“Deflation is not off the table,” said Jeffrey Gundlach, CEO and CIO of DoubleLine Capital, at a briefing in New York on Thursday.
Gundlach (left) opened up wide-ranging remarks with macro-economic views on the risks investors face now: “With so much debt, public and private…minor weakness in economy” could cause deflation, he explained. In the “[Great] Depression, there was a 300% ratio of debt-to-GDP;” this fell to “130% in 1951…[increased to] 276% in 2001,” and hit a whopping “353% in 2009,” his chart showed. “How will that issue affect the investing environment?” he asked.
There are now “$70 trillion unfunded promises to pay [U.S. liabilities including Medicare and Social Security, Treasury securities etc.], against $7.9 trillion of publicly-held Treasury debt,” Gundlach said. In his view, we “can no longer hide problems in Social Security,” Gundlach said, adding that the “deficit numbers are not showing the Social Security liabilities—a $1.6 trillion budget deficit versus $3.6 in Social Security liabilities.”
One solution, Gundlach said he’d read, was to, “gradually raise the retirement age to 69—by 2075. This is not a 2075 problem,” he exclaimed, to lots of laughter.
Anyone who has heard Gundlach speak, read his research or spoken with him in the last four years knows he was early to speak of the credit crisis and financial disaster. He called the mortgage markets an “unmitigated disaster,” during the first half of 2007. And he was proved right. That’s why when he speaks about the investing environment, so many listen. The Drawing Room at the Palace Hotel for the small lunch briefing was packed with institutional investors, family office executives and reporters.
“There must be a massive policy shift,” Gundlach opined, speaking of the debt to GDP ratio, the tax situation in the U.S. He remarked about the election of a Republican majority in the House of Representatives in November and then the tax cuts in December. Saying he likes a nice “long time horizon,” he lamented that we, “must shorten the investment horizon.” We “had [a similar] problem back in the late 1930s-early 1940s,” with the “300% ratio of debt-to-GDP,” he mentioned above. "We solved that," he explained, with “a humongous tax increase. Now we have the same problem—but we never cut the taxes. How do we solve that?” he asks. It’s much harder to boost taxes from a higher base.
Gundlach mentions that “81%” of participants in a poll in The Wall Street Journal said they would favor a “surtax on earnings of $1 million or more.” And “68% are in favor of raising taxes on $250,000 or higher wage-earners,” he said. Really, Gundlach added, we are “headed for 'The Taxes Are Too Darn Low Party,’ but don't be surprised if it doesn't win.”
Unemployment Much Higher Than Figures Show
There has been, contrary to other economic recoveries, Gundlach noted, “no job growth since end of the recession.” And unemployment, he said, is vastly understated. He’s said this before: while the government’s public figures are 8.9% as of February, Gundlach asserted that the real numbers a much, much higher once you account for the long-term unemployed and underemployed; that’s really “16% or 17%;” and if you count the people who have been “conveniently” categorized out of the work force and not counted, it’s “really 24% or 25 % unemployment.”
This is, Gundlach said, “Starting to have societal impact.”
The ‘Good News’
The "good news is, manufacturing is flat out good! Jobless claims today were in the 400,000 zone, better, but the global economy is not showing it,” noted Gundlach, moving on to speak of asset classes.
Looking at commodities, he said, “gold, I don't mind; I own shares from late ’90s. I don't really like gold so much…it's just so heavy,” Gundlach said, tongue-in-cheek. He likes “gemstones better, noting that you can carry a couple million dollars’ worth in your pockets. “All the gold [that’s been] mined fits in a 67-foot cube, so the argument is scarcity.”But Gundlach points to Warren Buffett’s remarks about gold: “’Would you rather have 10 Exxons, plus all the farmland in U.S. plus a couple-trillion dollars left over?’”
Silver, of course, is something else altogether. It has had quite a run, and as Gundlach put it, “When silver outperforms gold it's time to get out of commodities,” noting its “17 to 37 run-up in six months.”
Gundlach said he’s spent “years telling people mortgage-backed securities are low volatility; this is the truth.” Showing a chart of rolling 5-year standard deviation, he points out that mortgage-backed securities have “about 3%, 3.5% standard deviation, lower than Treasuries; munis also usually have low volatility—not so much right now.”
“A lot of people compare high-yield [corporate] bonds to Treasuries, but it’s a gross mismatch,” Gundlach asserts. It’s “better to compare high yield to long Treasuries. High-yield standard deviation is 11% or 13%; Treasury standard deviation is 5%—so high yield does not yield 500 bps over Treasuries. High yield matches a 15- or 20-year Treasury [bond].” An interesting note: Gundlach’s chart showed that 3-year high yield corporate bonds’ standard deviation is higher than even 15-year Treasuries’ standard deviation.
In municipal securities, Gundlach cautions, there are “more ways to lose than just defaults, What if rates rise, particularly on long munis in closed-end fund muni funds?” But there’s a flip side to this: "if rates fall substantially on munis, it means deflation, a weak economy—and weaker state credits, so you could lose on lower rates also.”
DoubleLine started an open-end fund with RiverNorth, the RiverNorth/DoubleLine Strategic Income Fund (RNSIX), that has "three sleeves," according to DoubleLine Analyst Loren Fleckenstein: one sleeve is managed by RiverNorth's CIO, Patrick Galley, and can buy closed-end funds that are in distress.
The reason for that is “to take advantage if munis start to decline—to pounce on the market when discounts are wide,” said Gundlach, who believes closed-end muni funds may get to 15% or 20% discounts.
A second sleeve, managed by Gundlach, uses DoubleLine's multi-asset strategy; the third, which Gundlach also manages, invests in "high-yielding distressed securities, for income and cash flow," said Fleckenstein. See “RiverNorth-Jeffrey Gundlach Fund Attracts Nearly $50 Million in Assets.”
Perhaps the most provocative remarks Gundlach made were about bank stocks. He began by saying how important mark-to-market is. “Banks are still not marking-to-market because many would be insolvent [if they did.] Banks are a fantastic play if you think the economy is getting better. If you’re not in that camp, there's no reason to be in them at all.” Gundlach said a senior Bank of America executive told him recently: “’The credit card business will never be the same;’” regulation eating up margins, and “’the only way to increase margins is to fire people.’”
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