February 21, 2012

On Call, Gundlach Voices Concerns on Consumer, Government Debt

The following notes were taken during a Feb. 14 conference call with DoubleLine’s Jeff Gundlach. Thanks to Nathan Dutzmann for the analyst coverage.

Decline and Fall of the Roman Empire

Gundlach spent quite a bit of time discussing the Roman Empire and Gibbon’s “decline and fall”. Not sure why most of it was necessary, but it was somewhat of a setup for discussing the current situation in the United States.

Each household’s share of the debt is approaching two years of income for the median household.

At $700 billion, the United States military spending is about five times that of the No. 2 country, China. Compare that to the “military overspending” theory of the Roman Empire’s decline.

As a percentage of total government outlays, though, it is only about 15%. In WWII, that peaked at 90% of total government spending. Health and Medicare outlays are rising rapidly on a dollar and percentage basis, now well ahead of defense, at over $1.2 trillion.

Composition of debt (household, non-financial corporate, financial corporate, and government) varies by country, but the common theme is that developed countries are awash in debt. Those four components of total debt are fairly balanced in the United States at present, except for financial corporate debt, which is fairly low as a percentage of GDP.

The three largest global debt rollovers for 2012 are Japan, $3 trillion (nobody’s worried); United States, $2.8 trillion (nobody’s worried); and Italy, $428 billion (big worry).

The combined balance sheets of the six biggest central banks have risen from $5 trillion in 2006 to around $13 trillion today.

Total real personal income has rebounded in the United States, but personal income less transfer payments is still in a major slump. This will be a big problem when stimulus ends. One reason: The employment-to-population ratio remains at extremely depressed levels. Compare that to the “permanent underclass” theory of the Roman Empire’s decline.

  • Lower unemployment rate driven by massive increases in percent of population not in the labor force.
  • Now 46 million Americans on food stamps.
  • Decline in labor force participation rate worst among the young. Teenagers cannot get jobs. The participation rate among 16- to 19-year-olds is down from 60% a few years ago to 30% now, partly due to older people accepting lower-paying jobs and crowding out the young.

Interestingly, 11 of 17 Fed board members predict rate hikes prior to late 2014, when Bernanke promised low rates until then.

Fed “transparency” is creating confusion.

Huge federal, state and local government unionization—much higher unionization rates than in the private sector, including manufacturing—makes it very hard to trim fat from the government.

The average federal employee makes $120,000 per year versus $60,000 for the average private worker.

Bloodless Verdict of the Market

Convertible bonds were the worst sector in 2011, currently the best in 2012. In general, risky assets are outperforming safe assets, the reverse of 2011.Gundlach suspects the big risk rebound is almost over; partly represents redeployment of capital that was on the sidelines.

Interest rates are up, but not much given the magnitude of the risk rebound.

DBLTX is up 2%, outperforming Barclays Capital Aggregate Bond Index by 140 bps.

In 2008, Treasury rates plunged, but then bounced back in 2009; in 2011, Treasury rates plunged, but they are not bouncing back. Overall, rates appear to be carving out a multi-year bottom.

As rates rise, long-dated TIPS do very badly, so buying TIPS may not be a good way to protect against inflation. Treasuries represent about 35% of the Barclays Capital Aggregate Bond Index, so if you think they are not a good investment, buying a bond index fund is not a good idea.

 

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