Dawn Bennett, Host of Radio Show “Financial Myth Busting,” Interviews Mike Pento, Founder & President of Pento Portfolio Strategies
BENNETT: Mike, just to educate our listeners, I want to say that high-yielding bonds are long term IOUs used by companies with shaky credit rates. In recent years, interest rates in these junk bonds have gone down to ridiculously low levels which is a real concern, because we saw this happen previously just before the stock market crash in 2008. Will junk bonds lead to a stock market crash in 2015?
PENTO: Well, no one knows the exact timing, Dawn, but I will tell you this. When you have 75 months of zero percent interest rate, the economy becomes addicted to the level of free money that's existed for that time. When the economy becomes addicted to these machinations there is a hundred trillion dollars' worth of interest rate derivatives that could blowup. These are people who have basically sold insurance against interest rates ever rising. So one of those things that I think could blow up are the high-yield markets, you are exactly correct.
BENNETT: The energy sector accounts for approximately 15 to 20 percent of the entire junk bond market. And now that oil is trading at about
PENTO: Well, this is in part because of what the Fed has done. They've created an imbalance of capital. You create all this money for free for so long, you create a bubble in oil prices—as you said,
Because the Fed has created this massive surge for yield, people go out along the risk curve and say, 'OK. This is higher than zero. Let me buy it. I don't care what the covenants are. I don't care what's backing it.' So they search for yield. They get 5-6 percent on these bonds. And then when these wells become absolutely unprofitable, they can't service the debt and then that debt explodes. That's just one miniature example of what's going to occur once interest rates normalize. I wouldn't even focus on that. That's the least of our problems. But you can see that the whole capital structure of
BENNETT: You published your book The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market two years ago. Have your views evolved?
PENTO: Well, yes, they've evolved dramatically. I never could possibly have imagined how far interest rates on the sovereign debt market could be distorted. Let's just take a look at
Think about that. Think about what's going to happen when the day comes that the
BENNETT: Apparently Europe thinks they were left out of how quantitative easing somehow 'saved the U.S. and
PENTO: Only the Keynesians and those who don't believe in capitalism and free markets believe that QE saved the economy. In 2010, the U.S. GDP was 2.5 percent -- the annual growth of GDP. In 2014, it was 2.4 percent. So we have not at all saved the economy by all this massive money printing and complete distortion of markets. What we've done is we've re-inflated asset bubbles, we've re-inflated the stock market bubble. If you look at all the market capitalization of stocks, we're trading right now at 127 percent of GDP. It has never been higher outside of early 2000 and we know what happened then. And it is much higher than it was in 2007. So we've created a massive bubble in stocks, a huge bubble again in real estate, another massive bubble in bonds from which there is absolutely no escape. All of this has done one thing: we have, in aggregate, increased the amount of global debt by
BENNETT: The U.S.,
PENTO: Yes. Real currency, real money is gold. Let me just talk about the dollar for a second. The U.S. dollar is not really strengthening, Dawn. We've had, as I said, 75 months of zero percent interest rate. We have
BENNETT: Based on everything you said, it's almost like 'magic' seemed to have sustained this universal faith in currencies until about the middle of 2014 when a lot of monies went south. Except the dollar, which of course has continued to magically levitate. What is it levitating on?
PENTO: Why is the dollar strong against the euro and the Japanese yen?
BENNETT: Yes.
PENTO: Because we stopped our quantitative easing. The Fed has been threatening to stop QE and raise interest rates since 2010. And every time we get to the precipice of actually having some normalization in the sovereign debt market of
BENNETT: The U.S. seems to be waging this currency war against other nations that can only blow back by incurring the animosity of every trading partner we have. Do you expect
PENTO: Well, this is not a prediction on- my part.
BENNETT: You never hear them talk about it here in
PENTO: Well, that's because if the U.S. dollar was no longer the reserve currency then we'd have a big buying strike in our bond market. So your listeners understand: the ten year note—if you go back 45 years, the average interest rate is 7.3 percent on the 10-year note. Today, we are about 1.9 percent on the 10-year. If interest rates were just to normalize—and I can make a very solid argument about why they can go much, much higher given the amount of debt that we have piled up as a nation. Now we are 18.3 trillion with over a 100 trillion in unfunded liabilities. We have had, as I said, zero percent interest states for so long. We had a massive increase in the monetary base. So rates can go much higher. But if they are normalized, we will be spending a trillion dollars per annum just on interest payments on our debt. So deficits rights now, the administration is saying "we are down to half a trillion dollars a year, five hundred billion dollars a year," as it is some kind of grand achievement. They are going to quickly go back to a trillion just based on demographics, but then if interest rate normalize, we are going to pay a trillion in interest, and guess what? The denominator in the debt, the GDP ratio goes away. We saw that what happened in 2008 that our phony economy, not just
BENNETT: Some are arguing that a strong dollar is not actually in America's best interests as it means exports are going to become unaffordable and foreign nations are going to have harder time servicing their debt. Where do you come down on this issue?
PENTO: I am very much in favor of a strong dollar. A strong dollar is very beneficial to U.S. consumers, equates to a rising standard of living; it is great for foreign direct investment. If you want to build a factory here, you're more comfortable doing that if you are a foreign nation. I mean, I am all in favor of a strong dollar. However, the dollar is rising in this case, as I said, primarily due to the fear trade and a sign of global deflation and the deflation of those massive asset bubbles that we built up, primarily since 1997. And those collapsing asset bubbles are not good news for anyone in the short term, but they are great news if they allowed to consummate, if they are allowed to play out. But I have no confidence at all that these central bankers—if you look at
BENNETT: After Yellen spoke Wednesday, sounding more dovish than ever, or actually sounding more dovish then the Fed watchers anticipated, the dollar actually crashed in overnight trading but then it recovered Thursday morning. Some are actually calling this a 'flash crash.' Do you know what happened?
PENTO: OK. So here is my assumption as to what occurred. The Street was on one side of the trade. They believed that
BENNETT: Yes.
PENTO: We don't know what level the dollar should be. We don't know what level interest rates would be. We don't know where home prices should be. We don't know where the bond yields should be. We know one thing for sure: they don't belong anywhere near where these prices are because the free market, as I said, has been completely eviscerated. So this just a small example of what's going to happen as the Fed and other central banks try to return to normal. It is not going to be a very smooth process. I liken it to landing a jet airliner on a driveway. It's not going to be very pretty. It never has been pretty and because they have been so dominant and because they've replaced markets for so long, this time around it is going to be much worse than what happened in 2000 and in 2008.
BENNETT: Are there are any short term strategies you're suggesting based on where the dollar is right now? Are you shorting it, or are you long?
PENTO: I had been. I had been in my fund. I have an inflation/deflation fund and that's where I think we are headed right now. This is where the rubber meets the road as far as your investors are concerned. We're going through more and more violent swings between inflation and deflation. If you look at what happened in the year 2000, we had a mild, or a semi-mild recession because they took interest rates to 1 percent and left them there for one year. I'm sorry if this is review, but it is important to understand.
Of course, that engendered the housing bubble, just having interest rates at one percent for one year. When the housing bubble burst in 2007 and in 2008, we took interest rates to zero percent, printed
So that's where I think we are at. And right now, my fund has been short the Euro, long the dollar. We did that through a very simple ETF EUO. We also very recently went into dividend paying stocks because
BENNETT: That's right.
PENTO: There's going to be a time very soon when both bond prices and equity prices fall in tandem. And when that occurs, you're going to have a much more dynamic strategy in place. And that's what I do hear in terms of portfolio strategies.
BENNETT: Mike, I want to thank you for being on Financial Myth Busting.
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