See “The Real Danger” below – Ed Money Talks

I started Pento Portfolio Strategies three years ago with the knowledge that the unprecedented level of fiat credit creation had rendered the globe debt disabled and would result in mass global sovereign default. As a consequence, there would be wild swings between inflation and deflation dependent upon the government provisions of fiscal stimulus, Quantitative Easing and Zero Interest Rate Policies…

For much of the third quarter the US Federal Reserve has avowed to raise rates. This in turn caused a sharp stock market correction on a worldwide basis. The flattening of the Treasury yield curve and the strengthening of the US dollar were the primary culprits. But then the September Non-Farm Payroll Report came in with a net increase of just 142k jobs, which was well below Wall Street’s expectation. The unemployment rate held steady at 5.1% but the labor force participation rate dropped to the October 1977 low of 62.4%. Average hourly earnings fell 0.04% and the workweek slipped to 34.5 hours. There were also significant downward revisions of 22k and 37k jobs for the July and August reports respectively.

The jobs data had previously been heralded by the Fed and Wall Street as the one bright spot in an otherwise dull economic picture; and gave the Fed extra incentive to move off of zero — as if offering free money to banks for seven years wasn’t compelling enough. But at least for now the weak data has caused the Fed to step back from jumping of the cliff on raising rates, which has caused a swift move lower in the value of the dollar and boosted the prospects for multi-national corporate earnings.

The reasons why Wall Street is so enamored with ZIRP and QE are clear. Here is a partial list of what will start to occur once the Fed moves away from the zero-bound range:

•  Debt service payments will begin to rise on the soaring outstanding $44 trillion in total non-financial US debt — $12 trillion of which was accumulated in the last decade. This will render the already debt-disabled consumer increasingly unable to borrow and spend.

• The value of US high-yield (junk) debt outstanding has doubled since 2009. Many companies have survived by rolling over this debt at record-low and perpetually falling yields. Default rates will spike as Junk-bond prices begin to fall and yields start to rise.

• Rising rates will decrease the home ownership rate of 63.4%, which is already at its lowest level since 1967. A rate rise will also cause home prices to fall back toward the historic home price to income ratio of 2.6; it is now 4.4.

• The Mean reversion of interest rates on the $13.2 trillion of US publicly traded debt would then take about 30% of all the Federal tax revenue. Rising rates would also cause annual deficits to jump back to $1.5 trillion as they did in the great recession, causing outstanding debt levels to rise inexorably, thus eating up a much greater portion of tax revenue.

• There is $9.6 trillion of US dollar denominated debt owned by non-US borrowers. As the US dollar rises debt payments become more challenging to manage and would cause rising defaults on marginal foreign corporate holders.

• It will sharply attenuate the amount of stock buy backs, which were done mostly by taking on new debt ($2.9 trillion worth since March of 2009) for the purpose of artificially boosting EPS. This would cause EPS and PE multiple contraction, sending the stock market into freefall.

• The impaired credit of hundreds of trillions’ worth of interest rate derivatives, such as credit default swaps and interest rate swaps, which will need an unprecedented bailout from the government once the counterparties become insolvent.

• Finally, pension plans will become bankrupt once the Fed succeeds in flattening the yield curve and completely crashing the stock market and the economy. Pension plans need 9% annual returns to fulfill their obligations. But the stock market has gone nowhere in the past 14 months even though the Fed has assured the country that there would be no competition for stocks from the fixed income sector for the past 7 years. Rising rates would most likely cause the stock market to lose half its value for the third time in the last 15 years.

Those are the reasons why the Fed is so afraid to start hiking interest rates.

The highly accurate Atlanta Fed’s GDP model is predicting Q3 growth of just 1.1%. As a consequence, the Fed Funds Futures Market now is predicting that ZIRP will be in place until March of 2016. Will five more months of ZIRP be enough to levitate stocks? The answer to that question is probably yes in the short term; but it will lead to a catastrophe in the long term.

The simple truth is QE and ZIRP blow up asset prices to an unsustainable level, but do nothing in the way of supporting viable economic growth. The proof of this can best be found in Japan, where the Bank of Japan is printing 80 trillion yen ($665 billion dollars) per annum but has rendered the nation in a perpetual recession. Indeed, after three years of Abenomics the nation will probably suffer through its third recession in as many years — Q2 GDP came in at an annualized minus 1.6%.

Further evidence of the ineffectiveness of central planning can be found in the United States, where we have experienced sub-par 2% growth for the last 5 years despite unprecedented monetary easing. And 2015 is now on track to underperform that low five-year bar.

The IMF recently lowered its global growth projection by 0.2 percentage points to 3.1%. This includes an overly optimistic 6.8% read on China growth.

The Real Danger

The real danger is that the higher asset prices get pushed by central banks and governments with fiscal and monetary stimuli, the more precariously they become perched high on top of a hollow economic foundation.

With ZIRP in place for another five months, this ominous condition should only worsen. However, it also means that whenever the Fed resumes its bluster about raising rates, the markets will careen lower from an even higher level. In addition, central banks’ inability to engender the promised prosperity is rapidly eroding confidence in these institutions. Therefore, there is a growing risk that the markets will collapse despite perpetually free money — especially in real terms. Such will be the unfortunate but inevitable consequences of obliterating honest money and free markets.

BIG PICTURE – Global business activity is slowing down and the majority of the developing nations are experiencing severe economic problems. Over in the developed world, Japan is contracting again, Euro zone is barely growing and even America’s leading economic indicators are suggesting trouble ahead. Elsewhere, the CRB Index is trading at a 13-year low and this implosion in the prices of commodities is suggesting that all is not well with the global economy.

The crux of the matter is that the world is severely over-indebted (debt to GDP ratio of 286%, Figure 1) and without fiscal measures, viable reforms and debt restructuring, we will probably remain stuck in this low growth environment for years. Unfortunately, you cannot solve a problem of too much debt by encouraging even more borrowing; yet policymakers are trying to fix this mess by lowering interest rates and injecting liquidity.

Figure 1: Global stock of debt outstanding (US$ trillion)

Source: McKinsey & Company

Make no mistake, the US housing boom and subsequent financial crisis of 2008 were caused by the Federal Reserve’s easy monetary policies which were put in place after the TMT bust. By dropping rates to emergency levels and keeping them there for years, Mr. Greenspan spawned the US housing bubble which almost destroyed the world’s banking system. So, by keeping its Fed Funds Rate at zero since late 2008, it is ironic that the Federal Reserve is (once again) walking down the same path!

It is notable that even though the Federal Reserve’s monetary policy has been extremely accommodative since the global financial crisis; the recovery in the US has been sub-par when compared to the previous economic cycles (Figure 2).

This is due to the fact that despite the carrot of record-low borrowing costs dangling in front of them, American households have refused to take the bait. Instead, they have done the sensible thing and deleveraged their balance-sheets.

Figure 2: US nominal GDP (1948-2014)

Source: Hoisington

Today, the household debt to GDP ratio in the US is 80%, well below the 100% level reached in 2008. This meaningful decline demonstrates that the Federal Reserve’s ultra-accommodative monetary policies have done very little in terms of boosting household borrowing and consumption.

Instead, by dropping short-term rates to zero and keeping them there for 7 years, this time around, the Federal Reserve has succeeded in spawning new bubbles in the corporate sector, which pose a serious threat to the economy. Presented below is a list of the obvious corporate bubbles:

• US Corporate debt – US$5trillion (+ US$2 trillion since 2007)
• High yield (junk) bonds and leveraged loans – US$2.2 trillion (+ US$1.2 trillion since 2007)
• Biotechnology – 7-fold increase in NASDAQ Biotech Index; most companies have no earnings

In addition to the above excesses in the corporate world, the Federal Reserve’s zero interest rate policy (ZIRP) has also blown the following domestic bubbles:

• Student loans – US$1.2 trillion (+ US$0.7 trillion since 2007)
• Auto loans – US$1 trillion (+ US$0.4 trillion since 2009)

Last but not least, the Federal Reserve’s monetary policy has also inflated these international bubbles:

• Commodities boom and subsequent bust
• Commodities exporters’ boom and bust (Australia, Brazil, Canada and Russia)
• Singapore property
• Stock markets of Indonesia, Philippines and Thailand
• Hong Kong property – HK$1.044 trillion mortgage debt (+ 76% since 2009)

In terms of the Hong Kong property market, although most experts and talking heads on TV remain convinced there is nobubble, research from the Hong Kong Monetary Authority (HKMA) shows that housing has become extremely unaffordable. If you review Figure 3, you will note that the housing price-to-income ratio has now risen to a record high of 15.9 and it is even higher than the 1997 peak of 14.6. Meanwhile, the income-gearing ratio has increased further to 70.7%, well above the long-term average of 50%. According to the HKMA, if the mortgage interest rate returned to a more normal level, say an increase of 300-basis points, the income-gearing ratio would soar to 95%!

Figure 3: Indicators of Hong Kong housing affordability

Source: Hong Kong Monetary Authority

Today, many Wall Street firms, prominent hedge fund managers and academics are putting forward arguments as to why the Federal Reserve should not raise the Fed Funds Rate. In their eyes, the macro-economic conditions are too uncertain to even warrant a 25bps rate hike.

In our view, these folk are dead wrong because unlike Europe and Japan, the US economy does not need ZIRP. If our assessment is correct, the longer the Federal Reserve stays on hold, the bigger will be the eventual bust.

Turning to the stock market, it is our contention that the bull market on Wall Street ended in May and we are now in the early stages of primary downtrend. You will recall that the US stock market fell sharply in mid-August and since then, it has gyrated within a wide trading range. To the casual observer, these wild swings may not make much sense but closer inspection reveals that there is indeed a method to the stock market’s madness.

If you review Figure 4, you will note that between late February and early August, the S&P500 Index carved out an enormous rounding top formation; which culminated in the plunge below the key support levels (shaded areas on the chart). Thereafter, in late August, the relief rally faded around the lower support (now resistance) level. The S&P500 Index then spent two weeks in a sideways grind and the next rally attempt also ended at the same overhead resistance. Following this failed rally attempt, the S&P500 Index re-tested its August low and over the past few trading sessions, it has put together another advance.

Figure 4: S&P500 Index (daily chart)

Source: www.stockcharts.com

At this stage, nobody knows when this bounce will end but if we are in a primary downtrend, the rally should fade around overhead resistance level (2000-2040). Under this scenario, the next leg down will probably take out the August-low and trigger a waterfall decline. Currently, we cannot guarantee how low the S&P500 Index might fall; but we see support in the 1,700-1,740 area. So, if our bear market hypothesis is correct, then the ongoing rally will end soon and give way to the next wave of selling.

Look. There are no certainties when dealing with the future, but our work leads us to believe that the bull market is now in the rear view mirror and the odds of new highs over the following months are slim to none. Our bearish prognosis stems from the following data points:

• S&P500 Index is below the 50-day and 200-day moving averages which are pointing down
• NYSE Advance/Decline Line peaked in April (prior to the stock market peak in May + July)
• Our proprietary trend following filter is now flashing ‘downtrend’
• NYSE Bullish Percent Index has dropped to just 31%
• The High yield (junk) bond ETF has taken out the August-low
• Only 22% of the NYSE stocks are trading above the 200-day moving average
• Biotechnology – The leading sector of the bull-market has topped out (Figure 5)
• Russell 2000 Small Cap Index and Russell 2000 Growth Index have taken out the August low
• Out of the 35 industries we monitor, just 6 are trading above the 200-day moving average
• Leading stocks are declining on good ‘news’, indicating the best has been discounted
• Stocks are declining despite ongoing QE in Europe and Japan
• Stocks are declining despite no rate hike and a ‘dovish’ Federal Reserve
• Volume is rising on down days and falling on up days

Bearing in mind the above price and volume data, we are almost certain that the primary trend for equities is now down and global stock markets remain vulnerable to heavy declines.

Figure 5: NASDAQ – Biotechnology Index

Source: www.stockcharts.com

Given the weak technical picture and worsening economic backdrop, we currently have no exposure to risky assets (commodities, high yield debt and stocks). Instead, we have invested our managed capital in the following manner:

• Long dated US Treasuries & Zero Coupon Bonds – 40% allocation
• Short-term US Treasuries – 35% allocation
• Short positions (biotechnology, industrials and technology) – 15% allocation
• ‘Long’ US Dollar position – 5% allocation
• US Dollar cash – 5% allocation

If our analysis of the situation is even vaguely correct, our managed portfolios will do well in the looming deflation and our strategy should outperform our benchmark (MSCI AC World Index) by a wide margin. Conversely, if stocks continue to rally (unlikely scenario) and our primary trend filter flips to ‘uptrend’, we will promptly re-position our managed accounts.

The top trends forecaster in the world warns what the elites are doing

also: Gold Is Headed Higher But The Stock Market Will Roll Over, Hit New Lows And Accelerate To The Downside – by Bill Fleckenstein

With the Dow surging and gold and silver continuing to trade firm, one of the greats in the business believes that the gold market has already bottomed and is headed higher, but the stock market will roll over, hit new lows, and then accelerate to the downside, plus a bonus Q&A that includes questions on whether or not the Fed has lost control and also covering the turn in the gold market.….read more HERE

The Elites Are Setting The Public Up For A Financial Wipeout – by Gerald Celente

The top trends forecaster in the world warns that the elites are setting the public up for a financial wipeout.  This interview takes a trip down the rabbit hole of government propaganda and deception, as the public is constantly misled by the elite’s massive propaganda machine….read more HERE

I’ve long maintained that the final quarter of this year, starting with the historically volatile month of October, would be the start of a roller coaster ride through hell. 

And if you haven’t already noticed, it’s shaping up to be precisely that.

Global equity markets are teetering on the edge of a cliff. For some, like Europe’s markets, it will be the beginning of a long, drawn out bear market.

For others, like our markets, it will be a severe sharp pullback that gets the majority bearish, but then sets the stage for yet another bull leg higher. 

You can see the blood starting to spill almost everywhere. Europe’s markets are cratering, with Germany’s DAX, the bulwark of the European Union, starting to rollover to the downside.

You can see it — if you look closely — with our equity markets:

Where more than half of all publicly traded U.S. stocks are now down more than 20% from their record highs.

Where the Dow Transports are now down 15.43% from the record high Nov. 14.

Where the Dow Utilities have slid as much as 18.8% since their January record high.

And where many U.S. stocks are down even more, many losing more than half their value since their record highs over the past year. 

Thing is, it’s going to get much worse this month for stocks, all over the world. Germany’s DAX is set to crash. The Dow Jones Industrials will plummet to 15,000 then possibly to 13,900 before recovering. 

And stocks aren’t the only asset class where holy hell is breaking loose.

 Bubbles are bursting in the biggest markets of all, sovereign debt. That’s true no matter what Janet Yellen and the Federal Reserve do with their official interest rates. 

In Europe, German bunds are starting to look like they will implode any day now. Same for Japan, where the Japanese government continues to print money with reckless abandon and Japanese government bonds have nowhere to go but down.

Here in the U.S., hardly anyone realized it, but interest rates started moving up way back in July 2012, when the 10-year U.S. Treasury note yield bottomed at 1.394%.

Slowly, but surely, investors worldwide are starting to shun sovereign debt, realizing that there are no returns to be had there and that the safety of government debt today is nothing but a mirage. 

Short-term interest rates, on the other hand, are indeed falling, with 
three-month Treasury bill yields now negative at -0.02%. They could get even more negative as investors flee the stock markets and park capital in money markets, pushing short-term yields even further into negative territory.

But don’t be deceived: Even in the short end of the yield curve, a government debt bubble bursting looms high.

Then there is the commodity sector, in one of its worse deflations ever. So bad that the world’s largest and most sophisticated commodity company, Glencore, has seen its share price plummet more than 70% this year, with half that loss occurring on Sept. 28. 

Gold, which has fallen more than 40% since its high in September 2011. Silver getting clobbered. Copper annihilated. Other base metals prices shedding 70% or more. 

Grain markets reeling. Soft commodity prices such as coffee, cocoa and sugar cut in half or more.  

Right now, a bounce is overdue, especially in gold and silver. But here too, don’t be deceived. We have not yet seen the final lows in gold or silver and any bounce is nothing but a fake out. So don’t — I repeat, DO NOT — get caught now in any commodity bounce. It will merely rob you blind. 

And what about the geo-political scene, where I warned way back in 2012 that the war cycles were ramping up, and where Martin Armstrong, one of the foremost economists alive today, also agrees? Consider the refugee crisis in Europe — while I am for humanitarian efforts, the strain of the crisis will be the final nail in the coffin for indebted European governments. And where cultural conflict is sure to rise. 

Or here, in the rise of Donald Trump, who is anti-establishment. No, I don’t like the economic policies he has revealed. 

But that’s not the point. His popularity is threatening the status-quo in Washington, showing you that the people are finally rising up against harebrained politicians who want nothing more than to save their butts at your expense. 

Or how about ISIS and Syria — where for the second time since the Cold War, Russia and the U.S. are polar opposites, just like they are regarding Ukraine?

Potential for a future international war? Very possible. Leaders in Washington, Brussels and Moscow need to divert their peoples’ attention away from the lousy state of domestic economic affairs. 

And more, now all coming together on the world stage, starting to turn nearly all markets upside down and inside out. 

No problem — if you are prepared. In fact, it’s exactly the opposite of a problem — if you know what to do. It’s an opportunity to better protect your wealth and build enormous profits to boot.

Already, as I pen this column, my Real Wealth Report is up 18.8% year-to-date. And members of my Supercycle Trader are enjoying gains of as much as 121% in less than a week, with several open trading positions on now and more coming  that could offer even better profit potential. 

Stay safe and best wishes, 

Larry

Billionaire investor Carl Icahn has released a new video below that warns of dire consequences coming for financial markets from low interest rates which ‘should have been raised six months ago’ but now the ‘Fed is boxed in a corner’. 

He is ‘the most hedged he’s been for years’ and says stocks are ‘going to go down a lot’.

14:45 minute video below:

  About Carl Icahn:

As a leading shareholder activist, Carl Icahn’s efforts have unlocked billions of dollars of shareholder and bondholder value and have improved the competitiveness of American companies. He and his affiliated companies currently own businesses in a wide range of industries, including real estate, telecommunications, transportation, industrial services, oil refining and manufacturing. Companies in which he and his affiliates currently own majority positions include American Railcar, XO Communications, PSC Metals, Tropicana Entertainment, Viskase Companies, CVR Energy, WestPoint Home, Icahn Enterprises LP, and Federal-Mogul. He and his affiliated companies also own stakes in many other public companies. Icahn Enterprises LP, his flagship company, has acquired many of these positions. Carl Icahn’s website HERE