WHEN: Today, Thursday, October 11, 2018
WHERE: CNBC's "Fast Money Halftime Report"
The following is the unofficial transcript of a CNBC EXCLUSIVE interview with DoubleLine Capital CEO Jeffrey Gundlach and CNBC's Scott Wapner on CNBC's "Fast Money Halftime Report" (M-F 12PM – 1PM) today, Thursday, October 11th. The following is a link to video from the interview on CNBC.com: https://www.cnbc.com/video/2018/10/11/doublelines-gundlach-rates-are-a-big-factor-in-this-market-sell-off.html.
All references must be sourced to CNBC.
SCOTT WAPNER: Our next guest, he predicted this move in treasury yields, Jeffrey Gundlach is the Founder and CEO of DoubleLine capital overseeing $123 billion on assets under management. Joins us now exclusively from Los Angeles. Good to see you again.
JEFFREY GUNDLACH: Good to be with you again, Judge.
WAPNER: Always good to have you. Six down days now in a row for the S&P 500. What's this about? Why are the markets suddenly unsettled? Is it all about rates?
GUNDLACH: it's partly about rates, obviously we talked about this before there was four years in a row basically that the 30-year Treasury bond was bumping up against resistance at about 3.25 and I think when we were last together we were talking about this before and it held up at 3.25 several times including earlier this year. But then I always felt if it broke above that we would start looking at yield curves steepening and see an acceleration to higher rates I think it's pretty clear that part of the issue here is the rise in rates. And also the speed with which it went up. Which isn't all that surprising I mean once we got above 325, we tacked on another 20 basis points really quickly. There's an issue that's been developing for several months now that I think doesn't get enough attention which is also part of the issue. And that is the fact that the U.S. stock market since January 26th, has acted uniquely strong compared to the global stock market including everything except the United States, it's a really fascinating chart. I had it on my webcast a month ago and I was pointing out that that was a strange divergence, that investor need to pay attention to. Basically what happened is the U.S. Stock market and compared to the entire global stock market, excluding the U.S., went up in tandem, about the same amount and with the same pattern, from the year-ago period into January 26th of this year. If you normalize the lines so that you, they both meet at January 26th, it's interesting, because they fell together. The U.S. and the world stock market fell together into that February mini crash and they fell the same act and then they rallied back up together about the same amount and they fell back down together about the same amount. Starting in about June something really strange started to happen. From the months before they were acting identically starting in June the S&P 500 went on a solo journey to new highs, it went 12% to 15% above the point it was at in June when the U.S. Stock market and non U.S. global markets were basically at the same starting point. At the same time the S&P was going to a new high, the global stock market x the United States went down and went down to the low of the 12-month period, and it went down about the same amount that the S&P 500 went up. You had this alligator jaws divergence on the chart that was really interesting. Because one market, U.S. exclusively went up by 12% to 15% and the global stock market x U.S. went down I said in my webcast, I think that the global stock market heads lower, still, there's no way that the U.S. Stock market could hang in there. Because the divergence is just too big. And if the global stock market is really going to take out the low and put in a new low, something bad must be happening. And I don't think the U.S. can hold in there. Well what happened, as rates broke to the upside on the 30-year. The global stock market x U.S did take a new leg down and did go to a 12-month low so it's interesting that the S&P 500 did what I said it would in my webcast. And that is, join the global stock market on the way down and one more effect that's going on is there's a couple of stocks, particularly Amazon and Apple. That responsible for massive gains here in 2018. And it just might be once the market started looking a little shaky, it just might be now that we're in the middle of October that some investors might be taking profits, thinking about year end. I mean back when I started in this business, we talked about yearend tax selling we talked about that in December, and that started to migrate into November about ten years ago and it seems to be getting earlier. Just possible that this weakness has encouraged some selling because you still have enormous profits, in Amazon even though it's down substantially from its high and Apple is almost on its high, hardly down at all that might be vulnerable to tax selling as we move into the few weeks ahead.
WAPNER: You mentioned the speed in which rates have gone up, was it faster than you thought? Does the fact that it went up in the manner in which you did lead to you believe we're close to the end of this recent move or merely getting started?
GUNDLACH: I think it's more like the middle of the move what I expected is when we got to 325 on the 30-year, if we broke above it, it would probably break above it with authority it sure did the one day it broke above 325, the long bond dropped over 2%, two points that day and there was a route across the entire yield curve that was followed by weakness the next day and another acceleration which I expected, up to around 344 or so on the 30-year treasury. That makes sense to pause there if you look at the charts and the way the market is behaving and you think about the trends that are underneath the bond market, it wouldn't be surprising at all to see the 30-year go to 4% before this move of the breakout above 325 is over. And the curve should probably steepen. Maybe the 10-year treasury makes it to 350 or 360 during that move. One of the things that's fascinating about this sell-off in bonds. If it's happening in the context of a really high short position against the treasury market. It was actually by far the highest ever on the data series. Not by a small amount, by a very large amount. And with the sell-off you would have thought maybe it would be braked a little bit by the floor positions, maybe looking to take profits, rarely do you have this kind of crowded positioning in a market and they're all making money on it. So that is really interesting. I think one of the reasons that people are comfortable staying short with the bond market number one, ultimately the fed wants to tighten and if the short rates go higher, that creates competition because the spread isn't very big. But also, investors are starting to realize just how many bonds are coming at us in the year or two ahead. I've talked about this repeatedly over the last couple of years we had a budget deficit in the states. That went up from around 600 billion a couple of years ago. To now the official number for fiscal 18 is a little over 900 billion. But that doesn't really capture how much debt is being added to the national debt of the United States. If you look at the deficit there are certain things that aren't included in there importantly there's a loan to the social security system, that is very big number. And it takes the increase in national debt for the fiscal 2018, is not 900 billion. It's $1.271 trillion. That's a cash accounting way of tracking the growth and the debt if you use accrual accounting which companies have to do when they report their financial situation, they have to accrue things like pension liabilities. We have pension liabilities in the United States, too, like the veterans benefits and so on that have been increased. Back a couple of years ago, we don't have data for 2018 fiscal yet I don't think. A couple of years, the two years before that, I think we had about 400 billion dollars of accrual. Obviously going to have borrowed in the future at some point for these liabilities. So in essence the actual growth in liabilities is more like $1.7 trillion in the United States and on top of that you have the fed cranking up quantitative easing to $50 billion a month. Which is another $600 billion for fiscal 2019, if they continue on that course. Which takes you to around $2.25 trillion of debt increase, judge. And this is at a time where we're supposedly in a good economy. GDP, real, was over 4% in the second quarter it might be in the high threes for the third quarter. And here we are, we were supposed to be having a surplus and the deficit is expanding. Ladle on top of that, the debt-to-GDP ratios, and ladle on top of that, $10 trillion per a McKinney study that came out about a month or two ago that global corporate bond maturities are something like $10 trillion over the next five years so there's kind of a problem with the compounding curve on debt service and I think that people are starting to realize that we're going to have to take down an awful lot of bonds and we're getting more isolationist in the way we're dealing with things. And maybe we won't have our foreign creditors continue on with their willingness to accept our bonds at these levels of yields. Maybe they have to go higher.
WAPNER: Let me ask you about that. I want to ask you, you think that, you think Powell is too hawkish? Do you think that he was too hawkish last week? Or do you think that the market got it wrong? I want to ask you about the president throwing the fed, and Powell and everybody else under the bus. But first off, was he too hawkish last week? Is the fed on the wrong path?
GUNDLACH: I don't think so. All the inflation measures are on the core basis at 2% or higher I think core CPI came out today at around 2.2% which is a little bit above that 2% target. You remember in the old days they were trying to get inflation up to 2% they were supposed to be like a ceiling and it became kind of like a target. Now we are supposed to be like symmetric around it, meaning because we were below 2 for a while i guess you've got, a pay-back okay to be above 2 with yields only at about 2.85% on the two-year and the headline CPI in the mid 2's, I'm not sure I can say the fed is being hawkish. Would say that problem was that maybe the fed was far too dovish for far too long, keeping rates very, very low and now they're trying to make the difficult journey getting back to a so-called normal rate I thought the fed's statement was really weird when they dropped the word accommodative it seems to me you're accommodative, neutral or restrictive. When the fed says that the neutral rate is far higher than where we are today, well, then I guess you're not at neutral and you're certainly not restrictive, so i guess you must be accommodative. But oddly, they dropped that when it comes to President Trump it's clear to me that he's being crazy like a fox with this fed rhetoric. Where he doesn't want to take the blame, if the fed overtightens and leads to a problem in risk assets, which you know, is starting to come out in real-time in the last week or so, so he's basically saying you know, if the market goes down, it's on the fed. And so you can't blame President Trump for the stock market's decline. That's where he's coming from. But ultimately we've gone back to old school methodologies by the fed where in the old days, 10, 15 years ago they would tighten it every single meeting, once they got into auto pilot mode now it's like once a quarter is the auto pilot mode. They'll keep tightening, as long as inflation stays above 2%, as long as the markets don't throw too big of a fit and as long as the inflation rate is in the mid 2's, i can see the fed continuing to tighten. We're in the place now that auto pilot place where you need the data to change to the down side. To change the fed's mind right now it's too premature for that leading indicators are super strong, year over year at 6.4 the sentiment surveys on some measures are off the charts, CEO confidence and home builder confidence has flagged a little bit but still at a high level. Would you need those things to drop in an observable way along with things like the PMI indices, junk bond spreads would have to start widening much more than they have already to be really concerned that there is already something that is broken in the economy. So the fed is likely to stay on that path.
WAPNER: Well, it's clear the president is probably looking for some political cover too, you know, if this stock market sell-off gets a little worse. But what do you think when he calls out the fed, the way he does, over the last 24 hours including just before we came on the air together today?
GUNDLACH: Yeah, I don't know. I think it's kind of a myth that the fed is really all that independent. They say that they're independent, but they're constantly, i think, having discussions about what is going on. President Trump is just a different kind of guy. The fact that he's calling out the fed, he calls out everybody. So it would be completely out of character for him to not try to point fingers and lay blame at other people's feet. He does that all the time. So, I'm not surprised he's doing that. I do notice, Judge, the administration has counterbalanced some of that rhetoric by trotting out Larry Kudlow saying the fed is independent and I think he used the word Powell is "on target." Meaning he thinks that it's just fine. So you've got kind of – on the one hand, you've got President Trump with his rhetoric and Larry Kudlow's there to kind of calm it down.
WAPNER: Right. But how much do you think of what we're seeing is self-inflicted? From the trade policy and tariffs and tariff causing inflation that may be still on the come. You've got commentary from so many big companies –
WAPNER: FedEx, Macy's, Ford, Micron –
WAPNER: I could go down the list.
GUNDLACH: Yes, exactly. And i think that that is not a coincidence, that a lot of that rhetoric came out while the bond yields were starting to push to the breakout point. I mean, it really is clear that tariffs are in the short-term. I mean, we have long-term strategy that -- it sounds pretty illogical, but by ramping up tariffs, you're going to eliminate tariffs. Maybe that's where you're trying to get to with this strategy. But along the way, it is clear that you're going to be raising prices. And I thought that that one-two punch of ford senior person saying, you know, "if we have to have certain rules now, regulations sort of, on higher input prices for car parts, obviously we're going to have to raise the prices of our cars." And if tariffs are inflationary. One thing that's strange about – you talk about self-inflicted, one thing that's strange about the administration is on the one hand, they praised tax cuts as being a wonderful thing when they're for corporations, and for the middle class. But at the same time, they're raising taxes. Tariffs are a tax. The Chinese don't pay the tariffs. American consumers pay the tariffs. And so if you're increasing the cost of cars, that could easily be sort of inflationary signal. And at the same time, you know, Amazon made that statement, they're going to increase minimum wage to $15, I think that that puts a structural cost boost into a lot of companies' businesses. I think Amazon is doing it in a fairly clever way. I think all they do is automate more and they're making it much higher barriers to entry for their competitors if they're forced to kind of, follow suit, follow the leader, and raise their minimum wages as well. But obviously that is also somewhat inflationary. Meanwhile, inflation is going to be a little more stable for a while. We have a model at DoubleLine, it's been very accurate, we expected the CPI core and headline to drop this month. It should be fairly stable until year end in the low 2s for core, maybe a little higher, and pretty much where we are for the CPI. CPI indicators --
WAPNER: CPI was cool, it was cooler this morning. I mean, maybe we need to take a chill pill on the expression thing.
GUNDLACH: We expected that. Yeah, we expected that, but at the same time, we have forward looking indicators on core inflation at DoubleLine. Pretty much all of which corroborate the idea that core inflation in the next year and a half to two years should probably move up into the high 2s, all things being equal, and these indicators don't even know that there is tariffs coming. These are using the historical relationships. So one thing that works is the New York Fed's underlying inflation gauge leads core CPI with a correlation of 80%, which is very high, over a multiyear period, by about 16 months. And that indicator suggests that core CPI should be headed into the high 2s. Also you can use the PMI surveys to have a forward look at core CPI and that also correlates with almost 80% with a 21-month lead. So these are very high correlations. And the PMI also suggests that it is plausible if not likely to expect core CPI to moving to the high 2s, which would mean, if that really happens, that means that for sure the fed will stay on this course.
GUNDLACH: And that's going to be really interesting to see if the bond market can absorb that, because with this deficit exploding, the way it is, and it is going to get much worse with the compounding of the entitlement programs, the cost of servicing our debt is going to increase. In the next five years there are $7 trillion of treasury bonds maturing over that period. And they're paying an average coupon of about 2%. So when that debt gets rolled over, what if rates are at 4%? That means you're going to have another $140 billion of excess debt servicing costs per year. So this compounding curve of debt, I think is going to gain a lot more attention as we move forward and these numbers get more and more real time. In the last few months, almost every month the estimates of the federal deficit have come in on the low side and the actual was much higher. And that's a trend that somehow seems likely to continue.
WAPNER: Let me ask you this: you've said on twitter, and this is your word, that stocks were, quote, "buckling" because of what was happening with rates. If they do in fact go, to a ten-year, 350 to 360 and 30-year to 4% or anywhere closer to those levels, what do you think happens to equities?
GUNDLACH: They go lower. I think equities go lower if rates go higher, particularly if rates go higher in a way that people seem to be alarmed by, which is kind of what happened in the last week. I mean, there are three sectors of the economy that have already seemed to been affected by rates. We have a major bear market under way in home builders. And there is no surprise there. I mean, we have had big increases in home prices, far in excess of average hourly earnings growth and income growth over the past 7, 8 years or so. And we have interest rates that are up by 200 basis points on mortgages. And when I hear people on financial media say it doesn't matter because rates are still low, that's nonsense. It is the delta that matters when you've had 3% and lower 30-year mortgage rates for several years in a row, obviously the pricing structure of the housing market has that factored into its construct. And now we have mortgage rates at 5.1%, possibly going to 5.5%. That would be almost a doubling of mortgage rates and we all know that mortgages as a monthly payment kind of a game. So if the rate is higher, the -- no surprise that we see declines in home builder confidence and also the University of Michigan survey that says is this is a good time to buy a house. Also, autos are in a bear market. And banks are doing terribly, because of the loan volume is likely to shrink as we see interest rates going higher because it's difficult for people to afford higher rates from this level.
WAPNER: So this whole thing of rates rising for the right reason, you don't sound like you buy that?
GUNDLACH: That just seems to me to be an empty platitude. I don't even know what that means, "rising for the right reason." Rising is rising --
WAPNER: -- for so long the economy is doing really well, it's ludicrous to have rates as low as they were this late into the cycle.
GUNDLACH: I agree with that. But before we get all excited about how well the economy is doing, let's think about a couple of things. We've increased the deficit by about 1.5% of GDP. So it shouldn't be that surprising that GDP is up by about 1.5% because part of the equation for GDP includes the delta in government spending. In this case, government borrowing. So it is not that surprising that we moved up to kind of more of a 375 type of economy from a 225 economy because we have sprinkled miracle grow on the plant and it is having the steroidal effect that you're wanting. Also, this nonsense about, "this is the greatest jobs economy in history," if you take a look at the last 20 months of Obama's administration, nonfarm payrolls averaged 211,000 per month in last 20 months of Obama. In the first 20 months of Trump, nonfarm payroll growth per month averaged 190,000. Last time I checked -- and I'm a math major, so I might have some credibility here – last time I checked, 211 is higher than 190. And if you zoom back and take a look at nonfarm payrolls, back to 1940, this is anything but the highest jobs economy, especially if you adjust per capita. It is kind of the same that we have had over all of the decades, but the population has grown since 1945, by 250%.so on a per capita basis, those jobs aren't there. Also, it is just not true that we have tremendous wage growth. If you just look at the charts, it is just not true. We're about where we have been. So it is true that leading interiors are good, part of that is the stock market. It's true that confidence is there, you know, but it really -- the economy can be explained by being tax-based and spending-based, tax-cut based and increase spending-based. And the delta isn't going to be there in perpetuity. And higher rates, with quantitative tightening, cannot be positive. One of the fascinating charts, there is two charts that are really interesting –
WAPNER: Alright, I've got less than 30 seconds.
GUNDLACH: Okay. One is the growth of national debt exactly matches the S&P 500's performance back to 2009. It's really interesting. The last one is the balance sheets of the central banks increase exactly the same if you look at the chart as the growth in the global stock market and now those balance sheets in accumulation are going down. So it is not surprising that the global stock market is going down and away from the U.S. This is not a good year for stocks at all.
WAPNER: Yeah. We'll leave it at that last – actually, you know what? You predicted the presidential election right. Who is going to win the midterms? And then I've got to run.
GUNDLACH: I think the Republicans keep the senate. And I think the republicans do better than what they're polling, but lose seats in the house.
WAPNER: Alright, Jeffrey, it's always good to catch up with you. Thank you for your time. And a good amount of it today.
GUNDLACH: Thank you, Judge.
WAPNER: Alright, DoubleLine's Jeffrey Gundlach joining us exclusively from Los Angeles. Thank you for watching.
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