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Jeff Gundlach "Society Looked Into The Debt Abyss And Decided Enough Is Enough With The Debt-Based Consumer Economy"

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Jeff Gundlach who has been spot on with timing his calls for Treasury inflection points, did a quick Q&A with Morningstar summarizing his outlook on the economy. In a nutshell while the DoubleLine manager is still skeptical that inflation may strike, he is convinced deflation is pervasive. To wit: "markets and the economy to date have offered scant evidence to support
the inflation case. Stocks are down over the past 10 years. Real estate
is down hard over the last five years. Commodities are down sharply over
the last two years. Instead of spiking to double digits, bond yields
are hugging the ground. M3, which is now calculated only by private
economists, is down nicely over the past year. And of course money
velocity is moribund: Society has looked into the debt abyss and decided
enough is enough with the debt-based consumer economy.
So, deflationary
forces still prevail. What could shift the balance of forces in favor
of inflation? A well-meaning movement to cut the deficit has at long
last arrived, maybe. But cutting the deficit that is supporting the
consumer economy will directly depress gross domestic product. If that
causes not just a look but a step or two into the deflationary abyss,
then maybe the inflation case will move to center stage." Sure, let's not forget the collapse in the shadow economy. But let's also not forget that the economy is in a vacuum, and were the Fed not in the picture, we would totally agree. But because the most irrational human being in the world is in charge of said world via his control of the US reserve currency (and irrational because he promotes exclusively policies that benefit the vast minority over the majority), we will have to disagree. And so would the price of gold.

Full interview by Morningstar's Liana Madura

1. You were favorably disposed to municipals at the Morningstar
Investment Conference in June. Is that still the case, particularly amid
mounting concerns about the ability of local governments to meet their
obligations?
Not much has changed for the muni-bond market
since June except that it has performed well. Munis remain in a good
place on technical grounds but a bad place on the fundamentals. The
technical part is that tax rates are likely to go up. It is difficult
for investors to part with their muni bonds because they can't find a
generic alternative that will be as attractive on an aftertax basis. As
long as we are in a zero-interest-rate environment in the cash market,
have 10-year Treasury yields in the mid-2s, and face upward pressure on
the marginal tax rates for higher earners, the muni market's technicals
will probably keep it firm. The fundamentals, however, are bad and will
likely get worse before they get better.

There is a battle brewing between public pensioners and the
bondholders who are basically providing the funding for benefits. The
scandal in the City of Bell, Calif., is only the opening chapter in what
will likely be a long, tragic volume. As it unfolds, the volatility of
the muni market should be higher than what we've experienced. Investors
who are tempted by the aftertax yield should certainly be buyers on
weakness instead of strength. Poster children for the municipal
concerns are California general-obligation bonds. At the end of the
saga, I deeply believe that California GOs are going to be
constitutionally paid, but increased volatility will mean investors can
pick their entry spots and buy opportunistically.

2. You were early and correct in signaling the potential for
deflation. However, there are a noticeable number of prominent investors
who still consider inflation a strong possibility. Are there any signs
of inflation as far as you're concerned or do you think the case is
flawed?

I agree that the inflation case looks compelling on
the surface of it. The Fed has run up trillions of dollars in stimulus
and guarantees, has printed a trillion-plus dollars via quantitative
easing, and seems to be gearing up for QE2. Chairman Ben Bernanke
himself vowed in 2002 to drop money from helicopters, should need be, to
fight deflation. With a called shot like that, no wonder many investors
see inflation as the policy-choice end game. And they may be right.

The problem, though, is that the markets and the economy to date have
offered scant evidence to support the inflation case. Stocks are down
over the past 10 years. Real estate is down hard over the last five
years. Commodities are down sharply over the last two years. Instead of
spiking to double digits, bond yields are hugging the ground. M3, which
is now calculated only by private economists, is down nicely over the
past year. And of course money velocity is moribund: Society has looked
into the debt abyss and decided enough is enough with the debt-based
consumer economy. So, deflationary forces still prevail. What could
shift the balance of forces in favor of inflation? A well-meaning
movement to cut the deficit has at long last arrived, maybe. But cutting
the deficit that is supporting the consumer economy will directly
depress gross domestic product. If that causes not just a look but a
step or two into the deflationary abyss, then maybe the inflation case
will move to center stage.

3. Given the strong performance of mortgages during the past
year, do you expect more moderate returns from your portfolio going
forward?
It certainly seems difficult for much of anything
in the fixed-income universe to reprise the strong returns of the past
year. Through August, 12-month returns were about 7% for agency
mortgage-backed securities, 8% for Treasuries, and in the 20% range for
corporate bonds, emerging markets and nonagency MBS. And almost every
active manager did even better because tilting portfolios to
historically cheap credit was such a common and successful strategy.

Returns in the past six months have been aided by a decline in
Treasury interest rates all the way down to just less than 2.5% on a
10-year bond against a backdrop of reasonably good credit-sector
performance. This credit improvement came in spite of the apparent
weakening in economic growth, an unusual juxtaposition. I should point
out that lately agency-guaranteed mortgages (Ginnie Maes, Fannie
Maes, and Freddie Macs) have actually underperformed. What was the setup
for this underperformance? During the summer, naive market belief held
that lower interest rates were unlikely or at least unlikely to trigger
any refinancing. That view is now being sorely tested, and refinancing
exposure is being repriced with each monthly prepayment report. Some
bonds are being hit by refinancings, while others are adjusting to fears
of government loan modification and refinance programs. I expect
mortgage portfolios will continue to exhibit the wide dispersion of
returns exhibited in the past few years since clearly the key variables
beneath the MBS markets remain in a very high degree of flux. It seems
feasible for a well-positioned mortgage portfolio to achieve
high-single-digit returns for a while longer.

4. Given your bearish outlook on the economy, the potential
risk of low inflation or no growth, and the debt/GDP ratio becoming
greater than 90%, what are the chances of the U.S. defaulting similarly
to what happened in Greece? Would you propose any changes to your
current investments?
Well, Greece hasn't defaulted--not yet
anyway. But I see your point, and there is no denying that the market
repriced default risk in Greece way, way up. Greece bonds were trading
at 5% at year-end. Even in March, when the world's eyes seemed to be
opened about the magnitude of the fiscal problem, the yields only moved
up to 6%. Then all of a sudden a full-blown crisis was on, and the
yields exploded to 20% intraday. Even with the nearly $1 trillion
bailout package and the issue supposedly swept under the carpet, you
have to notice that Greece bonds are yielding 12% now. The market is
certainly hedging its bets on the outcome.

The U.S. government debt/GDP ratio is only at 90% if you look at
gross debt, which I think overstates the problem because net debt is
what is outstanding if you exclude the government's own holdings. For
this calculation I think we should. And there is nothing magical about a
90% level, either, particularly when the nation being considered has
many economic advantages, not the least of which is the debt being owed
in its own fiat currency. So it is early to be looking for the end game
in the U.S. dollar or Treasuries. The market will let us know if this
changes. The signal I would look for would be persistent sell-offs in
U.S. Treasuries on days accompanied by disappointing economic news. So
far that isn't happening. If it does, portfolios will need to be
adjusted accordingly.

5. What have been the biggest challenges in setting up your
own management firm, and how do you balance the investment
responsibilities with the administrative ones?
It sure would
have been nice not to have been forced to set up DoubleLine without any
advance planning or even any know-how about how to proceed at the very
first. As it was, I had to go from zero to cruising speed much more
quickly than anyone would ever want to go. We had a lot to learn those
first couple of months, but now we are probably just that much stronger
for the experience. Investors have been so tremendously supportive, and,
in particular, the large number of new investors is gratifying. The
ability to focus the business rationally has increased so greatly that
it far outweighs these challenges.

As for balancing investment duties and administration, I can honestly
say that was more of a challenge before than it is now. I have always
been pretty good at leading a big investment team, as evidenced by the
team's tremendous dedication. Before founding DoubleLine, I ran a
department within a division within a subsidiary of a large
international bank. All those unproductive layers bring a great deal
more administrative responsibility and bureaucratic drag than does
running a privately owned, specialized money-management firm. So from
that perspective, it's really been a refreshing transformation.

 

 


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Wed, 09/22/2010 - 17:22 | Link to Comment FEDstidius
FEDstidius's picture

Society Looked Into The Debt Abyss And Decided Enough Is Enough With The Debt-Based Consumer Economy" - Like the FED gives a shit

Wed, 09/22/2010 - 17:29 | Link to Comment knukles
knukles's picture

Y'all git fired, like Laurence Summers when ya don't care.  Let that be a fuckin' lesson to ya'.

Ah, the joys and immunity of public service.

Thu, 09/23/2010 - 07:46 | Link to Comment zhandax
zhandax's picture

For that matter, when did Gundlach start hittin the pipe?  A serious amount of this is complete delusion.

Thu, 09/23/2010 - 13:11 | Link to Comment knukles
knukles's picture

teeeh heeh....

But Wait!
There's More!

If ya' signs up in the next 10 minutes, we can't do this all day, we'll throw in a personally autographed double-dong

Wed, 09/22/2010 - 17:23 | Link to Comment redpill
redpill's picture

We are all Nietzscheans now

Wed, 09/22/2010 - 17:34 | Link to Comment e_goldstein
e_goldstein's picture

snicker

Wed, 09/22/2010 - 20:39 | Link to Comment Kayman
Kayman's picture

redpill

you are so Kafkaesque !

Wed, 09/22/2010 - 22:05 | Link to Comment NoVolumeMeltup
NoVolumeMeltup's picture

The Nietzsche Family Circus

http://www.losanjealous.com/nfc/

Hit refresh for a new one each time.

Thu, 09/23/2010 - 04:08 | Link to Comment heyligen
heyligen's picture

Governed by platonist contrivers, as usual.

Wed, 09/22/2010 - 21:51 | Link to Comment JLee2027
JLee2027's picture

Deleted

Wed, 09/22/2010 - 17:33 | Link to Comment centerline
centerline's picture

"net debt"?  This assumes the government holdings are liquid and marked-to-market.  And what about unfunded liabilities?  As if an internal default of that magnitude wouldn't have the same consequences anyhow?

 

Seems to me an underestimation of the risks here.

Wed, 09/22/2010 - 17:34 | Link to Comment Dismal Scientist
Dismal Scientist's picture

I thought the US consumer was still maxing out credit and walking away when lenders pull the plug, as per ZH article earlier in the week. On that basis, society has looked into the debt abyss, and said 'SFW ?'. If you were a borrower with negative equity on your housing asset and no chance to refi, then its actually rational to blow up your credit rating on a short term view. What a twisted world.

Wed, 09/22/2010 - 17:40 | Link to Comment centerline
centerline's picture

I think the initial shock of the crisis caused a severe retraction on part of the average consumer.  And, the SFW attitude is emerging this year for sure.  Is a twisted thing for sure.

Wed, 09/22/2010 - 17:36 | Link to Comment Something Wicke...
Something Wicked This Way Comes's picture

I looked into the debt abyss and what did I see?

Helicopter Ben printin gobs of curren-cy

Wed, 09/22/2010 - 17:48 | Link to Comment markar
markar's picture

No evidence of inflation? Vanguard TIPS fund (VIPSX) says otherwise

Wed, 09/22/2010 - 17:48 | Link to Comment Quinvarius
Quinvarius's picture

Suddenly all these guys stuck in bonds are demanding deflation from all corners.

Wed, 09/22/2010 - 18:13 | Link to Comment BobPaulson
BobPaulson's picture

Exactly. My read on the T-Bill mess is that rates will stay low until they don't, then they'll go up. It's all gonna go down sometime between now and when hell freezes over, so keep your eyes open...

Holy Blind Man's Bluff Batman!

Wed, 09/22/2010 - 18:05 | Link to Comment bull-market_3.0
bull-market_3.0's picture

Wow. Advocating going into treasuries longer...very interesting...is the risk/reward worth it now? how much lower can they go? 

Wed, 09/22/2010 - 23:29 | Link to Comment Battleaxe
Battleaxe's picture

 how much lower can they go? 

There are as many decimal places between zero and 1 as there are millions, trillions, quadrillions, .... above 1.

How about .00000000001% interest? .0000000000000000000000000789%? There is also negative interest, which may become attractive if you don't think you can protect your cash.

Wed, 09/22/2010 - 18:21 | Link to Comment Takingbets
Takingbets's picture

Well at lunch yesterday I heard 4 people discussing how they were going to go to Best Buy and max out the credit they could get from them, then not pay the bill.

Those are the people who are willing to use the credit the FED so desperately needs.

Wed, 09/22/2010 - 19:40 | Link to Comment Snidley Whipsnae
Snidley Whipsnae's picture

I know people that are doing the same thing. Not only are they maxing out credit and not paying, they are not feeling any guilt about it... Not saying that they should after what has happened to them over the past 30 years.

Our government and mass media encouraged the consumer, buy it on credit, take a cash out refi lifestyles. Now it's coming home to roost.

There is definitely a party hardy attitude among many people that are upside down on everything they 'own'. 

 

Thu, 09/23/2010 - 07:46 | Link to Comment trav7777
trav7777's picture

had to counsel a girl friend whose having trouble spending less than earned to do the same thing...just walk from the CC and any private student loans.  The bank that lent went into the transaction with eyes wide open.  Once the first lates start going onto the credit report, it's pretty much fucked and you have nothing to lose by defaulting.

Thu, 09/23/2010 - 10:05 | Link to Comment grunion
grunion's picture

That is theft...Pure and simple.

Wed, 09/22/2010 - 18:39 | Link to Comment FranSix
Wed, 09/22/2010 - 19:30 | Link to Comment ghostfaceinvestah
ghostfaceinvestah's picture

"Stocks are down over the past 10 years. Real estate is down hard over the last five years. Commodities are down sharply over the last two years."

And the price of gold is anticipating what Gideon Gono's greatest pupil is going to do next.

Wed, 09/22/2010 - 19:51 | Link to Comment Carl Marks
Carl Marks's picture

The American consumer is worthless trash which is the heap they will all land on.

Thu, 09/23/2010 - 10:07 | Link to Comment grunion
grunion's picture

I really would like to meet you...

Wed, 09/22/2010 - 20:55 | Link to Comment Atomizer
Atomizer's picture

Your next epic failure. Another crisis will be spun on telly.

'We Need to Be Big-hearted and Hard-headed' As the world convenes at the United Nations to assess the progress on the Millennium Development Goals, President Barack Obama's speech outlines the administration's new Global Development Policy, which will change "the way [America] does business" when it comes to helping developing nations build a "path out of poverty." 

http://www.foreignpolicy.com/articles/2010/09/22/we_need_to_be_big_hearted_and_hard_headed?page=0,2

Sheep have forgotten about Patent No. 6904336

http://www.wikipatents.com/US-Patent-6904336/system-and-method-for-residential-emissions-trading

Thu, 09/23/2010 - 07:48 | Link to Comment trav7777
trav7777's picture

How many billionaire tinhorn dictators are we going to mint through this stupid effort?  I mean, goddamn, IQ and Wealth of Nations; how do we expect nations with IQs averaging sub-90 to become prosperous no matter HOW much we send there?

Wed, 09/22/2010 - 21:20 | Link to Comment Justaman
Justaman's picture

As has been stated on this website, biflation over the past few years will eventually give way to hyperinflation.  IMHO, this transition will happen fast, of course, without any lasting recognition by the mediament. 

A failed lumbering effort toward protectionism is going to prompt a currency battle (and other wars) the US can't win due to its poor fiscal and monetary decisions over the last 50 years or so.  Thankfully there is a higher power at work than mankind as this might get real ugly.  

 

Wed, 09/22/2010 - 21:27 | Link to Comment Hang The Fed
Hang The Fed's picture

Fuck carrying anymore debt...let the Keynesian assholes shrivel and die, for all that I care.  At the pace at which things appear to be unravelling, the last thing I need is another bill about which to worry, all for the privilege of buying some more useless shit.  I seriously doubt that that's even within spitting distance of being the first step to fixing what's broken today, but it DOES make for passably-reheated leftovers, rehashed since 1913.

Wed, 09/22/2010 - 21:39 | Link to Comment sporb
sporb's picture

This sounds like a religious revival meeting.

Ya; perma-bears need perma-bad.  

But: what if you are all wrong? Will you let those lesser mortals make all that money just because "you thought you were right"?

Wed, 09/22/2010 - 23:01 | Link to Comment Seer
Seer's picture

But... you have to ask yourself one important question: Is that "money" really backed by anything?  And, whatever you answer you've got to perform a similar testing/iteration; I doubt that you need to go to a third level, but at that point it should be pretty clear that it's Monopoly money and there really aren't any more people left playing the game.

Got food?

Wed, 09/22/2010 - 23:08 | Link to Comment sporb
sporb's picture

I'm Canuckistani. I "got food". I also "got order, got regulation, got the due process of law..."   

Wed, 09/22/2010 - 23:09 | Link to Comment sporb
sporb's picture

as they say: "just sayin'..."

Wed, 09/22/2010 - 23:56 | Link to Comment Hitman
Hitman's picture

The comment that "commodities are down sharply over the last two years" is not correct, at least as measured by the continuous commodity index, which is up more than 25% during the past one year and more than 60% since bottoming out in late 2008 or early 2009.  There is some good commentary on this by Dan Norcini on JSmineset.com (http://jsmineset.com/wp-content/uploads/2010/09/September0410CCI.pdf) who points out that  the rise in commodities has occurred in spite of only limited participation by energy commodities.

He (Gundlach) is not only incorrect on this point, but wildly incorrect.  

Thu, 09/23/2010 - 02:14 | Link to Comment Hephasteus
Hephasteus's picture

After I changed to the M0 M1 M2 LOL accounting system the financial system makes so much more sense.

 

Thu, 09/23/2010 - 08:23 | Link to Comment Grand Supercycle
Grand Supercycle's picture

Short signals detected yesterday have now increased.

http://stockmarket618.wordpress.com

Thu, 09/23/2010 - 11:15 | Link to Comment wisefool
wisefool's picture

Debt/Deficit spending over the last 50 years:

-Created a middle class that was tolerant to the poor and minorities largely through  public subsidy of education. (Americans spend more per student than nearly any country in the world)

-Updated many housing "paradigms"

-Supported the R&D for logistical and workforce mobility greatness. (largely through air travel, computing and mechanical automation)

The downside is that pushing these things much further becomes diminishing returns on free time and social cohesion as follows:

The Middle class is already turning on itself. Keeping up with the Jones has got to the point of "Yeah, the house, cars and vacations made us look like the best couple in town  for several years. Now lets get a divorce, use it as an excuse to get a bailout and do it again. The kids won't mind as long as they have electronic toys and go to private university that will explain to them how much better their life still is compared to those oppressed,inflexible  minorities,women and tinfoil hatters that live in their modest homes for life growing food in their own backyard gardens."

In my observation, the boomers went into debt for their "social justice" moon shot. And it was largely a good thing. However, there is a point where they stopped moon missions.

We are at that point now, the poor and the middle class knows it. Thats why we are deleveraging. We are telling TPTB (credit pushers) thanks for the sentiment, but we really do want to eat bread. Cake is nice once in a while but makes you sick in the long term.

Sat, 09/25/2010 - 23:03 | Link to Comment CL1
CL1's picture

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