, when (not if) the next economic contraction begins, money markets will once again freeze and the record number of zombie companies will begin laying off millions of employees as a result of being shut out of the credit market. Then, the global bubble in junk corporate debt will crater and cause panic in equity markets like never before in history.

According to the Fed and the deep-state on Wall Street, all is completely normal.

The China stock bubble burst 12 years ago, and the Shanghai exchange is still down 50% from that high. Japan’s bubble burst 30 years ago, and investors are still down 40%. Global central banks have set the table for a record implosion of markets and the major U.S. averages are by far the most overvalued. This is why it is imperative to model the dynamics in credit markets to ensure you can participate in the upside of stocks while the charade lasts. But most importantly, also avoid getting slaughtered like a passively managed pigeon once interest rates spike and the global credit bubble finally bursts.

 

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.”

 

How to Avoid the Next 50% Market Crash

October 28, 2019

This ageing bull market may soon face the third market collapse since the year 2000. Nobody can predict the exact starting date of its decline—but either a recession or stagflation will surely be its catalyst. During the next debacle, the typical balanced portfolio designed by Wall Street, which consists of approximately 60% stocks and 40% bonds, will no longer provide much protection at all. In fact, that type of portfolio construct has become downright dangerous.

The simple reason for this is that for the first time ever both stocks and bonds are in a massive and unprecedented bubble; and are therefore both vulnerable to significant selloffs. Bonds will no longer provide a ballast or offset to your stock portfolio once reality hits both of those asset classes. If a bond has a 5% yield and has 30 years left to maturity; that holder would lose 25% of his principal if interest rates rise by just 2%. Given the fact that bond yields are the lowest in history, an increase of 2% is certainly not out of the question; and is in fact most likely inevitable.

What happens with the equity portion depends on the reason why rates are rising. If rates increase because of a surge in economic growth, then equities should do well for a while longer. However, if rates rise because of inflation or credit risks; then stocks would likely get hurt very badly indeed. In that case, there is a high probability of losing money in both your equity and fixed income buckets.

Therefore, a smarter way to invest–rather than just blindly buy and hold a closet Index fund and hope for the best—is to map the economic cycle. Given that Wall Street’s version of diversification will most likely no longer work, it is now imperative to understand where the economy lies along the spectrum between Inflation/Deflation and Growth/Recession.

An alternative investment strategy is now necessary because the Fed decided around 20 years ago that recessions could be abrogated and it had the tools to repeal the business cycle. It kept pushing interest rates lower every time there was either a downturn in the economy or a sharp selloff in stocks. This is exactly what happened in the wake of the NASDAQ bubble of 2000 and the Housing Crash of 2008. Indeed, Greenspan started this practice in 1987; but its roots were planted in 1971 when the US left the gold standard completely.

Each iteration of this cycle served to push asset prices higher than what the underlying economy could support. This also caused even more debt to be accumulated. Now, we have a triumvirate of asset bubbles (stocks, real estate and bonds) that exist globally. Speaking of the real estate bubble–although it is no longer the nucleus of the current bubble–it should be noted that National Home prices have increased for 91 months in a row and have advanced 5.9% y/y—far above the pace of income growth. The sad truth is that the Fed, in full cooperation with Wall Street, has once again made home prices unaffordable for many first-time buyers.

The fact is that debt levels have exploded worldwide and yet at the same time interest rates have never been lower than they are today.

Here’s some data points that we all should and need to be aware of:

  • Total market cap of equities as a share of GDP is now 145%. That ratio was 100% in 2007, and has averaged just 80% since 1971.
  • $15 trillion worth of sovereign debt with a negative yield
  • 500 billion euros of junk bonds in Europe with a negative yield
  • $5.4 trillion of BBB, Junk and Leveraged Loans in the US, there was only $1.5 trillion of sub-prime mortgage debt in 2007
  • The US Treasury yields 1.7% but its average is above 6%
  • US deficits breached above $1 trillion in fiscal 2019 and the CBO projects deficits will be $1.2 trillion each year for the next decade but that assumes interest rates never normalize and the economy never has a recession. If rates rise and/or we have a recession, the annual deficit could approach 15% of GDP. Adding to our already-huge national debt of $22.6 trillion.
  • Total global debt has soared to $250 trillion up over $70 trillion from 2008 and is now a record 330% of GDP
  • US Non-financial debt has soared from $33 trillion in 2007 to $53 trillion in 2019
  • US National Debt was $9 trillion in 2007 and has skyrocketed to $23 trillion today
  • Business debt has jumped by nearly 60% since12 years ago

The point here is not to scare you; but to help you make good investment decisions.

The gravitational forces of deflation are immense and trying to bring about a healthy recession. This would cause a significant paring down of debt along with an even greater correction in equity, junk bond and property values. That is, if the economy was left alone and market forces were allowed to rectify the imbalances. However, global central banks are fighting these market forces and trying to keep asset bubbles afloat by pushing interest rates even lower and returning to QE.

The problem is, central banks are simply running out of room to reduce borrowing costs. And speaking of central bankers, if any of you still believe in the Fed’s omnipotence and omniscience then please remember that it was in Quantitative Tightening only a few months ago and now has returned to QE–just don’t call it that–even though Chair Powell is monetizing debt exactly like Bernanke and Yellen were doing. Therefore, buying $60 billion of short-term Treasuries is QE in every sense of the word. The only difference between QE 4 and QE’s 1,2 &3 is the Fed is now trying to steepen the yield curve, while the other iterations of QE were about pushing down long-term interest rates. In either case, it is debt monetization just like any other banana republic would do. Only this round of QE is worse than all others before it because investors know for sure it is permanent. The Fed can no longer pretend QE was temporary.

The truth is that central banks have destroyed free markets and the global economy has become massively unstable. We have artificial interest rates that are in the basement of history as a direct result of global central banks printing the equivalent of $22 trillion since 2008. This has in turn caused a humongous distortion in most asset prices that are now perched at dangerously high levels.

So, what should we do as investors?

What we should not do is just take a 50% stake in gold and go 50% short stocks and then claim that someday we will be right because of what ought to be happening right now. Instead, investors need to intelligently model the economy to determine what sectors and style factors of stocks to own. And, what asset classes should they be most exposed to; equities, bonds or commodities depending on the rate of growth and inflation.

Pento Portfolio Strategies uses the Inflation/Deflation and Economic Cycle Model SM and its 20-components to determine the macroeconomic condition of the economy.

Both public and private debt levels have grown so large that it must be defaulted on; either through inflation or deflation. How governments choose to default on the debt will make a world of difference in how you invest your money. Think back to 2018. It was a year where we were on a path towards interest rate normalization and QT. But that led to a crash in stocks by the end of the year. Now, most central banks have turned dovish and the Fed has redefined stable prices by making 2% inflation a floor rather than a ceiling. The major issue is that there is very little room at all to reduce borrowing costs in order to re-inflate asset prices and the economy.

So, the question now is do central banks have enough ammo to avert a recession? The recession of 2001 saw the NASAQ lose 80% of its value and the Great Recession of 2007-2009 saw the S&P lose half its value and home prices drop by 33%. The sad truth is the distortions evident in the prior two recessions are dwarfed by the record triumvirate of asset bubbles that exist today on a worldwide basis.

The whole idea is to make money slowly and carefully in the current environment but then also make sure we try to protect and profit from the inevitable recession and/or inflation with its mean reversion of interest rates.

This dynamic strategy gives us an opportunity to vastly outperform the major indexes during cycles of stagflation and recession/depression, in which equities undergo a bear market. Holding a static portfolio did not work during the Great Recession and it probably won’t work during the next crisis either.

Given this exceptional time in history–one where the main stream financial news has never been more incompetent and corrupt; and where the global economy has never been more unstable—a source like PPS is mandatory to obtain the correct market guidance.

 

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

Will Rate Cuts Be Enough?

October 14, 2019

 The mainstream financial media is absolutely ebullient about global central banks’ renewed enthusiasm to cut interest rates to a level that is even lower than they already are. And, most importantly, Wall Street is completely confident that theses marginally-lower borrowing costs will not only be enough to pull the global economy out of its malaise; but will also be sufficient to provide enough monetary thrust to blow asset bubbles into the thermosphere.

However, the truth is Fed stimulus does not always work. This was the case during both 2000 and 2008. A significant amount of rate cuts was not enough to avert a recession and also did nothing in the way of preventing the stock market from collapsing.

During the mid to late ’90s, the Fed’s 175bps of rate cuts did help keep the “irrational exuberance” alive in the equity market and helped propel the NASDAQ to what turned out to be a very dangerous level by the end of the decade. But then, reality inevitably came calling; and tech stocks crashed by nearly 80% from March of 2000 through the fall of 2002. That recession and concomitant plunge in stock prices occurred despite the Fed’s 550bps of rate cuts from 2001–2003. Likewise, the Fed’s 525bps worth of rate reductions occurring from 2007-2008 was insufficient to check the Great Recession and the 33% wipeout of home values and half the value of the S&P 500.

Fast forward to today, and we see not only has the Fed cut rates by 50 bps, but also many other central banks around the world have embraced a dovish tone. But again, the question must be asked; will these rate cuts become a panacea for the economy and markets like they were for a few years during the mid and late nineties, or will it turn out to be a complete debacle like the last two rate-cutting cycles. Wall Street and its shills believe in central bank omnipotence and omniscience, but history clearly illustrates their fallibility.

For a current example, let’s look at India. The Reserve Bank of India (RBI) last Friday cut its benchmark repurchase rate for the fifth consecutive time this year. The RBI cut rates by 25bps on October 6th to 5.15%, and the government recently enacted a major tax-cutting package as well. One would assume that the NSE India Nifty 50 Index should be soaring with the amount of fiscal and monetary stimuli thrown at it. However, shares are up just 2.8% since January 2019, yet also down 8% since June. That 2.8% increase for this year is expressed in Rupees. The iShares Nifty 50 ETF (INDY), which tracks the Index in US dollars, is up just 1.6% year-to-date.

India is not in a recession, and its equity prices are by no means crashing, but the massive stimulus already thrown at its market and economy is simply not working at this point. What is clear is that India’s stock market is floundering while its rate of GDP growth has dropped to a 6-year low.

Not only is it true that interest rate cuts don’t always work like magic, but it is also a fact that there is absolutely not much more room to lower borrowing costs on a global basis. It normally takes over 500 bps of rate cuts to eventually stabilize markets. However, now all we have in the U.S. is 175 bps left to cut before money becomes free and the ECB and BOJ are already below zero.

Whether or not rate cuts are effective has to do with debt levels, demographics, the presence of asset bubbles, and the degree in which central banks have the ability to reduce borrowing costs. None of those metrics offer much hope for this current rate-cutting cycle. Once and an economy becomes overleveraged, has insufficient labor force growth, overvalued asset prices, and where its central bank is already close to the zero bound, turning dovish at that point just isn’t very effective.

Global central banks are short on ammo and cannot easily ameliorate the damaged state of worldwide GDP growth. In fact, the OECD cut its forecast for global growth to just 2.9% for this year–that is the slowest rate of growth since 2009. Turning to the U.S., the ISM surveys show the economy took a sharp turn south in September. Overnight lending in the banking system is still so fragile that the Fed had to extend its Repo facility until November 4th. The yield curve remains inverted from Fed Funds all the way through the 10-year Note—which is the most important part of the yield curve–, and this has been the case for the last five months. And, total net new job creation in both the public and private sectors is weakening. The 3-month rolling average for total new job creation for September 2019 was just 146k; that is down from the year-ago level of 189k–that is a decline of 23%. Things were worse in the private sector, where job growth averaged just 119,000 in the last three months, which is down from the 215,000 net new jobs created for all of 2018.

S&P 500 earnings are expected to post three consecutive quarters of negative growth, and the report for this Q3 earnings season is projected to come in at -4.1%, according to FactSet.  Meanwhile, the annual fiscal deficit has breached above the trillion-dollar level for the first time since 2012 and is projected by the Congressional Budget Office to average $1.2 trillion for each year over the next decade. As bad as that sounds, it assumes interest rates don’t normalize, and a recession never occurs throughout the next ten years–neither scenario is even remotely realistic.

My base case scenario is that the current regime of fiscal and monetary policy has become exhausted. This is despite the fact that they have already gone beyond any measure of conventionality or reason. Therefore, to meaningfully boost asset prices higher from the current nose-bleed level, central banks will need to move further into the realm of unorthodoxy by deploying massive amounts of helicopter money directly to the public. Unfortunately, that type of lunacy is most likely where the Fed is eventually headed. Having an investment model that tracks such dramatic changes in the rate of economic growth and inflation has become 100% 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.”

 

Gold: It’s All About Real Rates Not the Dollar

The Federal Reserve’s recent need to supply $100’s of billions in new credit for the overnight repo market underscores the condition of dollar scarcity in the global financial system. This dearth of dollars and its concomitant strength has left most market watchers baffled.

Since 2008, the Fed has printed $3.8 trillion (with a “T”) of new dollars in an effort to weaken the currency and boost asset prices–one would then think the world should now be awash in dollar liquidity. Yet, surprisingly, there is still an insatiable demand for the greenback, leading many to wonder what is causing its strength.  And importantly for precious metals investors, there is a need to understand why this dreaded dollar strength has not served to undermine the bull market for gold.

The primary drivers for dollar strength are growth and interest rate differentials. The Federal Reserve was able to raise overnight lending rates to nearly 2.5% and end its QE program, before its recent retreat from a hawkish monetary policy to one that is more dovish. The Fed Funds Rate now stands at 1.75-2.0%. However, the ECB and BOJ both have negative deposit rates and are currently engaged in QE. Not only this, but the extra income investors can receive owning a US 10-year Treasury Note compared to those of Japan and Germany are 175bps and 200 bps, respectively. In addition, year over year GDP growth in the EU was just 1.4% in Q2 of 2019; and Japan’s growth registered a paltry 1.0%. Growth in the US was 2.3% y/y. While that is not an earth-shattering rate of growth, it is still better than our major trading partners.

With sub-par growth and little hope for improvement on the horizon, the ECB and BOJ have decided to continue with ZIRP and QE in a futile attempt to spur growth. Nevertheless, their economies are still stagnating.

The US central bank is now being forced to lower rates once again. This is primarily due to the strengthening dollar that is hurting foreign holders of USD-denominated debt–of which there are a lot.

The BIS estimates that foreign USD-based debt now exceeds $11.5 trillion.

A rising US dollar puts further stress on these dollar-based foreign loans and makes them harder to service. In effect, this creates a squeeze on dollar shorts. When you add in the Fed’s burning of nearly $800 billion worth of base money during its Quantitative Tightening (QT) Program, you can clearly see the reasons for dollar strength.

But those who believed the US dollar would increase its buying power against gold have been dead wrong. This is because the primary driver behind the dollar price of gold is the direction of real interest rates.

Therefore, it is imperative not to measure the US dollar’s real strength by measuring it against other flawed fiat currencies that are backed by even more reckless central banks. Instead, the genuine value of the dollar should be weighed against real money…gold.

Conventional wisdom would tell you that the dollar and gold have a reciprocal relationship. When the dollar decreases in value, gold increases and vice versa. However, recently, the dollar and gold have both been strengthening in tandem.  Just look at a chart of the dollar index vs the GLD.

 

Again, the primary driver of gold isn’t the direction of the dollar but the direction of real interest rates. Hence, if US growth is accelerating in a non-inflationary environment, gold should suffer regardless of the direction of the US dollar. Conversely, the USD dollar can be in a bull market against a basket of fiat currencies—as it has been for the past year—and yet can still lose significant ground against gold as long as nominal interest rates are falling in an environment of rising inflation.

The year-over-year change in core CPI increased 2.4% in August, which was the highest level in a year. All the while the US 10-year Note yield was crashing from nearly 3% to 1.6% over the past 12 months. Therefore, real yields have been crashing as gold has been rising.

These falling real yields were rocket fuel for gold, and this was in spite of the USD’s bull market against the euro and yen. The price of gold increased by double digits even though the Dollar Index has also increased by nearly 5% in the last 12 months. But still, for those of us who love gold it can be a love/hate relationship. It is still down 20% from the highs made in 2011, and the mining shares have crashed by 60%; underscoring the need to know how to trade the cycles of this sector.

The questions for gold investors now are: have nominal yields stopped dropping and what is the direction for the rate of inflation? In the short-run, the answer to that question can be found in the trade talks scheduled for October 10th and 11th. The reason for this is, the boy has cried wolf once too often, and it is now time to poop or get off the pot when it comes to reaching an agreement with China on trade. And yes, that boy is Donald Trump. Wall Street and international corporations cannot do business under this cloud of uncertainty any longer; where one-day tariffs go up, and the next day they are coming down.

Since early 2017, investors and the C suite have dealt with a perpetual series of dizzying trade war escalations and treaties. Just this September alone, Trump raised duties on China on the1st of the month.  Then on the 11th, he announced a list of exemptions to those very same tariffs. Then, on the 25th he attacked China viciously at his UN speech, saying: “”For decades the international trading system has been easily exploited by nations acting in very bad faith. Not only has China declined to adopt promised reforms, it has embraced an economic model dependent on massive market barriers, heavy state subsidies, currency manipulation, product dumping, forced technology transfers and the theft of intellectual property and also trade secrets on a grand scale,”

The very next day, Trump said that a deal with China could come “much sooner than most think.” Then, on September 27th, Bloomberg reported that the White House threatened to ban the listing of Chinese companies on US exchanges. Businesses simply cannot adequately plan capital expenditures under such unstable circumstances.

The US and China meet on October 10th &11th to decide the future of trade between the two nations. Tariffs are set to increase on Oct.15th on $250 billion worth of Chinese goods to 30%, from the current 25%. There is no appetite on Wall Street for the continued ambiguity of this trade war any longer. Therefore, on October the 11th, I expect President Trump to announce the most wonderful trade deal in history has occurred since we purchased Manhattan from the Indians. Such an announcement should provide a temporary boost in the major averages and could also cause a sharp selloff in gold. This is because such a deal should put a temporary hold on the Fed’s rate-cutting cycle.

The Fed’s broken models have caused it to fail to grasp the debt-disabled condition of the developed world. China can no longer boost global GDP because it cannot significantly add to its $40 trillion debt pile without cratering the yuan. Also, fiscal and monetary policies are already extremely stretched and are unable to easily pull the economy out of its malaise.

Global growth is faltering, and US GDP growth has shrunk from over 4% last year, to under 2% in Q3, according to the Atlanta Fed. The most important part of the yield curve remains inverted. There is illiquidity in the Repo market.  D.C. is in utter turmoil and annual deficits have vaulted over the trillion-dollar mark. The Q3 earnings report card is about to arrive, and it will receive an “F.” And global central banks are virtually out of ammo. Meanwhile, the stock market sits at all-time record high valuations.

The pressure on Mr. Trump is now immense. A trade deal must be reached in a matter of days that abrogates future tariffs and rescinds most, if not all, existing duties on China. Any other type of agreement will not be nearly enough to turn the global economy around or fool Wall Street any longer into thinking that it will.

The sad truth is, even a comprehensive trade deal won’t fix the massive debt and asset bubble imbalances that must inevitably implode. Which means, real interest rates should be setting record lows in the near future.

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.”