Jeffrey Gundlach: “Life Is Great!” by Stephen B. Blumenthal, CMG Capital Management
By Steve Blumenthal
“Everyone has to think about what will happen to their wealth when interest rates change direction.”
– Peter Briger, CEO and Co-CIO of Fortress Investment Group
At this year's SALT New York conference, Jean Hynes, the CEO of Wellington Management, took to the stage to discuss the role of active management in today's investment environment. Hynes succeeded Brendan Swords as the CEO of Wellington at the end of June after nearly 30 years at the firm. Wellington is one of the Read More
“By 2020, 70% of assets will be held by retirees and pre-retirees.”
– Salim Ramji, BlackRock’s Global Head of Corporate Strategy
Place those two quotes front of mind. The primary need of investors is shifting and the risk dynamics has changed. Gone are those wonderful defined benefit plans. This is the first generation of retirees retiring with control of their financial assets. That’s good news for your advisory business, yet, with zero bond rates and 10-year forward returns for equities in the 2% to 4% range, the challenges loom large.
The 65 year old is less concerned with performance relative to the S&P than the 45 year old. Income generation and capital preservation prevails. The number one question for many investors will be: how to generate a steady amount of income?
Several weeks back I attended an ETF Strategist event hosted by BlackRock. The 70% data came from that conference. BlackRock suggested that advisors focus on creating outcomes that provide income generation, capital preservation and inflation protection. I agree and, reflecting on the quote above, “everyone has to think about what will happen to their wealth when interest rates change direction.” Indeed. I see two outcomes: one good, one bad. It comes down to planning, client education and positioning.
So today, let’s continue the discussion started last week as I share with you more of my notes from the Strategic Investment Conference. Gundlach’s view is rates likely bottomed. There was much agreement on a coming corporate default wave. India was a common positive investment theme. I hope you find the information valuable and helpful in your work with clients.
Before we jump in, as a quick aside, high yield debt has been front and center in the news lately. This is a space I have particular expertise. As a follow-up to a piece I wrote for Forbes titled, Junk Bonds Are The Investment Opportunity Of A Lifetime, Just Not Yet. I’m going to present some ideas on May 20 on how to position high yield in your portfolio to both participate in further gains and risk protect in a way that puts you in the favorable position to take advantage of a coming once in a lifetime buying opportunity. I believe it presents within the next few years. You can sign up here: CMG Managed High Yield Bond Program Webinar.
Included in this week’s On My Radar:
- Jim Bianco, President of Bianco Research
- Jeffrey Gundlach, CEO and CIO of DoubleLine
- Ian Bremmer, President of Eurasia Group
- Trade Signals – Zweig Bond Model Says “SELL”
Jim began his presentation with a quote from the great Charlie Munger:
“I’m convinced that everything that’s important in investing is counter intuitive and everything that is obvious is wrong.”
This quote sets me off on a short detour. No wonder it is so hard at times to work with individual investors. A long-time client (with me since 1985) called last week with several hundred thousand to invest. He told me how his friend is making a killing in dividend stocks and he wants to get into something that will make him big money. It’s obvious to my long-time friend that it is time to buy into stocks. I sense return envy and a market top. Thirty years and far too many knocks on the head tells me I’ve seen this story before. Risk is high.
Advisors are telling me about how tough the calls are today – everyone comparing their broadly diversified portfolios to the S&P 500. Investor or speculator? Which one does the client want to be? Can’t be both and few are good at the latter.
Ok – back on track. Here are some of the notes that struck me as important from Jim’s presentation:
- He is not in the recession camp, not in the growth camp but in the “below average camp”
- A “C” grade at best for corporate revenues and earnings. Nothing great
- Today, even forward PE is high at 17. Not good when you are getting a decline in earnings and revenues
- Warren Buffett’s valuation measure, stock market cap as a percentage of Gross Domestic Income, near 140% is very high
- 1974-2008 real GDP tracked CBO’s (Congressional Budget Office) real potential GDP
- 2008-present there is a big gap between the real number and CBO’s estimate
- Something is holding back the economy
- QE might be the problem and not the solution
- Jim is telling Fed officials to raise rates now
- He believes that the Fed’s third mandate is investment market stability (SB here: Munger’s quote echoes in my head)
- Jim’s personal interpretation of the Fed’s duel mandate, forget just inflation and employment, he believes it is, “everything and whether the market throws a fit when the Fed acts”
- This is a meaningful point in my view: Jim stated that “the Fed funds futures chart shows that the market has not priced in a higher Fed rate move this year.” It will be a shock to the system if we get one.
- To this point he added, “as long as there is a gap between market expectation (the Fed funds futures level) and the Fed’s projection of rates (dot plot) the Fed won’t raise rates
- Jim restated the Fed’s third silent mandate – investment market stability
- The market is moving further away from a rate hike, not expecting one soon
- On oil: we are producing too much relative to demand and said that demand from oil ETFs like “USO” has supported oil futures prices
- He believes market participants see $100 oil again. Too many speculative bulls out there… no wall of worry – don’t buy oil (he suggests)
- There is roughly $40 billion lined up waiting to buy distressed energy companies
- Saudis see opportunity to step on the gas and break the back of the frackers
Ian Bremmer on the Geopolitical Environment
Ian is one of my favorite geopolitical analysts. I’ve followed him for years and enjoy his direct and candid view. Here are some of my notes from his presentation:
- He and his team see “unstable and they see dangerous”
- There are more refugees than at any point since WWII
- Dealing with a well-funded ISIS and growing Al Qaeda strength
- The world is experiencing geopolitical destruction. It is going to get worse
- Why is this happening: America is a large part of the reason why
- We do not want to step up for our allies like we have in the past
- Ask any American ally what they think about our foreign policy – you won’t get good answers (even from Canada)
- Europeans are another big part of the why
- The Brits put up the Heisman to us on the China Bank
- Not many noticed that the Netherlands hired a Chinese company (one led by China’s military) to build out their internet infrastructure (SB again – NSA fallout. )
- Russia is a part of the why
- First to be clear, Russia is in decline
- Putin won’t change his path. We are hitting him, his oligarchs, planes, apartments and bank accounts
- If there is a black swan out there, it is Putin showing us not to mess with him. Something big.
- We are going to see a much more assertive Russia
- S. has shown very little thinking around this
- The question is not if but what is Putin going to do?
- Russia in decline creates much more geopolitical instability
- Lastly, the rise of China is a big part of the why
- They are the only country that has a coherent global geopolitical strategy
- Asia Infrastructure Bank, Development Bank and Asia Bank
- It is impossible to look at the Middle East and see anything good
- Saudi’s recent leader change is a message
- No one is more hurt by an Iranian deal than the Saudis
- No more reform. The focus is on security
- They feel that no one is going to help them
- He believes Iran is likely to get a deal done with the U.S. giving it an 80% change
- Noted that Iran has cheated on every inspection. It’s a bad deal, they are going to continue to cheat, but not doing a deal is worse for the U.S. in his view
- Israel is unhappy but will they strike? He says no
- Jim believes the U.S. doesn’t want to do as much in the Middle East. A trend we’ll see more of. It is bad for the Middle East but he’s not so sure it is bad for the U.S. (SB: personally I have a different view)
- Israel and Saudi Arabia know we are pivoting away from the Middle East
- We spent billions on Iraq, made regime change and the country fell apart
- Other places, like Libya, the U.S. didn’t play a key role and the nation fell apart
- He said he has had meetings with every head of state. The biggest problem for the U.S. is our allies don’t trust us – He was consistently asked these key questions:
- What do you guys want?
- Who are you?
- Where do you stand?
- Relative to the geopolitical environment in most of the world, the U.S. looks good
- He believes this favors U.S. investment
- Brazil – corruption is being attacked. He expects that when the current president gets voted out, there will be a favorable investment environment in Brazil
- He is bullish on Asian economies
- Impressed with what Narendra Modi has done in India. Sees big growth
- Buy India. India’s growth has surpassed China’s and will continue to surpass it by a wide margin
- China understands they need to expand fast – there is a strong sense of urgency
- Japan has a strong leader in Abe. Delighted to see a single united government again
- He concluded his remarks by circling back to Russia stating, “if you press the Russians into a corner, Putin is going to bite you.”
On that depressing note, let’s jump to Gundlach.
There are three things Jeffrey Gundlach won’t sell: He is bullish on India’s stock market (by the way, a consistent theme at the conference), bullish on his absolute return fund and bullish on his hedge fund.
Here are selected notes:
- You have to take risks. He presented on those he believes are worth taking and not taking
- Bonds in Europe are in short supply. The central banks own most of them and the financial institutions must own them. He suggested:
- Not buying negative interest rate yielding bonds is a good idea
- Sovereign debt issuance has turned negative in Japan, UK, Europe and the U.S.
- Fed Policy is on the stage – “Don’t be a block head.” Implying Don’t Fight the Fed
- He noted that the Fed blinked relative to the dollar strength (SB here: I agree and here is what it means in English. If they raised the Fed funds rate, the dollar would have rocketed higher causing a potential major crisis much like the one in 1998. Recall the current estimated $9 trillion in foreign-based U.S. dollar owed debt. A higher dollar means crisis for those borrowers – dollar up 30%, they owe 30% more, up 50%… you get it. So much for those attractive low U.S. interest rates several years ago. The Fed blinked)
- Here is a good one: The market nor the U.S. economy will respond well to a Fed rate hike
- Bond market participants’ probability of a Fed hike?
- 60% say a hike by December
- 30% say by September
- 10% by June
- Jeffrey Gundlach – the Fed will wait for a few consecutive periods of strength
- On currencies: currency trends usually last ten years. The current trend likely started in 2011 or 2008. He believes ultimately the dollar goes higher. Current support is at 93
- Amazing weakness in commodities – not just last summer through today, but last four years to today
- Gold is unchanged over the last four years in dollar terms but doing well in other currencies
- He advises to hold gold
- I felt that one of the more interesting charts showed Core CPI in the U.S. against Core CPI in Europe
- The core CPIs are completely the same if you calculated both using the same inputs (the U.S. has a higher weighting on housing)
- In short, core CPI has declined in both countries from 2011 to present. Very little core inflation at 0.60%. Using the U.S. calculation, core CPI is 1.6% in the U.S. reflecting a bit more inflation but nothing like the 2.5% in 2011 and the trend is down
- He noted that nominal GDP seems to be a great predictor in forecasting interest rates (he favors a seven year moving average) and noted that nominal GDP might just be flattening out which would mean that interest rates will flatten out too
- Some question whether there is manipulation in the CPI data. He noted the Billion Prices Index (something I have written about in the past) showing the high correlation of CPI to that index. The Billion Prices Index scans the internet and tracks actual prices of billions of items. Pretty cool. Anyway, little sign of inflation and prices appear to be in decline
- History shows that every time the Fed tightened the yield curve inverted. (SB – recession has followed every invert). Again, it is flattening now
- Technically it looks like the 10-year Treasury rate has bottomed. The 2-year bottomed in 2011, the 5-year in 2012 and the 10-year at 1.38% in 2012
- He noted that the 10-year could not take out the 1.38% low in January
- The 30-year did take out the 2.45% 2012 low dropping to 2.22% on January 31, 2015; however, we quickly went up to 2.85% then to 2.50% and that rate is now moving higher
- Similar to all of the money that poured into U.S. equities at the top of the market cycle in March 2000 (my comment), January 2015 was the best month ever for inflows into bond funds. A top?
- On high Yield: “everything you know about HY is wrong”
- None of us have experienced a secular rate rise (something that he believes might happen in a few years from now)
- He believes interest rates will rise: first gradually, then suddenly
- If Treasurys go to 8%, then HYs are going to 14%, 16%, 18% or higher
- He doesn’t believe the Fed is tightening soon – so there is some time
- The HY maturity cycle picks up significantly in 2018 – that’s the coming stress point
- Also, the Fed’s refinancing needs are set to balloon in 2018-2019
- He sees a storm coming in 2018-19
- This will become an important theme
It really helps me to hear the views of some bright economists, political analysts and investment managers with true skin in the game. It challenges my thinking and I believe keeps me on my toes. I hope it does the same for you.
A quick note on Kyle Bass. He asked to keep his presentation private. I feel comfortable sharing that he touched on the progress he is making in challenging what he believes to be out of control manipulation by the pharmaceutical industry in regards to patent protection. Did you know that it is illegal for Medicare to negotiate drug prices? I didn’t. Blame both Bush and Obama and a very powerful lobby.
He mentioned that the U.S. could save $300-$700 billion per year over ten years if we paid the same prices Canada now pays for the very same drugs. Even more if we paid what Norway pays. I have not looked into those numbers.
Shorting Bunds might be the “trade of a lifetime”. If you’ve watched what has happened to Bund yields over the last week or so, someone is on the right track. Not so easy to do as the futures markets have their own set of complications. Great timing is required. Ultimately, I think their banks are in trouble but for now I still find myself in the Don’t Fight the Fed and Global Central Banks camp.
A final few notes on the conference. It was outstanding. India and China were central themes. I’m going to do some more research – I’m sure my mother-in-law is looking for a new idea having exited the short Yen trade. I left out other notable presentors: Grant Williams and Raoul Pal (some great ideas on stock selection), Stephanie Pomboy, Paul McCulley, David Zervos from Jeffries. This piece is getting too long so I’ll see if I can weave some central ideas into next week’s piece.
Also, I know that Mauldin recorded most of the presentations (with slides) and is providing a DVD (for a fee). If it is something you are interested in, just drop me a note and I’ll have him send you more information.
Trade Signals – Zweig Bond Model Signals “SELL”, Stock Trend Weakening yet Positive
I mentioned the following in Wednesday’s post:
The Zweig Bond model moved to a “SELL” signal this week signaling a move to shorten higher quality bond maturity duration. Our CMG Managed HY Bond Program is neutral and we remain long HY bond exposure. Momentum has declined and is essentially flat.
Risk remains high due to valuations, seasonality and the duration of the current cyclical bull market move, yet evidence continues to support a cautiously bullish position, in my view.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: The Primary Trend Remains Bullish for Stocks
- Volume Demand Continues to Better Volume Supply: Bullish for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Neutral Optimism (short-term Neutral for stocks)
- Daily Trading Sentiment Composite: Neutral Signal (short-term Neutral for stocks)
- Recession Watch – My Favorite Recession Forecasting Chart: Currently signaling no recession
- The Zweig Bond Model: The Cyclical Trend for Bonds is Bearish
Click here for the full piece.
David Harding presented at the Mauldin conference. He founded and runs Winton and has a 28-year track record of approximately 13.1% per year with zero correlation to the stock market. He said, “anyone in investments should know that when you add together a number of uncorrelating returns something magical happens,” I liked that quote. Sounds simple but how does one make that happen?
I have just finished a white paper titled “Correlation and Diversification”. In it I show how to make it happen. If you’d like a copy, send an email to [email protected] and note “send me the white paper”.
I’m writing you from Chicago this Friday morning. I’m attending Envestnet’s 2015 Advisor Summit. The pace of technology improvement is amazing. Good news for your business and mine. Take a look at their “goals based” presentation technology.
Coach K is speaking this morning so I’m sending to the team for edit and rushing to the event hall. I can’t wait!
Finally, daughter Brianna is graduating this weekend and the entire family is traveling to Penn State to celebrate. Post Sunday’s ceremony, we are heading to my sister’s house for a mother’s day brunch. Here is a picture of Brianna and her closest friends. She is so sad to be leaving what has been a fun experience for her. I congratulated her post her last final. She said, “Stop it, Dad, this is so depressing.”
Brianna is in the center. Wow – life is going far too fast.
Happy Mother’s Day! To all of the mothers in the world…know that there is no one more important than you!
Have a great weekend!
With kind regards,
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.