Washington, DC -- (ReleaseWire) -- 01/21/2016 --DAWN BENNETT: Mike Pento is founder and president of Pento Portfolio Strategies, and the author of the book The Coming Bond Market Collapse. In addition to his well-established knowledge of not only the U.S. bond market, Pento is also as a specialist in the Austrian School of economics. On January 15th of this year, Mike published an article titled 'A recession worse than 2008 is coming,' which was widely read and was featured on the Drudge Report. An earlier article from January 5th was titled 'Pento's predictions for 2016.' In both of these articles he lays out his forecast for recessionary symptoms in the United States in 2016 as well as his prognostications for 2016 trading strategies. Mike, welcome to Financial Myth Busting.
MIKE PENTO: Thanks for having me back, Dawn.
BENNETT: I want to talk about a few of your predictions and trading strategies for next year. You wrote that the S&P is going to fall minimally more than 20 percent as it finally succumbs to the 'incipient global recession,' as you call it.
PENTO: Incipient global recession, exactly. It looks like that is sort of coming true. 50 percent of the S&P 500 has already dropped 20 percent, so it looks like unfortunately it's going to come true a lot sooner than even I thought.
BENNETT: So when you say more than, what are you looking at? Some people are saying—and I'm not saying that they're accurate—that it could fall as much as 20 percent or 70 percent.
PENTO: I'll tell you this, the average drop of the S&P 500 in the last six recessions has been 37 percent. So if this coming recession is just the average variety, then I would expect the S&P to drop 37 percent, which puts us about 1300 on the S&P 500. So that's a really big hit. But, as I wrote about in my piece that appeared on CNBC and Drudge, I don't know what the Federal Reserve is going to do to pull us out of the next recession. In the great recession of 2008, the Federal Reserve took the Fed funds rate, which is the interbank lending rate, from 5.25 down to zero by the end of 2008. And that provided consumers and corporations, and even the federal government, with a lot of debt service relief. And that helped bring the economy out of the great recession, it also boosted asset prices, it boosted the stock market, it boosted bond prices, it boosted real estate. So the point is now the Federal Reserve is leveraged 77 to 1, they have almost no capital, it's way more over-leveraged than Bear Stearns or Lehman Brothers or any of those financial institutions were before the great recession. But, more importantly, the Fed has no more room to lower the borrowing cost to the private and public sector. That is one of the main reasons why I fear this inevitable next recession. By the way, the U.S. has suffered recession for about every five years since the beginning of the Republic.
BENNETT: So we're long overdue now, right?
PENTO: It has been seven years -- and not that we're just overdue, if you look at what's going on China, if you look at what's going as far as home prices, to income, stock prices, to market cap, to GDP, the fact is that asset prices can no longer be supported by incomes, and that is probably what is going to cause the great recession. Plus, if you look what has happened in high yield, borrowing costs have increased dramatically, outside of the Fed's recent 25 basis point rate hike.
BENNETT: So this may not be a normal or average recessionary drop, it could be more than 37 percent?
PENTO: No. Well, to add to that, you're exactly right, Dawn, and I don't want to scare people, I'm just trying to bring facts. Listen, I'm a proud American...
BENNETT: You are preparing them.
PENTO: I want to open my eyes, I want to open my clients' eyes to what's happening. So, for instance, the national debt in 2007 was 65 percent of GDP. Today it is 102 percent of GDP. So a natural function of recessions is a decline in federal revenue. That means debt and deficits are going to skyrocket. Deficits are going to go back to north of a trillion dollars very quickly—this year, in my opinion, if we have a recession, and by all accounts we're probably in one right now, Dawn. If deficits rise over a trillion dollars, we have 19 trillion in debt, a 102 percent debt-to-GDP. Wouldn't one expect it to be natural that we have some spike in interest rates, without any kind of QE currently going on at the moment? If that happens, a la 2012 in Europe, we are going to turn this recession into something much, much worse.
BENNETT: Somehow America's debt doesn't always get a lot of attention. As you've pointed out, the federal government's debt vs. revenue has soared to over 600 percent since last recession.
PENTO: It's now 600 percent of all of our revenue.
BENNETT: That sounds very worrisome, at least to me. Yet the debt seems to get bigger and bigger and bigger, and people just keep lending America more money. Maybe 20 trillion will be the point where people start asking how are we going to get paid back?
PENTO: Well, Dawn, as you know, people lending the government money has been the Federal Reserve. They have 4.5 trillion dollars on their balance sheet that was mostly due to quantitative easing. That has ended. China has stopped buying our treasuries. Could we have a debt crisis in the United States after the next recession? Absolutely. And that's why I believe the Federal Reserve is going to have to find a way to launch another massive and unlimited round of quantitative easing. And that's why I also believe the U.S. dollar is going to roll over. The U.S. dollar has priced in a tremendous amount of rate hikes that just aren't coming, and it will roll over against the Yen and the Euro. And that is also why one of my predictions was that we're going to have a huge rebound in the precious metals sector. Because that's down 90 percent since 2012, nobody likes it. Bloomberg has a parade of talking heads talking about how gold is just a rock and it doesn't serve any purpose. It is actually real, honest, true money. Human consciousness has deemed it money for 3000 years, so who has the hubris to come on television and say gold is just another rock? It's an element, it's virtually indestructible, and it's extremely rare. And I don't think God is making any more elements that are virtually indestructible or very rare.
BENNETT: So do you think gold and gold mining are going to be a major winner in 2016?
PENTO: Yes. This year. I think the S&P falls at least 20 percent. That's just the start, that already pretty much has come to fruition. I think the 10 Year Treasury goes below 2 percent. That happened this week. When I made these predictions in the end of 2015, it was not the case. It was 2.25 or 2.3 percent. I think there is going to more distress in high yield debt. I think the U.S. dollar rolls over hard.
BENNETT: Do you think that the dollar, when it rolls over, is going to continue to take damage, and how much?
PENTO: Yeah. I think it goes probably back to 80 on the DXY, on the dollar index from where it today, which is about 98. So that's a pretty big hit. And the MOMO algorithm traders on Wall Street are programed to sell gold every time the U.S dollar is up against the Euro. I think those algorithms say buy paper gold, and that's going to send us into another round of a huge bull market in gold.
BENNETT: I'm going to go back to Janet Yellen. I know you said that you think they're going to drop rates, there's going to be some type of quantitative easing going before year's end. She has only raised rates 25 basis points, where can they take this? Is it going negative?
PENTO: The deposit rate is negative in Europe, as you know, and I don't know why she wouldn't take it negative, but I also don't see how that's an immediate salve for the U.S. consumer. Our savers have already been screwed since the end of 2008, getting 0 percent on their savings, so taking the deposit rate to 0 percent or even less than that, I don't know how that really saves consumers, that's why I said the Fed is really out of bullets. They went 5.25 to zero, so that's 525 basis points of reduction in the overnight lending rate. Mortgage rates collapsed. Now, if the Fed takes the 25 basis point rate hike that they did in December, they take that back and they give it -10 basis points on the deposit rate, does that mean that banks are going to start lending money to a consumer who has no demand for their money? It doesn't change anything, Dawn, it really doesn't. It just means that banks will be losing money. Instead of getting 25 basis points on their excess reserves, they're going to get -10.
BENNETT: Let's talk about banks. Banks aren't as leveraged as they were in 2008, at least as far as we know. They seem to be better capitalized. Do you think banks are still a concern?
PENTO: First of all, let me just say that the banks are only supposedly better capitalized. A lot of their assets, as you know, are in treasuries and they're in bank loans. So if you go back to 1800s—I hate to go back that far, but let's just go back to the 1800s, just a brief moment of time—bank capital as a percentage of their assets was 50 percent. Do you know what it is today after all of the Basel II and Basel III and these regulatory bodies coming out and saying we need to shore up our banks, and they have to have 'fortress' balance sheets. Do you know what their leverage ratio is today? It's 6 percent! Dawn, that means if bank assets fall by 6 percentage points, banks are insolvent. Does that make anybody feel any better? But not only that, let's just give them that the banks do have higher capital ratios than they had before. Tier 1 capital has been improved and the leverage ratios have gone up a little bit, which is better, a higher leverage ratio is good. So let's just give them the fact that banks are better capitalized. But how does that solve the problem that you now maybe have a better banking system, but the central bank is insolvent and the U.S. government is insolvent. What would you rather have, a bank that's insolvent, but a pretty healthy central bank and a pretty healthy fiscal condition of the federal government, or would you rather have a little bit better bank that has capitalized, and an insolvent government and central bank? Because that's what we have today. So I don't have any solace at all given what we've done since 2008.
BENNETT: You've also picked up on a pretty startling trend in home ownership. I wanted you to talk about that here. The ratio of home price to income typically averages about 2.6 percent, but today that's climbed up to 4 percent. Is this something we saw in the run up to the 2007 housing crash?
PENTO: That ratio of home price to income was 4.4, and now it is 4.12 according to the calculations I made last week. As you pointed out, the average home price to income ratio is 2.6, so we have another condition of an asset bubble that cannot be supported by incomes, and what's worse is that you have the first-time home buyer completely shut out. So the average home price, the median home price I should say, is $250,000 roughly in the United States. That means these people coming out of college with massive amounts of student debt have to somehow come up with $50,000 worth of a down payment that they can't come up with. So if you take the first-time home buyer out, then the second home buyer can't move up, and the whole structure of the housing market crumbles. This is another consequence of a government and a central bank that's tried to fix a problem with asset prices and debt by vastly increasing both.
BENNETT: Talk about or you have said that they're going to have to drop interest rates probably to zero, what's going to happen to the 10 Year? I know you've anticipated it going below 2 percent, but what happens if it's no interest rate, what if it does go negative?
PENTO: The 10 Year Note right now, the price is going higher and the yield is falling because we're heading into a recession.
BENNETT: That's right.
PENTO: After the recession hits, I think debt and deficits skyrocket, debt goes to nearly 20 trillion, deficits go back to 1.5 trillion as they were in 2009-2010. And then I think yields rise, prices fall. And if that's the case then I think we're going to turn a great recession to a great depression, because the last thing we need as a household. Let me just go over these number really quickly. Households used to have 14.1 trillion in debt in 2007. There has been absolutely no deleveraging whatsoever as far as households are concerned. Corporate debt, that's up 2 trillion dollars since the great recession. And, as I pointed out before, the GDP has gone from 65 percent debt-to-GDP to 102 percent. So any kind of increase in costs to service debt will vastly exacerbate the recession, and that's what I'm mostly afraid of. And that's why I think 2008 will be a better scenario than what we're going to suffer in 2016. And without any help from the Federal Reserve, as I said the Federal Reserve is out of bullets, they cannot take down interest rates any further. I think they're going to have to launch another round of QE. But right now, and this is the fearful part, let me just go over a couple of data points with you and your audience, the Atlanta Fed GDP model, their Q4 reading is going to come in at 0.8 percent.
BENNETT: Yes, that's right.
PENTO: U.S. Q1 GDP is going to be very, very weak, barely above zero. You look at the Empire State Manufacturing Survey, it was -19 in January, a very slow start to this year. But, here's the point, I was listening to the Fed this week, they're so adamant about continuing with their rate hike.
BENNETT: I know.
PENTO: They came out and said four more times they're going to raise rates. Can you imagine raising rates 100 basis points into a global deflationary recession, depression? And here's why they're doing it, Dawn. They were at zero percent for eight years, printed around four trillion dollars, 3.8 trillion, in quantitative easing. And now they were so petrified, they were at zero for so long and they promised they would move off zero once the meaningless U3 unemployment rate fell to 6.5 percent. Well, it went down to 5, they fell back into a corner, they raised rates. And now they're in a position of just trying to talk up the economy.
BENNETT: Mike Pento, thanks for being on Financial Myth Busting.
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com.
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
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