Doubleline's Gundlach Weighs In on Debt Ceiling Debacle

Doubleline Funds (DL) hosted a conference call last week titled “Now What?” DL CIO Jeff Gundlach has been in the press quite a bit lately, including on the cover of Barron’s. Thanks to Nathan Dutzmann for the analyst coverage.

  • The debt ceiling has been meaningless thus far, but rhetoric finally leans toward making a new debt limit contingent on deficit reduction.
  • Gundlach believes a failure to raise the debt ceiling would be a bullish sign for Treasuries, despite consensus opinion. Reasoning: Forced austerity—governement will reduce spending before it will default.
  • Fed now talking about possible QE3.
  • Government has few remaining options to solve the debt problem. Different choices will have different consequences, and investors need to be hedged against both inflationary and deflationary outcomes.
  • Social security, Medicare, and defense are each over 20% of the budget. All three will have to be reduced to attack the debt problem.
  • Federal tax receipts as a percentage of GDP are down, but that’s largely because government spending is part of GDP (i.e., borrowing and spending reduces receipts as a percentage of GDP).
  • Income is concentrated at the top 0.1%/1% of earners. The “taxes are too darn low” party will point at low marginal tax rates vs. historic rates, but will ignore historic loopholes/tax shelters since eliminated, and will thus argue for much higher marginal rates.
  • Stimulus ideas have failed to live up to what was advertised. Unemployment is higher with stimulus than Obama predicted it would have been without stimulus.
  • Food stamp usage has gone up enormously. We are not going into a self-sustaining economic boom. Politicians want high consumption without high borrowing, but the math on that doesn’t look good.
  • Thus far in 2011, risk markets (stocks, high-yield, long-term Treasuries) have done much better than low-risk (short-term Treasuries).
  • Portugal/Ireland spreads are as high as Greece spreads were in May 2010.  Italy/Spain spreads are as high as Portugal/Ireland were in May 2010. Vicious cycle. Default is the endgame for the PIIGS.
  • In Europe and the United States, required austerity will be negative for economic growth.
  • 10-year Treasuries are at 3%. DoubleLine believes they only drop below 3% in times of fear. At 3%, a large portion of DL’s funds are in cash, waiting to see which way things will break.
  • 30-year Treasuries won’t drop below 4% even now. Very long-term bottom of yields as the United States weans itself off of its long-term, debt-driven growth experiment.
  • Dollar appears to be bottoming and could rally. DL does not own non-USD securities: They would add a ton of volatility with little added return benefit. 
  • Silver was vastly overbought. Investors could do better in gold, gemstones, land or antiques.
  • Commodities make sense as a 10-year hold, but the trade location is terrible (i.e., very hard to tell when to buy in).
  • The Shanghai Composite is strongly down and tends to lead the S&P. (Gundlach thinks Shanghai is the most important exchange in the world.)
  • Mortgages have the lowest volatility of all fixed income securities.
  • High yield has lost momentum vs. high grade issues.
  • We’re so used to lousy housing we don’t think about it enough anymore. DL uses a conservative base case of another 10% housing decline.
  • Homeownership rose to 70% in 2008, simply too high by historic standards.
  • DL advocates full avoidance of subprime. Delinquency is high and recovery is low. Five-year overhang at present.
  • DL strategy is low duration/volatility/risk, make gains on dividends/income.
  • Use Agency MBS as an inflation hedge, since spread is credit risk. Use Agency CMOs as deflation hedge, due to sensitivity to interest rate risk.
  • DL is underweight to Treasuies, but is not entirely out of them “like some poor folks” who missed out on this past week’s rally.
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