By David Nelson and Dan Wiel
Now that Federal Reserve Chairman Ben Bernanke has indicated the central bank will likely begin to taper its quantitative easing later this year, the financial markets — and economy — are in big trouble, says Michael Pento, president of Pento Portfolio Strategies.
"Here's what's going to occur," says Pento.
"Bernanke is foolish enough to believe that he can take his pressure off interests rates and allow the market to take interest rates a little bit higher. But what he fails to realize is that when interest rates rise, it's going to collapse the real-estate market, the stock market, the consumption bubble, and, of course, part of the bond bubble will collapse."
That bond meltdown will likely come in 2015 or 2016, says Pento.
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The yield on the 10-year Treasury note jumped to a 22-month high of 2.54 percent Friday. And the Standard Poor's 500 Index has dropped 3.6 percent since Tuesday.
Bernanke is a confused man, Pento says.
"So in the beginning of 2013, which was not even six months ago, the man thinks that inflation is way too low, and the economy is way too weak and that QE4 needs to be launched five years after the first QE was inaugurated," says Pento, author of "The Coming Bond Market Collapse."
But now, Bernanke "puts out a timeline for reversing QE," Pento says. The Fed chairman said tapering may begin later this year and finish around the middle of 2014. The central bank is currently purchasing $85 billion of Treasurys and mortgage-backed securities a month.
"The man is either 100 percent focused on his legacy, or he's actually starting to fear this $3.5 trillion Fed balance sheet and says what we've done to this point — taking it from $800 billion to $3.5 trillion — hasn’t worked, and we have to stop," Pento says.
The economic recovery has been "predicated on reigniting bubbles that had once popped," Pento says. The S&P 500's climb from 666 in March 2009 to a high of 1,669 last month "was predicated on multiple iterations of quantitative easing," he says.
QE has helped housing rebound too, Pento says. "So the unwinding of this process — the unwinding of asset bubbles— is going to crater the economy. And cratering the economy isn’t very good for corporate earnings. So how could that be good for stocks?"
While corporations sport impressive cash holdings now, that's not going to last, Pento says.
"Corporate balance sheets are flush with cash because they've been selling debt to buy back their shares, and the earnings look better," he says.
"So, when debt becomes more expensive, they're going to do a lot less of that. In addition, much of the health of corporate balance sheets stems from the current strength of the consumer sector," Pento says.
"And if the consumer has to pull back his horns, then what do you think's going to happen to corporate earnings?"