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The Problem With Modern Monetary Theory

The Problem With Modern Monetary Theory

Modern monetary theory has been…

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Billionaires Are Pushing Art To New Limits

Welcome to Art Basel: The…

Michael Pento

Michael Pento

Pentoport

Michael Pento produces the weekly podcast "The Mid-week Reality Check", is the President and Founder of Pento Portfolio Strategies and Author of the book "The…

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Pento's Predictions for 2016

2015 was a year where nearly every asset class failed to provide any returns at all. If fact, the S&P 500 hasn't gone anywhere in about the past 400 days. An analysis of that Index's performance at the end of the 3rd quarter by S&P Capital IQ showed that over 250 stocks were down more than 20% from their 2015 highs and 25% of the S&P 500 Index had plummeted more than 30%.

The 30-year Treasury bond has fallen over 2.0%, cash in money market accounts have returned just +0.11% (so after taxes and inflation your return was solidly negative), and the CRB index is down nearly 25%.

So what should investors do with their money when nothing is working? Before I get to that I want to very briefly explain why nothing has worked for so long. The global economy has become debt disabled and market prices have been massively distorted by governments and central banks. The Free market has been eviscerated and supplanted by money printing and deficit spending on an unprecedented scale. The bottom line is that there is now a historic and humongous gap between stock prices and economic fundamentals. And a gigantic gap between fixed income yields in relation to the underlying credit quality.

Evidence of the crumbling economic foundation can be found everywhere you look.

The US manufacturing sector is now clearly in a recession. The latest confirmation of this came from the Dallas Fed survey, which was announced this past Monday, showing a drop of -20.1. Commodity prices, junk bond spreads and money supply growth all indicate the global economy is not only weakening but approaching the Great Recession levels realized in early 2009. After all, investors would have to believe that commodity prices, taken in aggregate, which are trading at prices reached during the nadir of the Great Recession, say nothing about global demand in order to maintain the economy isn't in serious trouble.

So here are a few of my predictions and trading strategies for next year:

  • The S&P 500 falls more than 20% as it finally succumbs to the incipient global recession

  • Janet Yellen states in the 1st half of 2016 that the Fed will not increase the Fed Funds Rate any further and hints at another round of QE before year's end.

  • The inability to normalize interest rates is taken as a tacit admission by the Fed that it has utterly failed to save the economy from the Great Recession, and as a result the US Dollar crashes below 90 on the DXY.

  • Gold and the miners will be the major winners next year as they will be the primary beneficiary from continued low nominal interest rates, negative real interest rates and a watershed turn in the value of the USD--the yellow metal reaches a high of $1,250 next year.

  • The Ten-year Note yield falls below 2% by June on pervading recession concerns.

  • Continue to short high-yield debt and own put options on high-flying NASDAQ momentum stocks that are trading at monstrous PE ratios and whose prices should collapse given a deceleration in the US economy.

  • Finally, after the dust settles from this anticipated huge selloff, there will be a tremendous opportunity from owning high-divided paying foreign stocks, which have already been mercilessly beaten down during the commodity bear market of the last few years.

Why will 2016 bring about the long overdue equity bear market? It is not just because the Fed has finally started to raise interest rates and will continue to slowly do so until the US economic recession fully manifests. But also the catalyst for this imminent recession is that debt levels and asset prices have increased to a level that can no longer be supported by incomes and underlying economic growth. Any additional increase in the cost of money will only expedite and exacerbate this condition. Q4 2015 GDP growth is predicted to post a reading that is barely above 1%, according to the Atlanta Fed model. Therefore, we don't have much room left below before the economy enters contraction mode; and the trend is solidly in that direction.

I cannot stress how important this watershed change in US monetary policy will be for markets in early 2016. The major markets (meaning currencies, bonds and equities) have been anticipating a graceful exit from QE and the trillions of dollars' worth of deficit spending that have been deployed since 2008. In other words, global capital markets have been banking on the success of central banks. In the vanguard of this belief has been the universal carry trade of going long the US dollar and equities, while shorting precious metals.

I believe in realities not fantasies. I'm betting that you cannot solve the debt crisis evident during the Great Recession by taking on a record amount of debt. And that you cannot fix the asset bubbles evident during the Great Recession by artificially pushing them to record high prices through QE and ZIRP. It is this reality that will take its vengeance in 2016. And it is the unraveling of this delusion that is the basis of Pento Portfolio Strategies' investment model and is the opportunity we are prepared to profit from.

 

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