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DoubleLine Deputy Chief Investment Officer Jeffrey Sherman

Portfolio > Economy & Markets > Fixed Income

It’s the Best Time for Bonds in More Than a Decade, Gundlach’s Deputy CIO Says

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As stormy as the markets are today, the sun’ll come out tomorrow — as the song goes — though when that tomorrow comes is pretty uncertain. Nevertheless, there are pieces of sunny news, as suggested in a ThinkAdvisor interview with Jeffrey Sherman, deputy chief investment officer at DoubleLine, of which Jeffrey Gundlach is CEO.

For one: “On a go-forward basis, we believe that the fixed income market is the most attractive it’s been since 2011,” Sherman argues. He maintains that the U.S. isn’t in a recession now but believes “it’s increasingly likely that we’ll have some form of recession in 2023.”

The concern is that it won’t be “narrowly contained” but will “bleed over into” other sectors of the economy. Sherman insists, however, that “there’s not a lot of evidence that a broad-based recession is on the horizon.”

It’s smart to keep in mind that the stock market “usually bottoms in the middle of a recession,” according to Sherman.

On the brighter side of the interest-rate increase scenario, “We’re getting closer to the end of the Fed’s hiking cycle,” he says, “and [it’s] talking about a glide path” for getting there rather than “wait[ing] for inflation to come down.”

“The market has about another 1.5% of rate hikes priced in between now and February,” he notes. When it comes to investments, in the interview Sherman discusses some additional parts of the credit market that “look more attractive” today than “putting more money into equities.”

Formerly a portfolio manager and quantitative analyst at TCW, he is a chartered financial analyst overseeing DoubleLine’s investment management subcommittee and is lead portfolio manager for multi-sector and derivative-based strategies. His hit interview podcast, “The Sherman Show,” just released its 126th episode.

ThinkAdvisor interviewed Sherman by phone on Oct. 18. Speaking from his Los Angeles office, he allows that DoubleLine has been adding to the Treasurys in its portfolio, a move that indicates the firm is “taking more interest-rate risk,” he says. Here are excerpts from our conversation:

THINKADVISOR: What’s your forecast for the bond market?

JEFFREY SHERMAN: On a go-forward basis, we believe that the fixed income market is the most attractive it’s been since 2011.

People shouldn’t look at their statements to see what’s happened with their bond portfolios. They need to think forward.

Over a two- to four-year horizon, the best predictor of return in the bond market is the yield you start with.

If you believe, as we do, that inflation doesn’t stay elevated in multiple years going forward, that it gets on some path back to the Fed’s objective, the inflation rate will run at about 2% to 3% over the next few years.

If that’s the case and you’re earning 5% on a high-quality [portfolio], that means your purchasing power is preserved.

What sorts of bonds would be best?

You don’t have to buy junk bonds and get a 10% yield. You can buy corporate bonds that yield almost 6% today. You can pair these with Treasurys.

In our view, balancing out the credit risk and the interest rate risk is giving you one of the better opportunities on a forward-looking basis — a more risk-managed portfolio.

No one really knows how deep the recession will be. So we’ve been adding to the Treasurys in our portfolios — taking more interest rate risk.

Some say the U.S. is already in a recession. What do you think?

I don’t see us being in a recession [now] because the consumer has stayed resilient.

But the 90-trillion-dollar question is: Can we stave off a recession?

It’s becoming increasingly likely that we’ll have some form of recession in 2023. But what is the depth and breadth of it?

Is it going to be a recession focused on, let’s say, the real estate market [since] we know that housing is [slow] and mortgage rates are extremely high.

It’s pretty easy to see there’s going to be a meaningful slowdown in that part of the market.

But the question becomes: Does it bleed over into other things? The concern is that the recession is not just narrowly contained.

So far, there’s not a lot of evidence that a broad-based recession is on the horizon. It seems that it’s going to be more narrowly focused.

To what extent is there inflation in health care, where prices are usually rising?

The health sector will actually have a drag on inflation, making it a negative contributor. Health care is a bigger piece of the index [that the Federal Reserve] use[s]. That component is expected to be a detractor from the overall inflationary picture.

What are the implications to investors?

We’ll have to watch that because a lot of people didn’t expect the spike we saw in housing. That’s part of what was a surprise to the market.

Nouriel Roubini, New York University economics professor, just wrote in Time magazine that “The decade ahead may well be a Stagflationary Debt Crisis the likes of which we’ve never seen before.” Your thoughts?

That’s why he has the nickname “Dr. Doom.” He’s extrapolating the short term. Yes, we do have a debt burden and inflation.

But why I think we potentially will not have stagflation is that the central banks are trying to fight the inflation. They don’t want persistent inflation.

If we don’t get persistent inflation, you can’t get the recipe for stagflation.

It’s atypical for both the equity and bond markets to be awful at the same time, as they are now. Right?

Yes, except in inflationary environments, like we have. But just because we have a bear market in equities doesn’t mean it’s going to continue if we have a recession because that’s about earnings.

If earnings can deliver, the market will eventually look through the bad times.

The stock market is thinking: What cash will I get in 2023, 2024, 2025 — out 10 or 15 or 20 years? Earnings will recover at some point.

Why are we having this simultaneous bear market in bonds?

Bonds were way too expensive, and the yields were way too low for the environment we were in. This is why you’ve seen the Fed hiking interest rates; they’re fighting inflation.

We’ve been in an equity bear market for some months now. It’s traditionally thought that the market is, overall, the leading indicator of the direction of the economy rather than vice versa. Do you go along with that thinking?

I still believe that because the market is a forward-looking mechanism.

The market usually bottoms in the middle of a recession because people start to discount everything and think forward about what’s happening. It comes down to the relationship between interest rates and equity multiples.

Do you have any good news about interest rates?

I feel that we’re getting closer to the end of the Fed’s hiking cycle. There’s probably a little bit of upside risk to yields, which we gleaned from the Fed’s minutes [released Oct. 12].

The minutes signaled to the market that they weren’t going to wait for inflation to come down before they stop hiking. They were talking about having a glide path for getting there.

They want to get closer to neutral.

So that gave the market some optimism prior to the CPI [Consumer Price Index] report data: The Fed isn’t going to overengineer and try to wait too long. Their next meeting is in a few weeks.

And what are your expectations?

I think they’re going to be data-dependent. That isn’t likely to change between now and year’s end, meaning they’re going to deliver with 75 basis points at the November meeting. The market is on the fence whether it’s 50 or 75 basis points.

Cumulatively, the market has about another 1.5% of rate hikes priced in between now and February.

They’re trying to get a glide path where the next months will be .75% in November; .5% in December; and .25% in February.

Then they’ll try to take a pause. I’d prefer not to see that .25% in February. The meeting will be in the first week of the month.

I’m seeing that the way the market has priced in [increases], the rate hiking regimen seems to be at least consistent with the [Fed’s] dot plot economic projections.

And it has a little bit of upside.

It seems that the market is respecting the data and communication from the Fed and therefore has priced it in.

What does that imply?

It seems that we’re getting, at least, close to the end of this interest-rate hiking regimen, although they still have to deliver on those hikes over the next four months.

Are there any other investments that financial advisors should be recommending to clients right now?

If people are scared today — and rightfully so — just buy short-term Treasurys, buy T-bills. Put your money in a money market account and wait a little bit.

The only [negative] thing about money market accounts is that if bad things start to happen, those rates will come down.

So instead of putting more money in the equity market today, certain parts of the credit market look potentially significantly more attractive.

What else would be wise to do?

If clients are bellyaching about the return, advisors can [recommend] their holding a little bit of cash and that they shouldn’t be aggressive in their asset allocation right now.

Four percent for a six-month T-bill isn’t bad.

However, the client might say, “I missed a rally [in whatever].” But if it makes you sleep better and lets you stay the course with the rest of your portfolio, I think that’s important.


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