Gundlach: ‘Treasurys look vulnerable to me’
By David Enna, Tipswatch.com
A few years ago, I was working in the kitchen and listening to CNBC in the background. A guest came on and talked, talked, talked about debt investments and risks. The CNBC anchors, apparently in awe, said nothing and just let him talk for 10 minutes straight.
The guy was talking sense. I thought: Who is this guy? I ran over to the TV to catch his name: Jeffrey Gundlach.
That was the first time I heard of Gundlach, who is sometimes called “The Bond King.” He is the billionaire founder of investment firm DoubleLine Capital and a man who likes to speak his mind.
Gundlach appeared last week on an episode of Bloomberg’s Odd Lots podcast, hosted by Joe Weisenthal and Tracy Alloway. He raised lots of controversial topics, including a withering argument against the booming private credit market, which he considers very risky. But he also warned of dangers in the Treasury market and stock market.
Here is the podcast in full, streaming on YouTube:
While some might consider Gundlach’s arguments alarmist, my conclusion is: This guy makes a lot of sense. Stocks are overpriced. Bonds are overpriced. Private investments are a powder keg. Government deficits are out of control. If he is right (he says he is right 70% of the time), we might need to reconsider our view of risks in financial assets.
Let’s focus on U.S. Treasurys. Gundlach says:
Yeah. I’m concerned about the financing of long-term Treasurys, primarily because we are issuing a lot of them. And there’s inflationary policies that are being run and probably likely to be further doubled down upon when Jerome Powell leaves as Fed chairman. …
I’ve heard different numbers out of President Trump. He wants rates at 2%, 3%, but inflation is running above 3% on the headline CPI. And it’s not likely to come down to the Fed’s 2% target. …
And so there’s a lot of interest in artificially lowering lowering interest rates and perhaps taking the maturities of Treasurys ever increasingly to under one year in maturity. A lot of investors aren’t aware of the fact that something like 80% of all Treasurys issued in the last 12 months … are less than one year. …
This time, all interest rates are outside of the two year are higher than they were before the Fed’s first rate cut. That just never happens historically. …
And I’ve been saying this for five years now, that the secular decline in interest rates at … long-term maturities is over. In fact, in the next session, long-term interest rates are likely to go higher, not lower. …
And so where we stand on fixed income is we don’t like long term during the next recession. The deficit is going to go up because it always goes up during a recession. … So what happens if the deficit goes from 6% of GDP to 10% of GDP, or 12% of GDP, or 14% of GDP?
All of those are possible. What happens is that you have to blow up the entire system, because all the tax receipts would go to interest expense. We’re already at a large percentage, or about $1.4, $1.5 trillion of the $7 trillion budget is now interest expense. Of course, we have a $2 trillion budget deficit. So there’s only $5 trillion of taxes. And, you know, 30% of that is going to interest expense and that is going to go higher.
Gundlach goes on to predict that by 2030 — under current spending and tax policies — if a severe recession hit, the budget deficit could go to 120% of incoming tax revenue.
Well, by around 2030, you would have 120% of tax receipts going to interest expense, which of course is impossible. So that means that something has to happen. … So long-term Treasurys look vulnerable to me.
At this point in the podcast, Gundlach has been talking for about 15 minutes without any interruption or break. Tracy Alloway jumps in with: “Jeff, first of all, I hesitate to ask a question here because, you know, we could just let you go on.” I laughed. And then he launches into opinions on the stock market (overvalued), private credit (a dangerous “illusion”), foreign investments, gold, emerging-market debt (which he likes), the value of the dollar and even an oddball proposal for a tax on older Americans.
The entire podcast is worth a listen.
Thoughts
Gundlach is an aggravating truth-teller, sort of like the prophets that got stoned to death in the Bible. But there is no denying that the United States is running a $2 trillion deficit at a time of solid economic growth. That should not be happening. It should not be allowed to continue, but it will continue for potentially five more years.
Let’s be honest. We are all aware that this is rather terrifying problem that can’t be solved under current political conditions. So we end up ignoring it. And the end result could be higher long-term interest rates, possibly much higher, no matter how much cutting the Federal Reserve attempts at the short-term end of the curve.
If the nominal yield rises to 6% on the 10-year Treasury note, we could easily see a real yield of 3.25% to 3.50% on the 10-year TIPS. That would result in a hard hit for investors in bond funds and TIPS funds. It is something to think about.
Holders of I Bonds and TIPS held to maturity would survive. The resulting higher real and nominal yields would look attractive, but at least I Bonds and TIPS provide protection against a surge in inflation.
Do we need to rethink the theory that a 2.0%+ real yield is “historically attractive”? Possibly, if the U.S. economic future looks nothing like the past two decades. At this point, I am staying the course with a conservative asset allocation.
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• TIPS investor: Don’t over-think the threat of deflation
• Upcoming schedule of TIPS auctions
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
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