My Trip to the NYSE

By Michael Pento | July 16, 2010 | 2:32 PM |  3 CommentsTweet This

http://www.cnbc.com/id/15840232/?video=1545073625&play=1 

Above is my interview at the NYSE with Mark Haines and Simon Hobbs this AM. I'm not sure what war Mr. Hobbs is talking about but maybe you can tell me.

I'm just trying to change the perilous direction the country is headed in. Seems to me that anyone saying that the U.S. can borrow to infinity with rates staying low is setting the table for disaster.

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Congrats to the Fed

By Michael Pento | July 15, 2010 | 11:34 AM |  2 CommentsTweet This

My compliments go out to the Fed. I'm not sure how they did it but they have managed to cause nearly everyone on Main and Wall Street to fret over deflation. But just because we have one or two months of sequential declines in CPI and PPI, doesn't mean that deflation has become a secular trend.

Convincing Americans that we are about to "suffer" a protracted period of deflation is a pretty good trick considering the evidence of inflation that is all around us. And it is also pretty slick to have the investing public deathly afraid of deflation, while mistakenly seeking to embrace an optimal condition of moderate inflation.

How can we have allowed ourselves to be so easily duped? Thanks in most part to a monetary base that grew from $841 billion in August of 2008 to $2 trillion today; ten years ago the price of gold was trading below $300 per ounce, today it is above $1,200 per ounce. How is this evidence of deflation? The price of gold is the best arbiter for a currency's purchasing power. Therefore, gold is still telling us that inflation is eroding the value of our dollar.

Other commodities like crude oil are telling the same story. Ten years ago a barrel of oil was trading for $25. Today it is $77 per barrel.

Since 2001, the U.S. dollar has LOST over 30% of its value against our largest trading partners and has lost nearly 7% of its value since June alone. These facts have somehow caused the MSM to wring their hands about deflation.

More recently, the YOY increases in the CPI, PPI and Import Prices are 2%, 2.8% and 4.5% respectively. Even though these YOY increases aren't evidence for runaway inflation, they still can't be construed as deflation.

The truth is that prices should be falling. Aggregate hours worked are down 8% since their peak in March of 2008. Since the money supply should rise and fall along with the direction of the numberf of people in the work force, price levels should be falling as the money supply contracts. But that is not what we see today, as M2 is up 2.1% Year over Year.

Now I concur that If the monetary base continues to stagnate and banks stop lending to the government, then we could be headed for a deflationary environment in the future. However, at this time it is just conjecture.

But if that scenario does take hold it would not be something to fear. Lower prices are beneficial for those who have been thrown out of work and falling prices allow asset values to reach a level that can be sustained by the free market. The fact is that prices should be falling in order to reconcile the imbalances brought about by decades of profligate spending and borrowing.

Deflation...I say bring it on. But that is not what is occurring today. And because of the massive level of U.S. sovereign debt, inflation will be our most salient problem for the foreseeable future.

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Are Stocks Really Cheap?

By Michael Pento | July 13, 2010 | 10:37 AM |  3 CommentsTweet This

Perma-shills have been claiming of late that the stock market is now trading at an enticing valuation. Their main evidence for this, as they are fond to claim, is that the forward Price to earnings multiple is 12 times next year's earnings for the S&P 500. And, of course, a 12 PE multiple makes stocks cheap and the overall market a buy.

But for investors who want to accurately assess that number, there are two issues they should be aware of. First, the PE ratio isn't a good measure of the near term direction for the market. And second, nobody knows what the forward PE will actually be. Some pundits like to use that forward looking number because, when corporate earnings are projected to rise-as they almost always are-the PE ratio will look better.

So let's get into some real numbers that will help determine if the market is indeed cheap.

For Q1 2010, the PE ratio on the reported trailing twelve month earnings for the S&P 500 is 15.5. Historically speaking, the average PE ratio on the S&P is about 15 times earnings. So therefore, if one isn't promoting an ebullient guess as to what earnings will be in the future, the market is currently just fairly priced on a PE basis. Also, the PE ratio on an inflation adjusted average over the previous ten year period has ranged from 4.78 in December of 1920 to 44.2 in December of 1999. With such a wide range of valuations, it is difficult at best to make a case to buy or sell stocks solely on a PE basis. There are other factors like; the direction of inflation and interest rates that are necessary to consider when evaluating the PE ratio.

Some market cheerleaders also like to use the inverse of the PE ratio called the earnings yield when comparing stock prices to bonds. They say; with the current earnings yield being 6.4% and the Ten year note yielding around 3% that stocks are a great value. Again, there are problems here too. Firstly, investors don't earn the earnings yield as they do with dividends. And as mentioned, the earnings yield is merely the reciprocal of the PE ratio. The fact that the yields on government bonds are significantly below the earnings yield on stocks is merely an indication of the egregiously overvalued state of the U.S. debt market.

Rather than pick one or two statistics like the forward PE ratio or the earnings yield to convey an opinion on stocks, here are several important facts that will help you decide the future direction of the market.

A good metric to determine the valuation of stocks is the dividend yield. The current dividend yield on the S&P is a paltry 2.1%. The historical average dividend yield is a much greater 4.36%. The lowest dividend yield was 1.11%, which was reached in August of 2000. The highest dividend yield was 13. 84%, this was achieved in June 1932. Therefore, on a dividend yield basis, the market is currently significantly overpriced. To add salt in the wound of those low yielding stocks, tax rates on dividends are scheduled to increase significantly in 2011. Maybe that is the reason why all the cash sitting idle on corporate balance sheets isn't being sent back to investors in the form of dividends?

According to the Investment Company Institute, mutual fund cash levels are at a decade low. Cash levels as a percent of assets reached a cyclical high of 12% in 1991. Today, that ratio is less than 4%. With mutual funds already nearly fully invested where will the money come from to take stocks higher?

The Fed's balance sheet is at a record high $2.3 trillion. The unwinding of that balance sheet will send interest rates on their $1.1 trillion In Mortgage Backed Securities (MBS) soaring and will thus further damage the real estate market, stifle earnings growth and depress GDP growth. The Fed must also find buyers for all that MBS debt. This will crowd out investments that would have normally been made into stocks.

Household debt and the Gross National debt have never been at or above 90% of GDP at the same time. For the first time in U.S. history, that is the case today. Along with the massive deleveraging that still lies ahead for both the public and private sectors, the Treasury must auction off close to $9 trillion in debt each year to cover our ballooning deficits and to satisfy rollovers. This will further crowd out investments that could have been better placed into the stock market.

Once you view the real numbers on PE ratios and dividend yields it is hard to make an argument that stocks are cheap. And given the low levels of cash that exist at mutual funds and the crowding out of private investments that is taking place from the government, investors will find it difficult to assume the market can produce a sustainable rally of any real significance.

The only disclaimer here is if the Fed embarks on another doubling of its balance sheet in an attempt to crush whatever life is left in the value of the U.S. dollar. Then, in that case the market may rally in nominal terms. But you had better own precious metals and the companies that pull the stuff out of the ground if you want to earn a positive return after inflation.

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Geithner: The Good and the Ugly

By Michael Pento | July 09, 2010 | 12:39 PM |  0 CommentsTweet This

The Treasury Secretary conducted an interview with my friend Larry Kudlow this week. There was some good, and a whole lot bad with that interview.

First the good.

Treasury Sec. Geithner wants the capital gains and dividend tax to increase to only 20% instead of going to 39%. Here is Tim in his own words:

"Well, let me tell you what the president's going to fight for and propose. We're going to make sure that we extend and leave in place tax cuts that will go to benefit more than 95 percent--not just of individuals in this country, but of businesses across the country. We think that's good policy, good for the country, sensible policy. We're going to make sure that we keep at 20 percent the existing rates on dividends and capital gains. We think that's good policy, too."

It's not great to have taxes on capital or dividends increase at all but you have to like the direction the administration is going on this one.

Now for the Ugly. 

Geithner said, "I think this economy is healing. We're repairing the damage caused by the crisis. We're growing, and we've been growing now for 12 months now. We've had six months of sustained growth in private sector jobs. Coming out of the last recession, it took us almost two years before we had a sustained set of month-to-month increase in private sector jobs, so that's very encouraging. I think the most likely thing is you're going to see an economy that is growing at a moderate pace, hopefully strengthening over time. And this growth now you're seeing is being led by business investment, by exports, by manufacturing."

By saying that the damage to the economy was caused by the crisis shows his complete misunderstanding of the entire situation. Geithner blames the damage to the economy on the crisis. But it wasn't the credit crisis that caused the damage it was the credit bubble leading up to the crisis. He believes that by spending more money he can alleviate the crisis and therefore assumes the economy is on the road to recovery. He completely ignores the genesis of the problem. That is why he honestly thinks the economy can continue to grow. And that is why we are doomed to repeat the past.

 

 

 

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No Fuel for a Lasting Rally

By Michael Pento | July 08, 2010 | 12:01 PM |  1 CommentTweet This

Mutual fund cash levels are near an all time record low. So where will the fuel come from to engender a sustainable rally in stocks? Linked here is a chart of mutual fund cash levels. When cash levels get around 4% (as they are today) stocks usually sell off; not rally. And the inverse is also true. Cash levels must also increase significantly before the bear market ends.

The rally of yesterday is being heralded as the death of the double-dip recession theory and the beginning of a new bull market. But where is that money to send the market higher going to come from? Investors can't tap the equity in their real estate holdings and they aren't going to get it from wage increases either.

Be careful not to get sucked into believing all is well.

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