From the sheer hypocrisy of a fight over a few billion dollars when faced with trillion dollar deficits and the eventual austerity that will be forced upon the US, DoubleLine's Jeff Gundlach expounds on his growing concerns at markets where fundamentals "are trumped by policy decisions," and while he does not believe that bond markets are bubbly at the moment, the impact of an inevitable recession could be devastating given valuations. His subtle suggestion to keep powder dry through 2013 and into 2014 (as deploying money at that future point will make all the difference), follows from his view that he does not see much value in US equities and suggests great care be taken in US bond markets (focusing on low volatility funds) as he looks at Japan's dismal record (and hyperinflationary possibilities) and reflects on the US that "the issue isn't the fiscal cliff. The issue is the fiscal crisis that the United States has been looking at for the past several years."
Gundlach on how to invest in this environment:
"One thing is clear that this is the beginning of an attempt to bring the fiscal deficit under control or at least start to address it. When you raise taxes and when you cut spending, whatever the combination is going to be, you will have headwinds for the economy. The economy is really being supported--this isn't just in the United States, it's in Japan, the ECB and Britain--the economy is being supported by quantitative easing that is allowing for a massive budget deficit and money printing exercises to go on...
As you address the fiscal problems, you are going to have weak economic growth. What that means is that you are in an environment that is going to have further trouble in terms of investment returns that are in areas that are based on economic growth and areas that do relatively well like bonds... Broadly speaking, I think that investors should be looking for lower prices on most risk assets in these developed countries with the exception of Japan…Investors should be looking for the potential inflationary consequences of all this money printing exercise and the place to look for that is Japan..."
On whether Japan is foreshadowing for what will happen in the U.S.:
"Possibly... I certainly think that Japan is the pace car here. They started out 20 years ago with their zombie bank problem and they've tried various things to get the economy going. Now there's some political change afoot in Japan and they are definitely in the place to look. Japan is in a uniquely bad position. The United States is not in as bad as a position as Japan."
"Ultimately, when you start to look at all this money printing which may continue, Ben Bernanke has said forever basically that yes, at some point, one has to worry about inflationary consequences. I've been saying for years though, that investors who are focusing on the near-term on inflation are way too early and that's still the case in the U.S."
On whether investors should get more disciplined and look at fundamentals:
"The fundamentals are always important but it does get trumped by policy decisions when policy decisions are so radical as has been the case in recent years... There seems to be diminishing returns on the various rounds of quantitative easing. It's almost like a half-life of a radioactive particle. The first quantitative easing brought 50%, the second brought a little more than half of that, the third half again, the fourth less than half again.
It just seems that the idea of a Pavlovian reaction when you see quantitative easing that you should go out and buy risk assets--it has worked four times, but it doesn't seem like you are getting much bang for your buck any more... I would point out that gold, for example, hasn't done much of anything in the last couple of rounds of quantitative easing. It seems that the fundamentals are starting to exert themselves more powerfully against the backdrop of endless quantitative easing, so it's possible that the market support is close to finding its limit. This is why I think that investors should be holding cash and buying risk assets at lower prices once the fundamentals assert themselves."
On whether we're in a credit bubble:
"I don't think there is a credit bubble at this point in time actually. The most powerful fundamental, which is really artificial thanks to the central banks, is that there is a zero interest rate in place in this massive market of government guaranteed securities and therefor by extension, very high quality bonds. It pushes people by necessity into other investments. I don't believe that until there are cracks in the credit quality structure of the credit system that you are going to see a substantial selloff in the credit markets for high yield bonds, non-guaranteed mortgage securities, emerging market debt, so I don't really expect that is going to happen."
"The real killer is going to be the next recession. And there will be one. The policymakers are trying hard to have it both ways... Ultimately as you address the fiscal situation, you're going to run the risk of a recession. When the next recession comes, it's going to be a real killer because what exactly is going to be the policy response. It will be policies in terms of raising taxes and cutting spending that help to bring on the next recession I think, so I don't think it's very plausible that you're going to just turn around and go back to the old method of pumping up the economy with debt... Next recession comes. So the next recession probably is going to be somewhat cleansing, which means that you're going to see things repriced lower."
On where to put your money if not prepared to do short-term trading:
"You've got to survive with virtually no return if that's the way you look at things. I actually recommend that for many investors. I think the small amount of money that you might make by trying to push it here as we get closer and closer to the end game where this thing might tail out--the amount of money you might make will be dwarfed by the amount of money you might lose when things reprice lower.
Put it another way, if you just stay in cash and earn a small return or stay in a low risk investment and earn a middling single digit return--the money you might be able to make as we move into late 2013 or early 2014 with repricing, the amount of money you might make if you are able to deploy the money at that point will make all the difference. People always want investments to go up like a line... That's just not reality. You make 80% of your money in 20% of the time in investing and you have to be patient…I see some values in some of these foreign markets. I don't see a lot of value in the U.S. stock market and I think you have to play it safe in the U.S. bond market with funds that are really dedicated to having low volatility."
On fiscal cliff talks:
"Something is going to get done, it looks like, between John Boehner who has now blinked a little bit going with the million dollar tax bracket and the president going with the $400,000 tax bracket. They're getting close, but this is all just a big circus really. We have a $3.6 trillion spending going on at the federal government and they're taking in $2.3 trillion dollars. So the shortfall is $1.3 trillion and what we are talking about with the million dollar increase is about $20 billion of revenue that would be brought in. At the $400,000, you're talking about maybe $35 billion. So this is just masking a huge fiscal issue. The issue isn't the fiscal cliff. The issue is the fiscal crisis that the United States has been looking at for the past several years and this is sort of a down payment on finally some fiscal reform."