- why now is not the time to take risks in the corporate bond market;
- the dangers of an expanding deficit at the same time that rates are rising;
- how the next recession may spark the rise in popularity of social democrats.
To watch the second clip from this interview, please click here.
Can’t watch now? Read the transcript
Alex Steger (AS): Given your outlook, where markets are at the moment and where we are in the cycle, how are you positioned in your Total Return fund?
Jeffrey Gundlach (JG): We’re pretty much defensive. There's two things you have to worry about in fixed income investing. First is interest rate risk, which clearly has not been a positive now for a couple of years. You've not made money by price gains, you've actually had price declines. So you want to position yourself so that you're not so exposed to these price declines. If you take a look at like our Total Return fund, it's doing very very well since the bottom in rates and very well this year because of its defensive positioning.
Then the other thing you have to worry about is how much credit risk do you want. And I would argue that this is not a time to have a much of that either. So you need to be defensive against credit as well. So you're doubly defensive right now in the bond market and that shows up in our funds. Some funds have more credit than others, because of the nature of their mandate. Our Total Return fund, for example, never has any corporate bonds. So we are doing extremely well, because the corporate bond market is suffering. But it's only beginning. The corporate bond market is going to get much worse when the next recession comes. It's not worth trying to wait for that last ounce of return, or extra yield from the corporate bond market. Because the old phrase is: You're picking up dimes in front of a steamroller. Your chance of making big money incrementally in corporate bonds is virtually non-existent. And when it goes bad, it's going to go bad in a way that you'll lose substantially. So it's probably better to forego a little bit of extra yield in the near term, knowing that you'll get a much better opportunity some quarters or a couple years down the road.
AS: You’ve also expressed concerns about the Fed raising rates at the same time that the deficit is expanding.
JG: Yeah, it's a pretty interesting, unprecedented type of dynamic. We’ve never had the deficit expand, unless you're in a recession, by this kind of amount. And here, we are supposedly in a good economy, and the deficit is expanding.
And there's no law natural law that says expansions have to end at a certain age. But this is an old expansion. We came off of very low bottom, so maybe you can go on longer than average, which it certainly has.
But I think that that's a pretty big issue. The Fed wants to raise rates. They've gone from a regime two years ago of, “We'd like to raise rates, but the data isn't helping us” to now, “the data is good enough and unless it gets worse, we're going to keep hiking.”
So the Fed is going to keep raising rates per their own words, and the deficit is going to continue to expand, it's already expanding at something that should be an alarming rate to global investors. The official deficit for fiscal-year 2018 was around $800 billion. But the growth in the national debt was $1.271 trillion. So which is the real number? Seems to me that the debt is the debt. And so the reason that there's a difference in those numbers is the loans to the Social Security system, which, of course, will never be repaid. So it's a true deficit. So the deficit is already 6% of GDP in the United States. It's kind of interesting when you contrast that, to the kerfuffle in Italy, where they're supposed to be at 2% to be maintaining ECB membership, yet, they're at 2.4% and they don't seem to be concerned about it. And so there's a lot of talk about how they're out of control and a 2.4% deficit, but we're more than double that. So it's kind of strange. We have the advantage, of course, of being the global reserve currency.
AS: So what needs to happen? Should they stop the current path they are on in terms of hikes?
JG: I actually don’t think the problem is the Fed hiking. I think the problem is the deficit expansion is responsible for a significant part of the economic bump, because changes to government spending are part of the GDP equation. And not surprisingly, we've gotten a bump in GDP because we've increased the deficit. But if that's going to be your methodology, you're gonna have to keep increasing it. And one day, we're going to go into recession, not on the horizon now, but one day we will and when we do the deficit is going to absolutely blow up.
AS: Does that mean then that that downturn, that recession…
JG: That’s when the democratic socialists are going to take over. Because there will be a large demand for universal basic income, I think, which is already polling at nearly 50% favorable. So all you need is a recession and you're going to get a dominating favorable for further expansion of welfare programs.
AS: And how severe do you think that recession will be?
JG: I just think that there's already, for what is supposedly a good economy, there's a lot of discontent socially and economically, and it will just get worse when there's a recession. So I think it will fan the flames of social unrest. And that's a little bit negative.