Gundlach: What Everyone Gets Wrong

September 14, 2015

Jeffrey Gundlach requires no introduction. The DoubleLine chief executive and chief investment officer has built a reputation as one of the most insightful fixed-income investors. This year, he brought that expertise into the ETF space for the first time with the launch of the SPDR DoubleLine Total Return Tactical ETF (TOTL). The actively managed fund hit its first $1 billion in assets in just about five months, all the while outperforming its competitors. Gundlach, who is a keynote speaker at this year’s Fixed Income Conference, taking place Nov. 4-5 in Newport Beach, California, shares his views on the world and on where the opportunities are.

This is the second of two parts. Read Part 1 here. We saw a pickup in volatility late in the summer in global markets. Has your view on the health of the U.S. economy and the global economy changed at all?

Gundlach: [On Sept. 1,] I came to the opinion that markets were showing contradictory signals, and that the risk markets seemed to be out of sync. So I made a comment that got circulated: “If you look at commodity prices, and you look at emerging market equity prices, and you look at junk bond prices, and you look at U.S. nominal GDP, you would probably expect—looking at only those four things—that the Fed should be easing, not tightening.”

It seemed like stock market investors were walking around as if in a daydream, missing the fact that we have multiyear lows in commodity prices, multiyear lows in junk bond prices, multiyear lows in emerging market equity prices, and the U.S. equity market was very near its all-time high. That seemed completely out of sync with messages that were being sent elsewhere.

Also, the Shanghai Composite Index in China—the second-largest economy in the world—was crashing. The U.S. market was in need of pricing downward to get in line with the signals being sent elsewhere.

One has to believe that one of the drivers of the crash in commodity prices was a slowdown in China, which isn't really hypothetical anymore, because the autocrats in charge of that economy have reacted by cutting interest rates five times and changing reserve requirements, and the like, another three times. So, eight times this year, the Chinese authorities have found it a good idea to do some sort of emergency measures. Finally, they devalued their currency, which was a strong signal that they were concerned about their exports and were trying to amp up economic growth.

We did analysis recently where we said, what if the Chinese economy is not growing at 7.5 percent or 8 percent, which is what they hope to do? What if it’s growing at 2 percent or 0 percent instead? And we came to the conclusion that the global economic growth could very well be only 1 percent right now on an annualized basis. That’s an incredibly low rate of growth.

The problem with 1 percent on average global economic growth would be that a large fraction of countries would probably be in recession. When average growth is at 1 percent, some are at 3 percent and some are at negative 1 percent. Once you're negative, you're in a bad place for economic growth, and you probably want to do something about it. And the thing that’s left for most economies to do is to devalue their currency.

We’ve been of the view, for nearly three years now, that we entered a world in which currency devaluations were going to be the norm. And the reason we picked November 2012 is that’s when Abenomics began—when Japan started to vocally report that they wanted to stimulate their economy by devaluing their currency in a systematic way. They did that, and the yen has weakened very dramatically from 80 nearly three years ago to 120 versus the dollar. It’s a pretty big devaluation. The flip side of all this is a persistently strong U.S. dollar, right? What does that mean for the U.S. economy going forward?

Gundlach: We’re already seeing that multinational companies are having trouble with the translation of profits from foreign currencies into the U.S. dollar. What it means is that the U.S. competitive position in certain industries, and for multinationals, is getting more challenging. It also means that the U.S. inflation rate is going to have a hard time gaining traction, because a strong dollar is obviously a vehicle to import deflation, or at least disinflation. That’s been the consequence of a stronger dollar.

Now, the dollar was smoking hot from June 2014 until March of this year in a nonstop appreciation. After the dollar got so strong, it became problematic for the Fed, which wants to raise interest rates.

The Fed doesn’t have any fundamental reason to raise interest rates, but they're very nervous about being at zero for so many years, and how it ties their hands, should the economy weaken, which it appears to be happening globally.

Starting on March 18, Janet Yellen showed that they were thinking that the dollar might become a new issue for them, and it might cause them to have to wait in terms of raising interest rates. Ever since then, the dollar has moved sideways.

But we’re in a funny kind of circular logic world, where, since the Fed acknowledged a strong dollar could become a variable, that meant the odds of the Fed increasing interest rates declined. One of the reasons the dollar stopped strengthening is the consequence of the Fed mentioning its strength has been problematic, meaning there's less likelihood of them tightening. But the reason the dollar was getting so strong was that the Fed was talking about tightening.

You see the circular logic: The dollar is strong, so they can't tighten. So the dollar weakens, so they can tighten. So the dollar strengthens, so they can't tighten, so the dollar weakens, so they can tighten. And around we go. That’s where we are right now. What happens next?

Gundlach: It’ll have to break out one way or another, and we’ll let the market tell us which way. I don’t always have a view on where things are going to go. And much of the time, you don’t need to have a view, you need to watch the signals of the market.

Long [duration] bonds want the Fed to tighten. The long bond wants there to be deflation. Why else would you buy a long bond yielding 3 percent, other than there's a strong likelihood of zero inflation or negative inflation? If you think inflation is going to be 2 percent, you probably have no interest in a 2.75-percent-yielding 30-year Treasury bond, and certainly have no interest in a 2-percent-yielding 10-year Treasury bond.

The long end of the bond market—perversely, versus the way people think about it—rallies when the Fed is about to tighten, or is perceived to be more likely to tighten. And it struggles even in the face of high-stock-market volatility, when they think the Fed is less likely to tighten. That’s the Rosetta Stone right now to figuring out how the markets are behaving. Most people don’t get this.

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