DoubleLine’s Jeffrey Sherman: 2 Wild Cards That Could Derail the Economy

Next year we’re probably talking about inflation in the mid-threes — 3.5%, though it’s very hard to forecast right now because of all the uncertainty.

Some have been worrying lately about the specter of “stagflation” because of the inflation rate. Are we headed there?

We’re not in a stagflation world yet. The word stagflation makes people think of the late ’70s, early ’80s, with double-digit inflation and relatively low growth rates.

Next year is expected to be in the 3% to 4% range of real GDP growth. If inflation comes down a little bit and we get the right mix of growth with inflation, I don’t think it’s stagflation.

But inflation is likely to stay elevated. What should be on investors’ minds is that if you’re just sitting in cash, you don’t have the ability to outstrip inflation. Cash yields zero. 

Investors need to own some things that are correlated to inflation, and the best asset class that does that well is commodities. It isn’t bonds.

What’s a good hedge against inflation, then?

One way is to have a 5% to 10% allocation to commodities.

What about labor’s challenge to the economy?

You’re seeing labor demanding more in terms of wages, benefits, flexibility as to where they work — they don’t want to go to the office, maybe, all the time. People want to change careers.

So there’s a different dynamic that’s taking place; and, obviously, wage pressure is underneath all of that. If it continues, it could put a little bit more upside to the inflation number as well.

What needs to be done about the labor shortage?

There aren’t enough people in the unemployed labor force to fill the roughly 10.5 million jobs that are available. So you need a way to incentivize people to come back into the labor force. 

In some industries, wages are going to have to increase to incentivize people to work. But labor has the upper hand here for a little bit.

Regarding this, what will you keep an eye on over the next couple of months?

I’m going to watch what retail sales look like — consumption data. Now that benefits have expired, we’re seeing challenges.

What are your thoughts about interest rates?

They’re still too low. Next year you should see the 10-year Treasury north of 2%. So investors need to be cautious on their interest-rate exposure in the fixed income market.

When we talked in February, you warned about the corporate bond market. Are you still calling for caution?

Yes. The caution I see is due to the interest rate risk, not the default risk. The corporate bond market has roughly almost as much interest-rate risk as the 10-year Treasury.

The default risk is relatively benign, which is reflected in the spread. Spreads are really tight by historical standards.

For people who do want exposure to corporate America, I like things such as bank loans, parts of the CLO [collateralized loan obligation] market, which packages up bank loans and things that have lower interest-rate sensitivity, like residential mortgage-backed securities.

Asset-backed securities, such as loans, are attractive because they float.

They don’t have a fixed coupon; they have a coupon that’s tied to the Libor rate. That means each quarter, they reset. That dials down interest-rate sensitivity. 

So these assets look pretty attractive today, given that we currently have a benign default environment.

Please discuss the economic threats now associated with the coronavirus.

COVID-19 will be around in 2022, unfortunately. What could go wrong is that you can get more new contagious variants and breakthrough cases.

Will that upset the economy?

It absolutely can. But the damage of shutting down the economy and forcing everyone to stay home is greater, for a society, than some people getting sick and, unfortunately, dying.

If we get herd immunity, it becomes [eventually] just like the common cold. I don’t want to be flippant, but that’s ultimately what we’re gunning for and what the vaccines and herd immunity are about.