• Macro Masters Insights – Gundlach’s Entire Investment Thesis
• S&P 500 and Oil
• The Hindenburg Omen
• Random Tweets
• Personal Note: New York and Dallas
• Trade Signals: May 29, 2024

See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.

In short, Gundlach sees a slowdown—a recession nearing—and believes the Fed will respond aggressively. Another round of inflation will follow, and it will be higher for longer. He believes we are in a debt trap, and some form of government yield curve control is probable. I particularly enjoyed their discussion on being wrong and the importance of investment risk management.

Fast-forward to the 22-minute market for what I believe is the meat of the conversation. At the 32-minute mark, you’ll find Gundlach’s Entire Investment Thesis.

Rosenberg asks, what’s your view on where we are going?

Gundlach: We’re at the 40-year anniversary of the last big peak in interest rates, which occurred on May 31, 1984.

• Longer-term treasuries were 14%, and the inflation rate was 4% and falling. People were still afraid of bonds. They passed on a 10% real interest rate that turned into more than a 10% real interest rate. That was the turning point for yields declining.
• I feel like we almost have the exact reverse going on.
• The government has shown its willingness and ability to execute policies, which suggests to me that we’ll have more of the same going forward.
• In the near term, I think the inflation rate is not a problem. I feel like there’s more of a recessionary feel than an inflationary feel. But my fear is that the Federal Reserve will go back to its old tricks, and I think Jay Powell even said so in a kind of off-the-cuff in one of his press conferences (a couple of Fed meetings ago), that the Fed needs to reduce the Fed balance sheet so that they can get it back up again in the next recession.
• This indicates to me, sadly, that the response to the next economic downturn will be more money printing and inflationary policies.
• So, I fear that in that in the next recession, I expect that inflation will go down, and I expect that long term bond yields will go down.
• But then I think everyone’s going to get caught, because they’re going to print money. And they’re going to go on the balance sheet again, and they’re going to cause inflation again, and I think they’re stuck with this, because the interest expense problem is getting very real.
• We have trillions and trillions of dollars of treasury bonds that are maturing in this this calendar year in the next two calendar years or ~ $17 trillion. And many of them have coupons of 50 basis points or 25 basis points on 10-year treasuries. And these are coming due and if the debt is refinanced where interest rates are today, the interest expense is going to start turning into one of the largest budget items.
• It has already surpassed the official military spending and higher for longer means that these maturing bonds are going to be priced at 400 basis points or 300 basis points or 200 basis points higher than what’s rolling off.
• I spoke at Jim Grant’s 40th-anniversary conference back in October. And as luck would have it, there was a big news wire story about how Stan Druckenmiller was sounding the alarm on the interest expense, but he was using the CBO data. He said it’s (interest expense) going to be like 30% of tax receipts by 2040 or something like that. And this is a problem.
• But that’s not even close to accurate. The CBO estimates are highly optimistic. They assume real growth all the time of 2%. I can’t blame them for that because they make multi-decade projections. So how are you supposed to do business cycle estimates so they just throw in the towel and I can’t blame them for just going with 2% real growth all the time. But they make two assumptions in there that are really specious.
• One of them is that the interest rate will be 3%. Well, it already has a four (in the 4% range) handle across the curve and a five (5% range) handle on the T-Bills, so that’s not a good assumption.
• And they assume that the budget deficit will be something around 4% of GDP. Well, it’s already 6% of GDP. The Biden ministration predicts is going to be 6.1 next fiscal year.
• And, of course, that assumes no recession. When a recession comes, you add percentage points of GDP to the deficits in the old days, which used to be 4%. In recent recessions, excluding COVID, it was 9%.
• Let’s say it goes up by 6% in a total financial crisis. That means we would have a budget deficit of 12% of GDP.
• And if the interest rates aren’t the 3% they assume, but they’re, I don’t know, 6%, because people don’t like the inflationary response to the recession. We’re going to end up with something worse than Stan Druckenmiller’s prediction. The interest cost on the debt alone will be that size as the entire discretionary budget by 2030.
• So, we’re in the endgame here for this debt finance scheme. I believe that fixing all of this will make us a better world going forward, maybe in the 2030s.
• We won’t be able to borrow anymore. We’ll have to run a sound economy.
• That’s so outside the psyche of consumers today, who are borrowing money like crazy at 23% interest rates.
• I worry about how we’re going to deal with this interest expense because we have over $210 trillion of unfunded liabilities in the United States.
• These include unfunded pensions, Social Security, Medicaid, and Medicare. The Social Security trustees, using CBO estimates, say Social Security will run out of money by 2034. Another report says 2032, but it assumes no recession.
• So they’re going to run out of money in the 2020s… if there’s a recession, which I certainly believe there will be by 2030 and the Medicaid Medicare trustees say they’re out of money in 2030. No recession.
• So out of money like before the next presidential election after this one.

What are we going to do? I’ve got a sort of radical idea, and I’m not predicting this, but it’s something that I’ve started to implement. I don’t like taking any risks that I don’t get paid for. And if I can eliminate a risk at no cost, I want to do that.

• So, I’ve got this crazy idea that I want to buy only the lowest coupon treasuries, zeros if possible. Because if I have a very low coupon treasury, I don’t have to worry about being restructured. I worry that the federal government might be forced to restructure the Treasury debt. People say that’s impossible… That it is a contract… It’s illegal.
• And I say, well, don’t you remember the mortgages back in 2007 2008 2009. It was illegal to modify those mortgages. It was in the prospectus of trillions of dollars of mortgage-backed securities, that these mortgages cannot be modified. But they did it.
• The Federal Reserve Act of 1913 makes it illegal for the Federal Reserve to buy corporate bonds, but in 2020, they started doing it. They didn’t have to buy very much because just by doing it, the market repriced aggressively because the Fed was putting its unlimited balance sheet behind buying corporate bonds. That is perceived to be huge buying power, so they can underwrite this market. And so that happened, even though it was illegal.
• It’s unconstitutional to cancel student debt, but $7.7 billion of it was canceled yesterday, in one day alone.

So, the fact that something is viewed as a contract doesn’t mean it won’t happen because it’s been happening with regularity over the last several years, so what if, and I’m not predicting this… What if the Treasury says, hey, we’ve got all these bonds out there, and some of them are quite old and some are paying 4%, 5%, 6%?

• They come out and say, “We’re in a jam.”
• What if the Fed then decides that they are going to cap the yield on all Treasury’s at 1%?
• If you own a 6% coupon, 20-year bond, and it gets reset down to 1%, I’m not predicting it’ll happen, but it might… If it does, you’ll lose at least 50% of your value.
• People haven’t figured this out. This is a real risk.

Rosenberg pointed out that the biggest holders of Treasury bonds are pension funds. Gundlach answered, it’s a total disaster, but that’s what happens when you have no options.

• People like to put off bad decisions, you know, difficult decisions, but the danger is they put them off so long that the options are limited. People say to me, well, what can we do about these unfunded liabilities the value which is greater than all the financial asset value in the United States? What can we do about these?
• And I say, you can get somebody smart in Silicon Valley to create a time machine. And takes us back in time to 1982 and we’ll start over and we won’t do this again (accumulate so much debt).
• Unfortunately, I think the government scheme, which has gotten more extreme with every recession, is at a dead end. This means that in the next recession, in response, the Fed may move to potentially running negative interest rates and causing more inflation.
• That’s why I think the dollar will go down in the next recession, not up.

My entire investment thesis for the last couple of years, which has been working quite well, is fundamentally around dealing with the idea that what we think we know from the 40 years into 2021 and 2022 of falling interest rates is over.

• Junk bonds were able to refinance at lower rates. Yields fall during recessions, and junk bonds, shaky companies, instead of defaulting they would, could refinance.
• What I’m just saying is that those bonds never matured. So, with interest rates where they are now, the junk bonds that were able to issue bonds at three and a half percent in 2020 will never be refinanced.
• So those companies in a hard time, they’re going to have to default.
• Therefore, with rising interest rates, default rates will be higher than we experience.
• Now, counteracting that is that there are some good things about the junk bond market. It’s more secure than it used to be. It used to be largely unsecured, and there are more secured sections of the market today. CFOs are pretty smart. They push up maturities. We don’t have a maturity wall coming this year or next year, so that’s good.
• At the same time, we’ve got this very diversified bank loan market. What I mean by that is that the Triple C bank loan market looks like a disaster to me because these companies are borrowing at a very high rate. They started out at 4%, and some of these companies are at 10%.

SB here: We are all going to be wrong some of the time. Gundlach says he’s wrong about 30% of the time. In the investment game, the goal is no fatal mistakes. Don’t let anything blow you up. Keep that in mind as you allocate your wealth. Avoid major errors. Always second-guess yourself. Risk management is not about going all in but ensuring nothing blows up your wealth. Risk manage everything: diversification, sizing, downside stop loss risk management. 

This is not a recommendation to buy or sell any security. It is for educational discussion purposes only. Opinions are subject to change. Consult your advisor. 

Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.

I’m taking an Amtrak from Phila to NYC on Tuesday afternoon for dinner with good friends Rory Riggs, Barry Habib, and Peter Boockvar. An agriculture investment conference follows on Wednesday. Dallas follows June 18-21 – Energy related. 

The following are pictures from my stepson Kieran’s college graduation last weekend. Go Big Red! Go, Kieran!

Susan rented an Airbnb on Seneca Lake. We celebrated and hit a few wineries. Spending time on the lake was peaceful and great fun. It was a beautiful weekend in Upstate NY. 

                                                                                                                         Susan and Kieran                                                    Kieran, Tyler, Pat, Jim, Connor and Susan

Here is a toast to you and your family. Hold it high… Cheers! Time is moving much too fast. 

Wishing you a wonderful week, 

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