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Gundlach Enlists Mother Goose to Explain Market

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Bond manager Jeffrey Gundlach lived up to his contrarian reputation in telling an audience of professional investors that the consensus that interest rates cannot go lower is mistaken.

The DoubleLine Capital founder noted he was nearly laughed out of the room when he called for a “bond melt-up” one year ago, at a time when Wall Street consensus opinion forecast the 10 year U.S. Treasury would end 2014 up 70 basis points.

Instead, it fell by nearly that amount, ending the year at 2.17%, and falling since that time to 1.8%.

Speaking to a packed room of more than 1,800 investment professionals, mostly financial advisors, at ETF.com’s InsideETFs conference in Hollywood, Florida, the bond manager notes that today’s Wall Street consensus once again calls for the 10-year Treasury rate to rise 100 basis points.

This “stubborn” consensus, Gundlach quips, is “the triumph of hope over experience, metaphorically the same as a second marriage,” he said to laughs.

To Wall Street pundits who claimed a year ago, doubling down today, that yields can’t go any lower, Gundlach says such views are “provably wrong” based on market history.

“People are clamoring to buy debt from 12 countries offering negative yields” today, he says, and noted that throughout 2014 the 30-year long bond not only fell in yield, it virtually never rose (except for a 20-basis point blip in the third quarter).

Indeed, he predicted the long bond has “one last gasp,” with yields potentially falling as low as 2% this year.

“A year ago nobody wanted long-term Treasuries, and today many investors are afraid not to own them,” he says.

Sprinkling his talk with nursery rhymes for humorous effect, Gundlach said of today’s consensus that “birds of a feather flock together,” warning of the danger of flying with the Wall Street crowd.

But it’s not only Wall Street but the Federal Reserve’s oft-noted desire to raise rates in the new year that Gundlach derided, saying all the king’s horses and all the king’s men can’t keep Humpty Dumpty together again.

“The Fed’s idea about raising rates will be short-lived,” he said, noting that it makes little sense to do so while major economies such as the European Union and Japan are lowering rates. Gundlach added that the Fed’s premature lowering of rates in 1937 at a time when credit conditions were poor led to the second phase of the Great Depression.

Returning to the nursery rhyme theme with Old McDonald’s Farm, the bond manager noted that the meaning of some of the lyrics is hard to discern—like E-I-E-I-O. “That sounds like the Fed talking,” he said.

Gundlach presented both a bullish and bearish case for the economy, though he clearly found the latter more persuasive.

On the bullish side, bolstering the case for the Fed raising rates, there is less slack in the labor market, sales are improving, disability claims have fallen and food stamp usage has flattened, following a massive increase in recent years. The decline in oil prices goes straight into the pockets of consumers, he adds.

Taking a long-term perspective with his bullish hat on, Gundlach expects India to outperform over the next generation, particularly vis-a-vis China, whose one-child policy will cripple the country’s economy. “India is where the population growth is,” he said.

Shorter term, in terms of currencies, “the dollar is the place to be,” though he cautioned the dollar is “an overbelieved trade,” meaning that a temporary setback should occur though the currency consensus is correct. The euro’s fall will continue, declining to parity with the dollar or even near its record low territory in the 80s.

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Turning to Goldilocks and the Three Bears, the money manager made the bearish case, and flip-side positive case for gold, which he says has proven yet again its worth as a safe haven in times of turmoil.

The portfolio manager noted that going back to 1874, U.S equities have never risen seven consecutive years; with the S&P 500 having risen six consecutive years, history does not favor another positive year.

Gundlach is especially worried about the effects of lower oil prices. The gain to consumers was immediate, he said, though positive holiday sales were less robust than they should have been, he added. But the energy sector was hugely responsible for job growth and capital expenditures, both of which will trend strongly downward.

In staking out a bearish view of energy, Gundlach acknowledges he is opposing mighty smart money, such as energy investor T. Boone Pickens.

“He knows a lot more about oil than I do, but I do know about markets, and I know that when prices drop enough someone is at the edge of bankruptcy,” he said, suggesting that some regional banks or hedge funds may now be in danger.

“I’ve bet a great deal of money it won’t get back up to $90 a barrel,” he says, calling the cratering of the key economic sector a true “black swan.”

Energy’s crash will be a huge blow to U.S. shale producers, all of whom are below breakeven at current oil prices.

That’s especially troubling in an economy that has shut young people out of jobs. “It used to be a high school kid you’d see behind the counter at McDonalds,” he comments, acerbically noting that the position is now held by a senior who cannot afford to retire.

Abroad, Chinese growth is rapidly decelerating, as seen through dramatically falling home prices.

Also heading down, ominously, is inflation.

Using real-time data, as opposed to government Consumer Price Index statistics, Gundlach says inflation is zero. Citing the Patty Cake rhyme, he said central banks’ easing moves were aimed at baking an inflation cake as fast as they could.

As a result, London Bridge, a metaphor for interest rates, is falling down.

“You are now paying Switzerland for 10 years to safeguard your money,” he said, reaffirming his view that the U.S. cannot raise rates in the face of negative-rate pressure from other stable economies.

But one implication of this trend is that gold, which famously yields zero, now out-yields the world’s most stable currencies. Gundlach said he increased his position in gold a couple of weeks ago.

Gundlach warns that high yield energy and metals bonds are under pressure, but offers an unexpected consolation in noting that bank loans in the high-yield market are not that exposed, as they were in the 1990s. For that reason, “bank loans may [serve as] a safe haven play if oil decides to make a home at $50 a barrel,” he concludes.

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