Notes from the DoubleLine Lunch with Jeffrey Gundlach
- Joshua M Brown
- September 29th, 2011
Yesterday Barry and I had the pleasure to meet Jeffrey Gundlach and attend the DoubleLine Luncheon at the New York Yacht Club. If you’ve never been, the club is on 44th Street (a block from my office) and you can tell it by the second floor windows which are shaped like the
bow stern of a ship. The dining room has a three-stories high stained-glass ceiling and is laden with ornately carved wooden accents, maritime artifacts and models of all the yachts that have defended the America’s Cup for the last century and a half. It’s really a mind-blowing space that many native New Yorkers don’t even know about.
Jeffrey Gundlach, who possesses one of the most fascinating investing intellects of our time, was there to greet the guests in a gray-checked suit with bright red tie and pocket square in the foyer. For the uninitiated, Jeffrey opened his own asset management shop, DoubleLine, in Los Angeles two years ago. Since then, he’s raised about $16 billion starting from zero. This is an astounding feat and no one has ever seen anything like it in Wall Street history. On top of that, he’s managed to absolutely crush his peers in the bond market year-to-date with an elegant risk-offsetting pairs trade that’s meant bigger yields than most of his competitors without compromising on liquidity, credit quality or duration. More on that later.
Once we were all seated, it was a whirlwind through some of the most important charts and datapoints of the current market moment. I’ve got 5 pages of handwritten notes that I’ll distill down for you guys below.
Anyway, let’s get straight to the meat and potatoes…Just like my notes from the Rob Arnott lunch everything below is paraphrased unless it’s in quotation marks, in which case it’s a direct quote from the man himself. I’ve put these little nuggets in an order that I think adds clarity to the overall message. Hope this is helpful to you guys…
On Policy: “I’m not a policy maker, I am a steward of other people’s capital and I’m here to outperform.” The crowd had to practically sit on its hands to keep from applauding. (Josh’s note: Jeffrey Gundlach has now set himself up as the anti-Bill Gross, who has now underperformed 80% of his peers year-to-date as he’s become preoccupied with pitching policy solutions and making quasi-political pronouncements.)
On Government Revenue: In 1902, the Government only took about 10% out of the economy in the form of taxes, now it’s more like 35%. Debt Ceiling on the same upward trend as taxation as a percentage of GDP, a complete farce, it is regularly “raised on an as-needed basis” and has no meaning at all.
On the 2012 Election: “This will be the most important election of our lifetime,” he says that there are two parties: The Taxes are Too Dam Low Party and the Spending is Too Damn High Party – if either of the two parties gets a mandate from voters next fall is could be “a disaster”.
On Entitlements: Retirement age simply MUST be raised, probably to 70 years old. FDR originally set the retirement age (for Social Security benefit eligibility) at 65 years old – but at a time when the average life expectancy was 61! So rather than being a softie, he actually was being rather tough. Nowadays, our life expectancy is 79, if you were to do what FDR did, you’d be setting retirement 4 years later at 83 years old!
On Discretionary versus Mandatory Government Spending: “What they consider ‘mandatory’ today could become discretionary’ tomorrow.” Even if you cut the entire Defense budget slice (from 20% of total spending) down to zero, you still don’t even come close to making a dent in the deficit so at some point, the social security and income security (unemployment) entitlements are going to get touched.
On Tax Hikes: Because Corporate Profits are not doing anything for much of the country, corporate income tax hikes are actually possible. Even muni bond tax hikes (at a certain income level) are currently being discussed. There is a precedent for our current situation, 1940. During that year, tax receipts as a percentage of GDP exploded from the 6-8% range up to a whopping 20%.
On Income Inequality: Reagonomics and the idea that you could use deficit spending to “prime the pump” took hold in the early 80′s. One of the unintended (or perhaps intended) consequences has been a massive increase in the top .1% of earners’ share of total income. When factoring in capital gains, the top 1% of earners in this country are now 25% of total income. This means that some kind of wealth tax is almost a certainty going forward.
On Asset Allocation for the Ultra High Net Worth: Jeffrey says his own assets are now 2/3rd’s outside of the “financial system” other than his ownership stake in DoubleLine. This means fine art, gold, gemstones, rental property etc. He says the ultra wealthy should have 50% of their assets outside of the financial system.
On Bull Markets and Bear Markets: If you study history, you’ll see that “bull markets are about cooperation, bear markets are about divisiveness.” Jeffrey says the Euro common currency came about in 1999 at the very peak of global cooperation, the fact that asset prices peaked around then too is not a coincidence. Right now divisiveness is everywhere and a global bear market is underway.
On the Euro Crisis: “I don’t know what’s going to happen in Europe but there is one thing I am certain about – eventually, someone is going to take a big loss. As investors, the most important thing we can do is to make sure that we aren’t the parties taking that loss.” He says DoubleLine’s portfolios have zero European stocks, zero European bonds, zero european currencies, zero assets denominated in euro currencies – also, zero exposure to US bank stocks.
On Volatility: There is nothing magical about the 40 level for the VIX, and whether we are trading above it or below it doesn’t necessarily signify anything important for stocks.
On Stock Indicators: “The single most important stock market in the world right now is the Shanghai Composite”. It is an “excellent leading indicator for the S&P 500. Shanghai needs to improve before we can be bullish on US stocks.”
On Stock Dividends Being “Higher than the Yield on a Ten-Year Treasury”: he says this is nonsense because there is no risk parity between a stock and a Treasury bond, he says you have to look at this comparison on a volatility-adjusted basis or not at all. For example, If the yield on the ten-year bond doubles overnight from 3 to 6%., you’ve lost about 20% of your principle – but if Microsoft’s yield doubles from 3 to 6% overnight, you’ve probably lost 50% of your principle. Apples and oranges.
On Economic Indicators: The ECRI Growth Index is extremely important, as of the latest reading, this index is at negative 7.
On the US Dollar: While everyone is whining and crying about the falling dollar, the simple fact is that the dollar actually bottomed three years ago and is now strengthening. “The problems in Europe are wildly bullish for the dollar”. “All of our assets are dollar denominated.”
On Gold: “I understand the allure of gold but in a deflationary environment or a true liquidity crisis, there is serious risk to gold prices up here.” he says around 1500 gold gets interesting again. Jeffrey showed us the pronounced daily volatility in gold prices (hi-lo chart) since the Debt Ceiling debate – he notes that “Increases in volatility almost always precedes a reversal in trend.” Jeffrey bought gold personally in 1997 because he thought it looked cheap – “For five years it did nothing, I actually lost money, then I made five-fold on my investment.”
On Natural Gas: The all-asset class portfolio is currently legging into a long natural gas position – slowly. Jeffrey says it probably goes nowhere in the short-term but in a decade or two could be a five-bagger just like his gold trade was. Natural gas is very cheap and has a lot of potential in the long-term.
On Copper and Commodities: Copper is still trading at 40% above the marginal cost of production so there is still risk to these prices. Commodities (other than gold) have been terrible over the last three years. Since September 19th 2008 through this week, the DJ UBS Excess Return Commodity Index is down 18.4%, it was up 12.72% during QE1 and 6.73% during QE2.
On Barry’s Book Bailout Nation and My Upcoming Book: “It’s raining books with you guys!” Jeffrey mentioned that he is meeting with Michael Lewis (Liar’s Poker, The Big Short) this week about being the subject of a book (Gundlach’s long-term track record and battle with ex-employer TCW would be fascinating). Let’s all pray that this happens, you guys.
On Government Bonds: The big winner this year in asset classes is Government Bonds, up 9% year-to-date.
On Duration: Basically he says ‘No, thank you.” to anything with a yield under 1% – “this glass of water is more worthwhile than a government bond under 5-year duration”. DoubleLine had been loading up on long-dated Treasurys since March in anticipation of the end of QE2. The trade is working right now obviously. Markets don’t wait for some publicly known date and then adjust to something, they anticipate and game it in advance, which is what the end of QE2 trade was about. People looking at the 30-year bond lamenting the low yield forget that it is the price action that made the trade work – the long bond’s price can move 20%. Says the 30-year has not yet “punched through” to the yield lows of 2008 although the 5 and 10-year bonds have. It definitely could but is short-term overbought.
On Corporate Bonds: Investment grade corporates have done extremely well but the below investment grade (junk) market “has absolutely fallen apart”. Junk bonds will really hit the wall and face serious wave of defaults beginning in 2012 as all the refinancings of 2009 and 2010 vintage come due. Many of these companies have improved cash flow by lowering their interest expense with refis but they haven’t reduced their indebtedness overall. That said, pension funds are still underfunded and will be forced to use investment grade corporates to make their assumptions, this will keep a “technical bid” beneath that market.
On Muni Bonds: “They’ve done well but can this market really stand up to a wealth tax” imposed on the income?
On Money Market Funds: Why would anyone own a non-government money market fund? “This is what we call ‘Reward-Free Risk’.”
On the Next Fund: Tomorrow DoubleLine is introducing a brand new fund to the stable, Jeffrey says he can’t say much but that it will be a money market fund surrogate with yields approaching 2%.
On Housing: Way too high ownership level still – “Home ownership rate at 70% is still absurdly high”. More foreclosures – five years worth – unavoidable and politically speaking no one is going to be bold before the election with any kind of sweeping forgivable or modification plan. The existing programs are all one-by-one which is why they are not helping at all. Expect more malaise in housing. he is very bullish on rental property for the foreseeable future.
On Mortgage Bonds and the Big Trade: This is where Jeffrey began his career and what he knows best. ratings agencies don’t understand how to rate securitized mortgage pools and he takes advantage of what the the repayment risk that they misperceive as credit risk. He is pairing mispriced GNMA bonds with long-dated treasurys to put together a risk-offsetting bond position that offers both interest rate-risk protection and a higher yield than the other total return bond funds. There is no repayment of capital or leverage involved in getting a higher yield, just a better constructed trade than the next guy.
On Emerging Markets Fixed Income: “A secular improving credit story”. G7 countries have 4 times the debt-to-GDP ratio of EM nations. He is blown away that EM Debt trades at “twice the yield of developed country debt and triple the fundamentals”
Two Final Rules:
- “The Bloodless Verdict of the Market” – In the end, he who gets it right wins, there are no points awarded for being smart but wrong – I love this.
- “Never, ever take counterparty risk.” – It is the one risk you are almost never rewarded for taking. Unless you are running $800 billion dollars, there is no need to use swaps, synthetics or baskets – trade cash markets and avoid any trades that require a counterparty.
Anyway, hope you guys got something out of this post, will do it again as I attend other events if you find it valuable. – Josh
Full Disclosure: I am not currently an investor or actively recommending any DoubleLine funds to clients. This may change in the future. The above was not an endorsement or a solicitation of any investment product or strategy, please do your own homework before making any investments.
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.