Jeffrey Gundlach and Felix Zulauf on Global Markets Amid Secular Change 12-12-22

Name: Jeffrey Gundlach and Felix Zulauf on Global Markets Amid Secular Change 12-12-22
Uploaded: 2022-12-16T17:42:58.000Z
Duration: 1 h 56 min 4 s

Introduction

The video begins with music playing in the background.

Welcome and Roundtable Discussion

Riddell, President of DoubleLine, welcomes everyone to a live discussion with Felix Zuloff and Jeffrey Gundlach. They both sat on the Barons Roundtable for many years. Ron mentions that there is a lot going on this week with FED week and everything happening in the economy. He also mentions that they have their own Round Table Prime coming up in January 4th which will be moderated by Charles Payne. Today's moderator is Sam Garza who is portfolio manager for multi-asset strategy products.

Felix Zuloff and Jeffrey Gundlach are investment legends.

They will discuss micro markets, inflation, economy, and central banks.

Ron mentions that when they entered 2022 there was a totally different mindset and valuation setup than where they're ending the year.

The S&P 500 was so unusually overvalued versus its own historical evaluation framework.

Looking at P/E ratio, Cape ratio Price to Book price to sales all showed the S&P 500 was highly overvalued like top percentile or top couple percentile on virtually every metric versus its own multi-decade valuation framework.

Takeaway Points from 2021

Sam asks Jeffrey and Felix about their takeaway points from this year and what is most memorable about 2021 for them.

When they entered 2021 there was a totally different mindset and valuation setup than where they're ending the year.

The S&P 500 was so unusually overvalued versus its own historical evaluation framework.

The yield on stocks was actually quite a bit below average compared to the yield on the 10-year treasury bond.

Bonds had the worst year for investment grade U.S Bonds in history.

The 30-year treasury bond had a 50 drawdown from its high price late in 2021.

Stocks have become cheap compared to bonds.

The Effects of Rate Hikes and Quantitative Tightening

In this section, the speakers discuss how the effects of rate hikes and quantitative tightening will make 2023 a recessionary year.

The Effects of Rate Hikes and Quantitative Tightening

The accumulation of quantitative tightening and draining of liquidity from the bond market is going to make 2023 a recessionary year.

Zero interest rate policy in the U.S. and negative interest rate policy in Europe could not continue because inflation rates were expected to rise.

Central banks around the world realized that they were far behind the curve and then they tightened very aggressively, which gave us the bear Market in stocks and bonds as well continuation in bonds into late September or October.

The Bond Market has most likely already seen the highs for the cycle, and we may only see 50 basis points this week by the fed, which may be the last hike in this cycle.

Geopolitical Changes

In this section, Felix discusses how geopolitical changes have affected trade patterns between countries.

Geopolitical Changes

The war in Ukraine made it clearer to many that the world has changed from a geopolitical standpoint.

When you look at a map divided into two colors - blue for countries that do more trade with US than China, red for countries that do more trade with China than US - you can see that 20 years ago, most of the world was blue except for China. Today, most of it is red except for North America, Canada, Middle America, Great Britain, three or four countries in Europe, and a few small Asian economies.

This change reflects the geopolitical situation, which has accelerated the building of two blocks because the conflict between the two superpowers is going to intensify.

After the supply chain disruptions we had due to lockdown, we will probably have more intended distortions to the supply chains in coming years due to that conflict.

Fundamental Scarcity

In this section, Felix talks about how fundamental scarcity for many items in the food chain and in the supply chain of products makes it very difficult to analyze the world economy as we used to do in the past.

Fundamental Scarcity

There is a fundamental scarcity for many items in the food chain and in the supply chain of products, making it very difficult to analyze the world economy as we used to do in the past.

Most analysts that Felix follows have not really taken enough care of this important factor.

Inflation Rate Expectations

The inflation rate was expected to go up, but it overshot by at least four percentage points. The consensus now is that the CPI will fall just as fast as it went up and might stop at around two or three percent.

Inflation Rate Expectations

Many people thought the inflation rate would go up, even the FED wanted it to go above two percent.

The CPI is forecasted to decline at exactly the same pace as it went up and then magically stop at around two or three percent for the next three or four years with absolutely no variation.

If the FED follows through on its rhetoric and keeps doing quantitative tightening, I've got a feeling that if these economists and if the CPI fixings in the market are correct and the headline CPI does make it down to two and a half or so, I don't see any reason to believe it's going to stop there if you have that kind of momentum on the downside.

If these policymakers follow through and the inflation rate has that momentum, I would be surprised if it went lower than what the forecasts are at least temporarily.

Implications for Markets

A lower inflation rate would be positive for bonds. The copper-gold ratio suggests that fair value for 10-year treasury right now with prices of copper versus gold is somewhere around two to two and a half percent.

Implications for Markets

A lower inflation rate would be positive for bonds.

The copper-gold ratio suggests that fair value for 10-year treasury right now with prices of copper versus gold is somewhere around two to two and a half percent.

The numerator going up correlates to 10-year yields going up, and the denominator going up correlates to 10 years going down.

This is very consistent with inflation coming down and the many economic signals that are flashing potential recessionary signals leading indicators.

Yield Curve Inversion

There are many sets of weakness in the economy, which seem to suggest a lower inflation rate. Yields are expected to peak sometime in the fourth quarter of 2022.

Yield Curve Inversion

Many sets of weakness in the economy seem to suggest a lower inflation rate.

Yields are expected to peak sometime in the fourth quarter of 2022.

The United States seems hell-bent on increasing the rhetoric of fighting a proxy war with Russia, which we're already doing.

Global Recession Predicted

In this section, the speaker discusses the possibility of a global recession in the first half of 2023.

Fighting Russia and China with Technology

The speaker predicts that there will be a war with Russia and China.

He notes that fighting two billion people with only 350 million is difficult.

The speaker suggests that technology may be used to fight these wars.

Geopolitical Changes

The keynote speaker at an Arab conference was President Xi from China, not the US president as usual.

Saudi Arabia has moved closer to China and away from the US.

These changes are important factors in geopolitics that are not being taken into account on inflation.

Worldwide Recession Predicted

Commodity prices have already started falling dramatically.

Leading indicators of different economies around the world are also in decline.

The US Fed is tightening into a declining PMI indicator below 50 for the first time ever.

All these suggest that there will be a worldwide recession in H1 2023.

Deep Economic Crisis

China is currently experiencing a deep economic crisis and serious recession.

Europe has entered a recession which will be deep.

Energy prices have gone up so much that it will hurt economies quite dramatically in H1 2023.

Consumer Spending and Inflation Rates

The consumer is already on borrowed time because they try to sustain their level of spending by drawing on more debt, and savings rates are down as far as they can go.

The consensus expecting four to five percent inflation rate next year may be wrong again, as we could see a worldwide recession in H1 2023.

The speaker believes that the inflation rate will probably come down, but it will not stay that low for a long time.

Yield Curve Inversion

For the first time in decades, there is a yield curve inversion on a global level.

The United States is in a massive yield curve inversion which has sustained for a sufficient period of time to suggest a recession.

If we have a recession in place in H1 2023, then central banks will change policy and make the inflation rate bottoming in H2 and turn up again for another cycle.

The Impact of Deficit on the Economy

In this section, the speakers discuss the impact of deficit on the economy and how it is usually in response to a recession. They also talk about how this time, it's different because unemployment is at a low level.

Deficit and Unemployment

The current deficit is due to the fed's losses, interest rates going up, and the economy softening.

Usually, when there is a deficit like this, it's in response to a recession. However, this time it's different because unemployment is at a low level.

The fiscal response during a recession could lead to inflation and decline in the dollar.

World Dollar Liquidity

In this section, Felix talks about World Dollar Liquidity as a proxy for measuring liquidity since you cannot measure liquidity precisely. He also discusses how quantitative tightening has been more severe than what people see when they just look at real interest rates.

World Dollar Liquidity

World Dollar Liquidity is not followed broadly but tells us that quantitative tightening has been more severe than what people see when they just look at real interest rates.

Quantitative tightening was a driver of the dollar going up and has turned. There will be medium-term correction in place with the dollar declining into 2024.

Once the dollar declines, emerging markets begin to outperform foreign markets which begin to outperform U.S stock market.

Quantity of Money Indicators

In this section, Felix talks about quantity of money indicators being bearish for the U.S economy, particularly in the first six months of the year. He also discusses how poor trading liquidity has been in the United States during 2022.

Quantity of Money Indicators

Quantity of money indicators have a bearish message for the U.S economy, particularly in the first six months of the year.

Poor trading liquidity has been sustained periods even in the most liquid market, which is the U.S treasury market.

Bond Market Challenges

In this section, the speaker discusses the challenges faced by the bond market due to quantitative tightening and bond issuance.

Bond Market Challenges

The bond market has been facing challenges due to quantitative tightening and bond issuance.

There have been many days where it was impossible to sell assets that were down in quality.

The speaker believes that there will be a bounce in markets between now and a month from now as money is rotated.

However, the speaker thinks that this will be short-lived, and we will see a renewed bear market in risk assets.

Treasury Market Support

In this section, the speaker talks about how the treasury market will be supported given the falling inflation rate.

Treasury Market Support

The treasury market will probably be reasonably well-supported given the falling inflation rate.

The treasury is approaching its debt ceiling again and therefore running behind in issuance. It fears hitting that ceiling and is drawing down on the general account at the Fed, which is adding liquidity to the credit system - short-term bullish for risk assets but means they are running more behind.

Once catch-up phase begins, then huge amounts of paper issued by treasury flood into markets leading to a spike in treasury bond market prices. This gives an opportunity to go long again on that spike.

Rising Inflation Rates

In this section, the speaker talks about rising inflation rates and their impact on various markets.

Rising Inflation Rates

The speaker believes that the central banks and fiscal authorities will swing around when they realize that we are in a recession and stimulate again as they always do.

Unlike in previous periods, this time the bond market is aware of the problem, and excess liquidity created by central banks will flow into scarce assets such as commodities.

Due to geopolitics and fundamental underinvestment, there is a scarcity in commodities, leading to a very tight market in crude oil. The speaker does not exclude crude oil hitting $50 in the first half at some point but thinks it will trade closer to $200 by 2025.

If crude oil swings up to $200, many other commodities will follow suit, leading to double-digit CPI readings in 2025. This means bond yields will not stay where they are right now and come from a lower level.

In the next wave of rising inflation rates, bond yields will try to catch up because the bond market will play vigilante. If central banks try to avoid that, then we have a currency crash; if they go for automatic yield curve control, then we have a calamity in currency markets. A meltdown in currency markets leads us into a completely different ball game.

English Bond Market Veteran's Perspective

Jeffrey and Felix discuss the psychology of bond markets and how it affects yields. They also talk about the possibility of negative yielding debt in the future.

Psychology of Bond Markets

At the beginning of a bull market, people are skeptical about yields dropping.

After a bear market, people are scarred and don't believe that yields will drop even when inflation rates are low.

The same effect can happen in reverse when inflation rates overshoot on the upside and undershoot on the downside.

People may not believe that bond yields will decline again, but there is almost no bottle left to put the genie into.

Possibility of Negative Yielding Debt

There was nearly 18 trillion negative yielding debt at its peak, but today there is none outside of Japan.

The tools available for central banks are blunt and limited with negative interest rates and free money being their only options.

Central banks have shown every inclination to use these tools more brazenly every time they're needed.

While it's possible to see negative yields again in the future, Felix thinks that the odds are very low in the next few years.

English Opportunities in Fixed Income Market

Jeffrey talks about opportunities in fixed income as we move into 2023.

Best Opportunity in Fixed Income

September into October had probably been the best opportunity in fixed income in 10 years because treasury yields were up above four percent while economy slowing down.

Credit as you go down into various pockets of credit market had yields go up even more than Treasury yields so yields went from non-existent to double-digit.

Mix Assets for Opportunity

You can own long treasuries which will provide price gains under economic weakness and dropping inflation

You can buy credit in single B Double B category and sometimes high yield bonds were attractive Emerging Market bonds certainly got attractive

Consumer related receivable assets like asset-backed Securities and some mortgage-related assets all of these things have risk they have recessionary risk and default risk but you could offset them with the treasuries.

Bonds vs Equities

In this section, the speakers discuss the relative value of bonds and equities in the current market.

Portfolio of Bonds

A portfolio of bonds can be put together with a yield of 8-9% and fairly balanced risk.

Risk offsets with risk-free long-term treasuries offsetting much higher yields.

Bonds became drastically cheap to the opportunity in equities due to a rotation in the first nine months of 2022.

Opportunities in Fixed Income

Quality spreads are expected to widen into an upcoming recession.

The directional play is waiting for a bounce in bond yields, which could lead to a fantastic return.

Lending standards on commercial and industrial loans have tightened significantly over the past year and a half, which could lead to an uptick in default rates.

Reversal of Trends

In this section, the speakers discuss how trends have reversed or are reversing in various markets.

U.S. Stocks vs Foreign Stocks

U.S. stocks had outperformed foreign stocks for 10-15 years but that trend has already reversed.

Emerging markets are expected to underperform due to trends reversing.

Growth vs Value

The peak in growth versus value has already been reached and is now reversing.

European Stocks

Even European stocks are not underperforming compared to U.S. stocks anymore when currency is hedged out.

The Impact of Tightening Lending Standards on the Bond Market and European Equities

In this section, the speaker discusses how tightening lending standards will negatively impact the bond market and quality spreads. They also discuss opportunities in European equities, focusing on multinationals that have outsourced production to other places where it's cheaper to produce.

Impact of Tightening Lending Standards

The tightening of lending standards is occurring not only in the US but also in Europe.

Loan officers are taking back their umbrella as they see the outlook for business deteriorating.

Tightening lending standards will be negative for the bond market and quality spreads.

Opportunities in European Equities

The change in energy sourcing for Europe, particularly Germany, is structural and weakening competitiveness.

Multinational companies are moving around and outsourcing production to other places where they have reliable access to energy at a low price.

Concentrate on European equities that are cheaper than US equities by focusing on multinationals that have outsourced production.

The European Equity Market is near an end, but there may be an opportunity to enter it when it touches lows again sometime in the first half of next year.

Structural Changes Affecting German Industry

In this section, the speaker talks about how changes in energy sourcing for Europe, particularly Germany, are structural rather than cyclical. This has led to German industry paying multiple times more for energy than US producers and manufacturers.

Changes Affecting German Industry

Changes in energy sourcing for Europe, particularly Germany, are structural and not cyclical.

German industry and several other European industries have to pay multiple times more for energy than US producers and manufacturers.

Multinational companies are outsourcing production to other places where they have reliable access to energy at a low price.

Opportunities in European Equities

In this section, the speaker discusses how multinational companies are outsourcing production to other places where they have reliable access to energy at a low price. This makes Europe attractive for investors looking for cheaper European equities.

Opportunities in European Equities

Multinational companies are moving around and outsourcing production to other places where they have reliable access to energy at a low price.

Concentrate on European equities that are cheaper than US equities by focusing on multinationals that have outsourced production.

The Future of the UK Economy

In this section, the speaker talks about the pension crisis in the UK and how inflation is expected to be quite high in 2023. They also discuss how central banks will deal with 2023 when there is stickier inflation as well as growth problems.

The Future of the UK Economy

Inflation is expected to be quite high in 2023 in the UK, higher than mainland Europe and the US.

Growth is expected to be worse in 2023, creating a Central Bank dilemma between fighting recession or inflation.

If there is a serious recession, central banks will focus on fighting the recession and not inflation.

The Game is Over for Central Banks

In this section, the speaker talks about how central banks and governments seem to believe they can underwrite the economy and print as much money as needed to pay for that debt. They also discuss how this game is over and will backfire badly.

The Game is Over for Central Banks

The perpetu mobile that central banks and governments seem to believe they have discovered, namely that they could underwrite the economy and print as much money as needed to pay for that debt, will backfire very badly.

This game is over, which is a problem for 2024 and beyond. In 2023, there will be a recession followed by lower bond prices.

The Consequences of Economic Policies

In this section, the speaker discusses how economic policies put in place in response to lockdowns and deficits will have negative consequences that take time to reveal themselves.

Economic Policies and Negative Consequences

The policies put in place in response to economic lockdowns and deficits will have negative consequences.

It takes longer than people think for these consequences to appear.

These consequences are a result of the seeds sown in the past.

There will be more negative consequences coming.

Market Swings

In this section, the speaker talks about market swings and how they are a consequence of policies put in place.

Market Swings and Policy Changes

Market swings are a consequence of policies put in place.

People give up on the idea that there will be negative consequences before they start piling up.

There have been many stocks that have fallen into mine shaft type declines.

The Bank of England situation is an example where policies were changed abruptly leading to crisis.

Crypto Scams

In this section, the speaker discusses crypto scams and how they are a result of seeds sown in the past.

Crypto Scams and Seeds Sown in the Past

Crypto scams are happening due to seeds sown in the past.

These things take time to reveal themselves.

More such situations may arise soon.

Future Market Developments

In this section, speakers discuss future market developments.

Future Market Developments

There will be more market swings.

The valuation correction is over, but a correction in earnings is still ahead.

Earnings will decline much more than expected.

There may be an opportunity to invest again in the first half of the year.

FED Rate Cut

In this section, speakers discuss the possibility of a FED rate cut.

Possibility of a FED Rate Cut

The odds are greater than 75% that there will be a rate cut in 2023.

When it comes to these types of developments, there's never one cockroach and there's going to be more.

Interest rates have seen some pretty epic pivots in just the last few years.

The pivot will be just as quick when they face adversity.

Interest Rates and Policies

In this section, speakers discuss interest rates and policies.

Interest Rates and Policies

The minute something starts to change on the ground in the economy, we've seen some pretty epic pivots on interest rates in just the last few years.

Jay Powell abandoned quantitative tightening three weeks after announcing it in 2018.

The pivot will be just as quick when they face adversity due to policies put in place.

Cyclical Correction

In this section, speakers discuss cyclical correction.

Cyclical Correction

There will be a cyclical correction from about a year ago that should complete with another leg down.

There is an opportunity for investment at the next opportunity sometimes in the first half.

Favorite Investment for 2023

In this section, speakers discuss their favorite investment for 2023.

Favorite Investment for 2023

Felix expects a year of volatility and opportunities.

It's too early to say what the favorite investment will be.

Investment Strategies for 2023

In this section, Jeffrey Gundlach and Felix Zulauf discuss their investment strategies for 2023. They talk about the performance of commodity-related stocks, bonds, emerging market equities, and Chinese investments.

Long-Term Treasuries

Gundlach shares that they entered the year negative on bonds and with very low duration but started buying long-term treasures in September.

They now have the longest duration in some of their flagship products since they founded DoubleLine over 13 years ago.

Gundlach believes that long treasuries are a great opportunity for a multi-year holding period.

Emerging Market Equities

Gundlach thinks that emerging market equities will be the biggest opportunity coming up.

He suggests buying them now but expects to buy them cheaper later.

He believes that it's a great combination with long treasuries.

Chinese Investments

When asked if he would buy China for political reasons, Gundlach says no as a US citizen because there is no way of winning in buying Chinese investments.

If they work, China will confiscate them; if they don't work, US citizens will be holding the bag.

Conclusion

The speakers wrap up their conversation by thanking each other and discussing how much territory they covered.