DoubleLine CIO: "It Sure Feels Like 1987"

Submitted by Christoph Gisiger via Finanz und Wirtschaft,


It’s one of the most important questions this year: Where are bond yields in the United States heading next?

For Jeffrey Sherman the answer seems to be obvious: «Up», he signals with his thumb while at lunch at the Los Angeles headquarters of DoubleLine Capital. The Deputy Chief Investment Officer at the renowned fixed income boutique of bond king Jeffrey Gundlach expects more turmoil for financial markets and draws parallels to 1987, the year of the monster crash. At this time, the lively and approachable Californian spots the most attractive opportunities in the commodity sector since commodities tend to perform well in the late stage of the cycle.

Mr. Sherman, tensions in the financial markets are rising. As someone who likes financial history, what are your thoughts when you look at the big picture?
From a short-term perspective, it sure feels like 1987: a little spookiness in the stock market and yields rising. So there are a lot of parallels to 1987. For example, tariffs, a weak dollar and a new Fed Chairman. And remember, there was the crash before the crash. That year, the stock experienced some jitters already in April and about six months later you had the big crash on Black Monday.

That day in October 1987 the Dow Jones suffered its biggest loss in history. At that time people pointed to electronic trading and new financial products like portfolio insurance. Do you spot similar risks today?
People blame quants, people blame algorithms, people blame risk parity. But I’m not convinced. The reason we had this sell off is not algos or risk parity. It’s because of humans. For instance, we all have been told that ETF buyers are buy and hold investors forever. But they’re buy and hold investors until they’re not, until they panic. That’s why these websites for electronic trading like Betterment and all the other Robo-Advisers were down on February 5th. I think even Fidelity had an issue because of the huge volume. So why did all these people try to log in? They weren’t logging in to buy, they were logging in to sell!

What’s next for stocks?
I think you’ll see it again. If bond yields rise you are going to see another scare. It’s the velocity, it’s the speed at which this correction happened: 10% in roughly three to four days, that’s a big move. But what’s interesting is that the bond market was not behaving in a manner which is consistent with the recent past. It didn’t seem like it wanted to rally. Bond yields essentially ended flat that week if not slightly higher. To us, that causes us pause. It means that this correction was an equity market story and bonds weren’t even paying attention to it. Basically, the bond market said: look we continue to trade on fundamentals. We have bigger deficits, we have a growth story, so yields need to be higher.

So what has changed in the bond market?
What has changed is the tax cut. The tax plan really started in the middle of September and that’s when you saw the bond market reacting. That’s when President Trump felt he had to do something and it took him and congress the rest of the year to get it done. At that point, the market had shifted from its disinflationary mindset to a moderate inflation mindset. And that’s the repricing that has been taking place.

Is the tax cut really a game changer for the US economy?
As critical as people were initially of the tax cuts, the cuts are beneficial in 2018 for roughly 98% of the working class. That means that there is more money to be spent or saved. Also, there is something about paycheck growth versus one-time bonuses. In the former case, people tend to spend more, especially people low-income earners because they are the spenders by definition. They don’t make enough money to save. So I think there is the potential to get a little bit of inflation. Because if it is that expansion from the consumer, it will look growthy, but it will also look inflationary. But how long it persists is the multi trillion-dollar question.

What’s more, the tax cuts will bloat the deficit even more. What’s your take on that?
We have an administration and a Congress which want to spend money. For instance, Senator Rand Paul was filibustering for about two hours, ranting about the increase in the deficit and then voted for the tax plan. It’s hypocrisy. So I think they will continue with this deficit binge.

How will this impact the midterms in fall?
People are speculating if the Democrats are going to take over. Socially, they probably could. But they are going to have a hard time economically to take over either the House or the Senate; simply because the tax cuts are going to trickle through and many workers are going to get the benefit of minimum wage. So even the people who aren’t truly getting a tax cut are getting a pay hike. They are going to say: “Look how well we did.” So for the Republicans the timing is beautiful. But I think it reverses in 2020. That’s something we have been talking about for a few years: It’s not the 2016 election that really is the one that’s going to be a pivot. It’s going to be 2020. The reason for that is that the deficits are going to explode, and this administration seems to love debt.

And how do you cope with political risks like the Muller investigation form an investor’s perspective?
The Mueller investigation looks bad. I mean that thing gets worse every week or two. But markets don’t care. They only care if there is an impeachment and then you will get a short-term correction. But it’s very hard to impeach the president. Even if the Democrats get it in one arm of congress they would have to get it through the Senate. So they would have to go to trial in the Senate and the Republicans still have a blocking majority there. And the Republicans showed that they’re loyal to Trump. So it’s practically impossible. But there is always political risk in the world. And typically, the flight to quality trade is what works. That’s why you own high quality bonds like Treasuries, Japanese government bonds and things like that.

So where are US bond yields heading in 2018?
I think we’re going to 3.25 to 3.5% on ten year Treasuries. We broke through most levels on the ten year bond and on the thirty year bond. They have broken their downward channels. Coming in the year it was like: “Hey, we will probably test 3% on the ten year by the first half of the year. Then in January it turned into: “You know, it’s probably the first quarter”. Now it’s maybe March because the bond market does not want to rally. But it’s not just technicals. We’re talking about the Fed’s balance sheet, we’re talking about expanded deficits and we’re talking about less revenue coming in for the government. Don’t forget tax cuts aren’t free.

What does that mean for the new Fed chief Jerome Powell and his plans to tighten monetary policy further?
In March he’s going to hike the Federal Funds Rate. But if you want to hike interest rates three or four times this year plus do the balance sheet unwinding then I think we’re going to have a problem early 2019. I think the financial markets will respond and that’s not good for risk assets. So I’m not convinced that the Fed will take this entire path because I think it becomes painful. This was all set up by Yellen around a year ago. Since then, a lot of fundamentals have changed in the debt market. The plan was set up when yields were lower and before we were set to double the deficit. So it’s really hard to say how the path will look like for the Fed. That’s why we were all listening and watching how Powell behaved when he took the stage this week. It looks like the Fed is going to be more hawkish. But If you want to finance all that debt, you kind of need some dovish people on the board of the Fed. You don’t really want Hawks on there.

Where do you see the biggest risks if something goes wrong?
It’s not that we are extremely bearish on the world. But if rates go up it will put some upward pressure on spreads. And if you respect financial history, what the Fed has always done is hike until something breaks. We definitely had the debt build up. Looking at debt to GDP, people talk a lot about a bond bubble. But it’s not in the treasury market and it’s not in the housing market. It’s in Corporate America.

What’s wrong with Corporate America?
Many companies really lived on due to this low interest rate environment. Zombie companies, those that earn less than they pay in interest, are on the rise again. That’s why you have to watch the corporate market. Right now, it’s not a problem. But let’s say we go to 4% on ten year Treasuries. Does a 6% high yield bond make sense? Probably not. It’s probably 9% or 10% because you have to worry about refinancing. So this is something that hasn’t really happened historically. In fact, the high yield market lived through the entire secular bond bull market. So if we go into this structural bear market, the junk bond market is toast. You are going to have 30% to 40% default rates. That’s extreme thinking. But let’s just take it back down: A 4% on the ten year bond seems completely plausible. So how do you think these risk assets respond? And what does it mean for other markets? People have become complacent with high yield bonds. They assume they don’t default hardly ever. But we know that’s not true. There’s a reason they carry this kind of rating.

Junk bonds tend to act more like stocks in their market behavior than other bonds. What’s your outlook on equities?
One of the most dangerous things is naive extrapolation. Last year, most equity markets advanced more than 20% in dollar terms. So I think some of the risk this year is this naive extrapolation of this recent experience. It’s this recency bias that people think that it just can continue forever. So the risk is that people get complacent and think that equites can always go up.

What is your recommendation when it comes to investing in stocks?
In the US, it’s very difficult to say stocks are cheap. In terms of valuations, when you think about the CAPE ratio for instance, you have roughly a 33 ratio on the US market, something closer to 22 to 23 on Europe and about 18 on emerging markets. So what you see is that the European market and emerging markets are a lot cheaper. Also, if you buy into this thesis that we will continue to have this coordinated global growth story, then the emerging markets should be the biggest benefactor. So the ideas is that if you want to deploy new money into equities it’s probably best to kind of shy away from the US because everybody knows the story about the tax reform already. US stocks are priced I won’t’ say to perfection but to a pretty rosy scenario. So if yields push significantly higher it’s really hard on a discounted cash-flow basis to rationalize all of that.

So where do you spot more attractive opportunities for investors right now?
Commodities is our choice investment for investors to get diversification at low prices. It’s an area that tends to do well late in the cycle. It’s a fundamental story.  The consumption side has been increasing and there’s upside to that. If we go from 3.5% global GDP growth to 4% that changes the consumption dynamics significantly. Also, commodities are cheap by historical levels which means it looks like they have room to run. People have kicked them out of their portfolios because of how bad they did for years. It’s an asset class that has underperformed the S&P 500 since the financial crisis every year. But if you get some inflation it’s going to be exhibited in this part of the market. Commodities aren’t perfect on inflation. But they’re pretty good when you have changes in unexpected inflation – and that’s what investors are waking up to.

And which commodities do like most?
I like industrial metals. Copper is kind of iffy at times. However, there’s a strong case for nickel due to demand from electric vehicle production. And if we get growth, zinc still looks interesting because it’s used in galvanizing steel. So I think industrial metals have momentum. I’m optimistic for the precious metals as well. If we do get inflation signs you will see that in the gold and silver price. What’s more, I still think oil goes higher. I think demand will pick up and we will get back to $80. Maybe not this year. Maybe it takes two years. But if the growth story is true the energy market is too cheap still.

Comments

tgatliff Tue, 03/06/2018 - 16:27 Permalink

I like gloom and doom "porn" like the rest of them, but I am growing tired of people comparing today with the pastt.  In 1987, central banks weren't directly buying equity futures (or directly buying stocks like the SNB/BOJ/etc).   I personally think the future is seeing massive swings as central bankers fight for control.

MK ULTRA Alpha Baron von Bud Tue, 03/06/2018 - 22:56 Permalink

This man was not alive in 1987, or maybe he was born in 1987.

What is the real reason for 1987? The reason was the Jewish Shemittah. It's a Jewish concept that a year of fallow. Which means the Jews take their money out of the market to make up for sin, and they must repay debts and a whole host of reasons. The Jews no longer have that much control of the market to cause a sell off for a Jewish holiday.

Go correlate market crashes and market move up, to the Shemittah cycle, it's a cycle that most people don't know.

When you trade in the market do you listen to CNBC, Wall Street Journal etc.? Then you don't need to be in the market.

You forget everything when you trade, forget everything means you don't listen to news from Goldman, WSJ, CNBC etc. You only listen to the MARKET MAKER.

This is how it's done, you pick three stocks, three good companies. Several times a week you send in an order which is the SAME NUMBER OF SHARES YOU ALWAYS BUY IN THE MORNING. The market maker must make a market. The market maker will know that your $100K buy in is you. He knows. He knows what time you come in and the size. He knows what time \you sell in the afternoon. He will make you money. A 1%, 2%, 3% 5% 6% and so on gain is big money and it's safer than leaving your money in over night.

IF you must leave your money in over night or a week or a months, you tie a bow tie. This means, if the $100K goes down, you make money, if it goes up you make money. It is insurance. If you don't understand this you shouldn't be trading in the market.

You must learn to tie your bow tie correctly, if it's too tight, or too loose, you won't make good money. It takes practice.

I traded for years, then I read a book it was about the 1920's era, he called himself a "bucket operator" or something like that, he used the "bucket" to describe trading, he was a market maker.

That's when it hit me, the news isn't the source of trading info, it is working WITH the market maker to HELP him make the market.

Ok we understand that, now when a stock is shooting to the moon, do you stay on the ride to the end? no, you must train yourself to take profits before the peak.

It's like a steak, you cut the best part out and leave the fat. You decide before hand, what section of the run you will take, what percentage gain without riding long term.

I got more for, you want to trade, look for firms that compensate employees with stock. One of the oil platform companies that manufactured and operate oil platforms would go into the market each month to buy stock for the employee compensation program.

At the first of the month, the stock is low, but towards the end of the month is higher, it may only be a 5% capital gain, but that's good. A $100,000 investment earned you $5000. And it's safe, because you want to hold if it's hits the fan because this is a good firm, major player in the petroleum industry. No need for insurance, but something you must learn, always sell if it's hitting the fan and take losses. You must train yourself not to be caught up in the up and down and take profits early and losses quickly.

There is a great deal one must learn, how to spot naked shorts, who is shooting bullets and from where.

Volume used to be an important factor, it means demand or losses and you must be able to spot the trend in volume early. Is it a demand trend, is it a loss trend?

I just wanted to write this because the article is another doom and gloom from a person who may be shorting a firm and he's caught and has to use agitprop to roil the markets to get his short, because there are hundreds of thousands of traders who ONLY SHORT THE MARKET. They hate what is called a short squeeze and you must learn to participate in a short squeeze.

It takes years of actually trading, hard core trading to know this, a 401K is nothing.

In a 401K, you must have a negative correlation to the market, this means you must have a certain amount that you can live with in precious metals like gold and silver, it may be 10% or 20% for you or it may be higher. It's insurance.

It means, if the market crashed, you won't be hurt that bad, because the gold and silver would more up. And what is the best stock for a 401K, big and mid size oil companies and defense contractors. Why? they always come back. And don't discount the power of dividends, some companies will have a system to reinvest the dividends into stock. That's a super cheap way to build wealth.

What else can I teach you, there is so much more but you've worn me out, see, I was alive in 1987, and the next Shemittah cycle I caught and the next one after that until now I know, the market is so much larger it can't be controlled by the Shemittah cycle. However, it has an impact and you can still make money if you watch the cycle and trends.

And find the book on the bucket operator so you have a better understanding of the market.

In reply to by Baron von Bud

ImGumbydmmt hedgeless_horseman Wed, 03/07/2018 - 00:36 Permalink

Jeffrey Sherman

https://www.bloomberg.com/research/stocks/private/person.asp?personId=1…

 

 

Jeffrey J. Sherman CFA

Portfolio Manager, DoubleLine Funds Trust - DoubleLine Strategic Commodity Fund

Age 40

Total Calculated Compensation

This person is connected to 0 Board Member in 0 organization across 10 different industries.

 

In 1987 the "knowledgeable" Mr Sherman was no doubt "Jeffy" as he was barely 9 years old. 

So to him 1987 feels like bed wetting.

I lost out on a trip to France i competed to qualify for to study Architecture my junior year of college, when my father's company tanked in 87, so i at least had a clue the market sucked and kicked a lot of hard working people's ass.

This Guy, Don't effing lecture me about what 87 felt like when you were 9 years old.

ALSO WTF is 2017 Why do you look like the dick head executive "Ellis" from the very First Bruce Willis Die Hard movie in 1988

https://www.youtube.com/watch?v=1ipagRxiCqM

 

" Booby I'm your white knight"

In reply to by hedgeless_horseman

Laowei Gweilo tgatliff Tue, 03/06/2018 - 17:01 Permalink

+1

came to post the exact same thing. holy eff enuff of the 87 analogies again.

if I had a bitcoin or amazon stock for every time ZH posted a chart over the last 8 years showing a current and historic trend line similarity as why this time the stock market is gonna crash ...

 ... well, i'd probably be on hookers and blow instead of on zero and hedge XD

In reply to by tgatliff

Constitution_Bitches tgatliff Tue, 03/06/2018 - 17:17 Permalink

Agree not 1987 worse much much worse not doom and gloom just is what it is.

We have as you mentioned the Worlds Fed to thank for the parabolic debt and derivatives that did not exist in 1987.

Leverage through many facets of toxic instruments have pushed assets to levels never seen.

The amount and one-sided nature of the systematic leverage will be the catalyst for huge market swings on the horizon bigger and badder than what we just witnessed.

Example, When the market insiders were given a wink and nod to short the VIX at will all it took was a group of market Robin Hoods to expose the leverage and blow up XIV.  

Tip of the iceberg me has the felling that what is about to be exposed in the so called markets will be nothing like 1987 much much worse. 

This will not be good for most of us as the Plutocratic's will pull Moral Hazard on We the People.

 

In reply to by tgatliff

ted41776 Tue, 03/06/2018 - 16:32 Permalink

{yawn} On one side, there is fiat that is created out of nothing, mostly in digital form. On the other side, there is a limited amount of finite resources. Any "crash" will be quickly corrected by central banks adding a few zeros to their balance sheets. Bonds and stocks will then be bought up by economic stability algos with money that does not exist. There will be no crash because there is no market. The only alternative is culling the population. The fix is in. That is all

tgatliff ted41776 Tue, 03/06/2018 - 16:48 Permalink

There are consequences for the printing, which is wealth inequality.  Eventually a political response (more extreme that Trump) occurs due to all of the wealth inequality that has been created by all the printed money.  The percentage of the population that is poor reaches a threshold that politically things become impossible to not change, which is when things fall apart.  These poor people will be cheer the collapse because they never profited from it.  In short, this upcoming political response is what will ultimately reset the system and end the current madness.

In reply to by ted41776

taketheredpill Tue, 03/06/2018 - 16:36 Permalink

Based on pretty much EVERY article I read and talking head I listen to....BOND YIELDS ARE HEADED....UP.

 

So based on the theory that the market will fuck over as many people as possible....the likely direction of (Government) bond yields is...DOWN.

 

 

 

buzzsaw99 Tue, 03/06/2018 - 16:52 Permalink

What’s wrong with Corporate America?

Many companies really lived on due to this low interest rate environment. Zombie companies...

I knew if I kept reading this long enough that eventually zombies would emerge.  Zombies bitchez.  You can't have good doom porn without zombies.

I am Groot Tue, 03/06/2018 - 16:53 Permalink

One hit wonders, 80's clothes, every woman was dressed like Madonna with big hair, Miami Vice, Michael Jackson was still Black and not molesting kids, movies were great, MTV had music videos, Video games were awesome, SNL was actually funny, Reagan was president, Cool Ranch Doritoes, and the Democrats weren't total Marxist/Communist scumbags then.

 

Same financial doom porn, different day......Meh.

Jeepers Creepers Tue, 03/06/2018 - 17:07 Permalink

My guess is this same clown had zero problem with Obama running up the debt more than the last 40+ presidents combined and QE to Infinity.  But the government stealing less of your money is suddenly a crisis.

innertrader Tue, 03/06/2018 - 17:14 Permalink

TOTAL different situation!  The referred to break was one within a huge bull market.  This market has already been a massive bull market for 10 years!!!

 

SETH RICH!!!

TRIUMPH with TRUMP!!!

GotGalt Tue, 03/06/2018 - 17:16 Permalink

Commodities fund I watch (BCX) was doing good for awhile sing Gundlach said be long commodities but has since retraced all the profits and then some.  Obviously depends on what commodities any given fund is investing in, each one is different.  Straight up buying Zinc or Lithium or Palladium may be the better way to go.