Time to Invest for Stagflation

Whether you call it a 1970′s style stagflation or, as we call it, a recessflation, investors need to prepare their portfolios to profit from a protracted period of rising prices in the context of zero growth. Here are some facts: Growth in the U.S. has averaged just 2% since 2010. However, Q4 2015 GDP growth grew at a 1.4% annualized rate and the Atlanta Fed model has Q1 GDP growth slowing to just 0.1%. The simple truth is that the rate of growth is slowing towards 0%, just as asset prices continue to rise to record levels due to vast intervention from central banks.

The U.S. is now in the process of moving away from an environment of disinflation and slow growth, to one of inflation and recession. Indeed, the entire global economy is careening towards an epic recessflation crisis.

Central bankers have bombarded the world with unprecedented levels of QE, ZIRP and NIRP for the past 7 years, which has produced a significant amount of inflation in equities, real estate and bond prices–especially in relation to income and GDP growth. Now, all this money printing has finally started to spill over into core consumer prices. In the U.S., CPI has risen 2.3% year-on-year, which is the largest increase since May 2012, and well above the Fed’s 2% inflation target. The home price to income ratio has soared back to 4.4:1 and the ratio of total market cap to GDP at 117 is in extreme overvalued territory. This bubble in stock prices is evident despite the fact that the S&P 500 is in a revenue and profits recession.

But a recessflation isn’t just an issue here at home. China exports fell 11.2% in January, while imports dropped 18.8% from the year prior. Yet, that sign of economic stagnation hasn’t stopped home prices in Shanghai from soaring over 50% from January 2015!

What is the game plan of global governments to combat falling GDP growth and rising asset inflation? More stimulus of course. Japan’s Prime Minister, Shinzo Abe, has proposed to increase government spending by 5-10 trillion yen in this year’s fiscal budget to encourage more consumption. But Japan has already run budget deficits worth 8% of GDP for the past several years, which has piled onto the nation’s government debt that is now nearly 250% of GDP. Nevertheless, despite over three years’ worth of Abenomics (money printing and deficit spending), business sentiment in Japan hit a three-year low this March.

Over in Euroland, where ECB head Mario Draghi has been busy pushing sovereign debt into negative territory, he has now resorted to buying non-bank corporate debt. Indeed, 15 billion euro’s worth of business debt now trades with a negative yield. Even debt in the primary market is being sold with yields less than zero percent. Mario Draghi has so distorted the capital markets that corporations are now being paid when they issue debt.

There are now $7 trillion worth of sovereign debt (30% of the developed world’s total) with a negative yield.

Not to be outdone by her foreign counterparts, Janet Yellen (the Queen of the dole of doves that perch at the FOMC) promised recently in a speech before the Economic Club of New York to move slower than a frozen dead snail when raising the Fed Funds Rate. This was a clear attempt to prevent the dollar from rising any further against our major trading partners.

The truth is governments and central banks “solved” the Great Recession by creating the greatest global bubble in real estate, stocks and fixed income in economic history. Now the fuse has been lit for complete market chaos and the achievement of central banks’ inflation goals will lead to its destruction.

Central banks are incapable of producing viable GDP growth. The only condition these money printers have ever been able to achieve throughout history is inflation. But inflation isn’t the product of economic growth, nor does it come from a low unemployment rate–unlike what modern day Keynesians contend to be fact. It doesn’t even come from the piling up of excess bank reserves. Rather, it comes from a deliberate government-led attack on the value of paper currency. It is accomplished through direct central bank monetization of humongous deficits. And, unfortunately for the world’s middle classes, this is exactly where we are headed.

But what central bankers seem unable to understand is that economic growth comes from productivity; not a weakening currency. Inflation kills growth by destroying the purchasing power of consumers and savers, just as it also encourages huge capital imbalances and a massive accumulation of non-productive debt.

There’s a tremendous shock coming to markets when it becomes clear that inflation and growth are not joined at the hip. And that governments were competent in their ability to create inflation, but completely whiffed on producing growth. In fact, history has proven that inflation coupled with recessions are the more likely pairing of economic conditions.

Until central banks learn that they aren’t a viable alternative to free markets, we will suffer through steep recessions that are also marked with periods of both deflation and inflation. Investors must now be prepared to weather such volatile conditions. A dynamic strategy that incorporates the ability to own precious metals and also short the broader market is an essential hedge towards the goal of preserving the
purchasing power of your wealth.

24h Gold
April 11, 2016
Michael Pento