Federal Reserve Chair Jerome Powell testified in front of Congress this week to defend his current monetary policy.
He said he’s now seeing the kind of disinflationary path for the US economy that he's wanted to.
This of course has Wall Street salivating again that rate cuts are near at hand.
Are they?
For perspective, we're fortunate today to talk with money manager Michael Pento, president of Pento Portfolio Strategies.
Michael warns that we have the most overvalued stock market ever, and the liquidity that drove it to today's extremes is starting to run out.
In his words "We're running on fumes". And stocks are at risk of correcting 30-80% from here.
Here are my key takeaways from the interview:
Michael warns we have the most overvalued stock market and real estate market in history.
He warns that today’s high asset prices and economic headlines present a deceiving facade of prosperity, with significant underlying issues. Specifically, the bottom 80% of the population has seen their purchasing power eroded by the post-COVD spike in cost of living. In contrast, only the top 20%, who own the vast majority of assets, are faring well. Indicators like the equal-weight S&P 500 and the broader Russell 2000 index reveal stagnation, contrasting sharply with the gains seen in a few high-profile stocks like Nvidia.
The period from 2008 to 2022, characterized by negative real interest rates, fueled massive borrowing and led to asset bubbles in stocks, bonds, real estate, and credit. This extended duration of negative real interest rates, a deliberate policy move, created significant economic imbalances, leading to skyrocketing home prices and equity valuations. For instance, home prices rose 47% in the last four years, and the total market cap of equities has reached 195% of GDP.
The nation now faces a $2 trillion deficit and $1 trillion in interest payments. Unlike in previous decades, the U.S. is now an insolvent nation, where liabilities exceed assets, handicapping the Fed's ability to use its traditional tools to stimulate the economy.
The Federal Reserve's projected schedule of small interest rate cuts will not significantly relieve economic pressures. Instead, Michael suggests that significant rate cuts of around 200 basis points may be required to re-liquefy the banking system. But to have the air cover to make cuts that big, the Fed will have to wait until things are really starting to break (= pain for investors and households). And should it indeed cut rates that substantially, such actions could lead to rising commodity prices, higher import prices, and further inflation, exacerbating the current economic instability.
The yield curve is deeply inverted, marking the longest inversion in history. If this continues, it could lead to significant banking issues by 2025, when assets held under the Bank Term Funding Program (BTFP) are returned to banks. Currently, banks are strained, with their assets yielding lower returns (around 3-3.5%) than their cost of funds (around 5%), squeezing their net interest margins and potentially destabilizing their financial health.
Michael predicts a possible market crash with a significant decline in stock prices (potentially around 40%). He anticipates that the Federal Reserve will attempt to prevent this by various means, likely leading to stagflation—persistent high inflation combined with high unemployment and stagnant demand. This scenario would necessitate a shift to investing in commodities, base metals, and energy while avoiding long-term bonds.
Michael plans to reduce volatility in his portfolio by investing in one- to three-year treasuries and reducing equity exposure. He aims to protect and profit by actively managing assets and being prepared for a potential market crash. This strategy includes selling investments in India and increasing holdings in low-volatility assets like utilities, minimum volatility ETFs, and gold.
The real estate market is significantly overvalued, with 25% of homes owned by investors, potentially leading to a crisis similar to the subprime mortgage crisis if home prices fall and rental incomes decrease. The commercial mortgage-backed securities market, now larger than during the global financial crisis, also shows signs of significant risk. Restructuring has already occurred in 10% of these securities, indicating underlying instability that could be exacerbated by further economic downturns.
For the full interview with Michael Pento, watch the video below:
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