WHEN: Today, Monday, December 17, 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, Monday, December 17th. The following are links to video from the interview on CNBC.com: https://www.cnbc.com/video/2018/12/17/doublelines-jeffery-gundlach-this-is-definitely-a-bear-market-stocks.html, https://www.cnbc.com/video/2018/12/17/doubleline-jeffrey-gundlach-government-dysfunction-negative-world-economy-congress-demorcrat-house.html, https://www.cnbc.com/video/2018/12/17/a-high-quality-bond-portfolio-is-2019s-best-bet-says-doublelines-gundlach.html, https://www.cnbc.com/video/2018/12/17/jeffrey-gundlach-federal-reserve-should-not-raise-interest-rates-december-jay-powell.html, and https://www.cnbc.com/video/2018/12/17/doublelines-gundlach-tariffs-are-only-going-to-get-worse-in-the-trade-war-before-they-get-better.html.
All references must be sourced to CNBC.
SCOTT WAPNER: Welcome to Los Angeles Jeffrey. Thank you for having us back.
JEFFREY GUNDLACH: Welcome to DoubleLine.
SCOTT WAPNER: Almost a year to the day we were last with you.
JEFFREY GUNDLACH: I think it was December 13th last year.
SCOTT WAPNER: That's right. We're still volatile in the market. Today is another representation of that. We're still about 50 points above on the S&P of the February lows.
JEFFREY GUNDLACH: Yes.
SCOTT WAPNER: Do you think we're going to go below that?
JEFFREY GUNDLACH: Well in the fullness of time, I think absolutely we'll go below that. I'm pretty sure this is a bear market. People like this definition of 20% down as a bear market, but that's obviously very arbitrary. I've been around over 35 years in the business and have seen a number of bear markets. It's more about how you lead into it, how it develops and how the sentiment changes, and I think we've had pretty much all of the variables that characterize a bear market I remember going -- usually something happens that really doesn't make any sense at all and I'm kind of amazed how it goes on longer than it should like back in the dotcom days when companies were being IPO'd and had no sales let alone revenues that's hard to be and they would actually explode to the upside on the IPO. That's kind of crazy and then we had the subprime lending with pick a pay loans back in '05 and '06 and that was kind of crazy and that went on longer than it should have. This time like we talked about a year ago it was crypto, bitcoin which was truly a mania, we talked a year ago it just went up. Maybe in the end it's a good thing or the block chain technology is a good thing. The way it was being treated and believed in was a mania and then it crashed about a week after we met a year ago and it was at 17,500 when we were speaking right in this spot and of course now it's down below 3,500 so an 85% decline. And one after another you start to see various sectors of the global financial markets give it up. The global stock market peaked January 26th. And so did the New York Stock Exchange composite, January 26 but the Dow Jones Industrials, the Nasdaq, the S&P 500. All of these things, one by one, started to roll over and come the summertime or later in the summertime you were down to the FAANGs and then you were down to two stocks it was amazon and apple and then amazon gave it up. And then finally when they decided they weren't going to tell you how many phones they sold anymore apple gave it up.
SCOTT WAPNER: That was the last straw.
JEFFREY GUNDLACH: That was kind of the last straw. It was October 3rd when the tariffs -- well, it was that USMC -- whatever it's called, it's really NAFTA but it was announced we would have this change in NAFTA that would lead to a requirement that a certain fraction of car parts be made in higher costs locales which basically meant not Mexico. A senior executive at ford motor said, well obviously we're going to have to raise the prices on our cars if input prices are going up. Suddenly the market seemed to wake up to the fact that this was real and the next day the stock market tipped over in fact, on October 3rd, Jay Powell said we're a long way from neutral. And that was a big problem, too.
SCOTT WAPNER: That seemed to be the tipping point.
JEFFREY GUNDLACH: Yes that with the USMCA thing and the Ford Motor executive, those things seemed to come together and coalesce into we've had enough. And, yeah, the Jay Powell thing was interpreted by the market as a scary thing, the fed was going to keep going a long distance further and then the market dropped over 10% and suddenly the Fed had to massage the rhetoric. And suddenly it was, well, we have a new definition of neutral maybe. We're actually within the lower bound or close to the lower bound of neutral in an attempt to stabilize the market. So, yeah, it seems like a bear market to me in the way things trade with late day volume being bad and the like the best thing for the near term, I think, is that the most export sensitive stock market, South Korea, the Kospi bottomed October 29 so at least that's not pushing to new lows and emerging markets broadly are doing better because they're extremely export driven. Maybe this leg down is getting toward an exhaustion point the sentiment is pretty dark right now. I'd be happier on the short term outlook if the VIX would go above 40 which is usually a sign.
SCOTT WAPNER: That would be quite a spike.
JEFFREY GUNDLACH: Well, that's typically what happens when you get to the bottom, there's so much nervousness and fear but the Vix is a little bit disturbing how it doesn't go higher. Actually as the market pushes to the down side. But i think this is a bear market and i think we'll go below the February lows almost with certainty.
SCOTT WAPNER: Is it a long lasting bear market or it can be short term as some have suggested on our air and then this secular bull market will resume?
JEFFREY GUNDLACH: I don't think so. I think it's a bear market. I think we've had the first leg down and the second leg down is usually more painful than the first leg down if this is indeed a bear market. Maybe in the short term we're getting flushed out. I think it's lasted a long time. It has a lot to do with the fact i believe we're in a situation that maybe unprecedented was too strong but it is highly unusual that we are increasing the budget deficit so spectacularly so late in the cycle while the fed is hiking interest rates. I know you've teased the segment by talking about the suicide mission I've been talking about for months. The fed almost seems to be on a suicide mission. What i mean by that the deficit in the United States is extraordinarily high from where we are in the economic cycle and given what the debt level accumulated is already. In the first two months of fiscal '19 it was just announced last week there's a funny thing that happened in November where the payments for December ended up being pushed to November because December 1st was on a Saturday if you take that out it's $44 billion that's a big number. So if you wake that out and say that's December and not November. Still, the first two months of fiscal '19, the budget deficit is going up at an annualized rate of $1.62 trillion. And that's the official budget deficit. The actual budget deficit is larger than what the report -- for example, for fiscal '18, which ends September 30th, the deficit was around $800 billion. But the national debt went up by $1.3 trillion almost now. Why? What's the difference there? There are items that are off budget. So the budget deficit really for fiscal '18 was $1.3 nearly trillion that's 6% of GDP and we're supposedly having a good economy and we're supposedly having jobs growth and all this other great stuff. In actuality we increase the deficit by 6% of GDP since government deficit change is a significant fraction – a significant variable in the GDP equation it seems to me there's no real economic growth that's happening away from the deficit. So what worries me is that as we move into a weaker economy, which will happen at some points and certainly the economy looks weaker now than it did entering 2018, that the deficit will continue to expand at a rate which could be prohibitive for the usual decline in interest rates helping to stimulate the economy. That's what I think is the real big variable investors need to focus on. And while this is happening with the deficit exploding, the fed is raising interest rates which means the interest expense is going to be increasing year by year as these zero interest rates that we had for a number of years start to roll off and the bonds have to be refloated once they mature, the next five years we have something like $7 trillion of treasuries that are maturing the average coupon on those treasuries is almost as low as 2%, slightly higher, 2.1%. When they roll over, they're going to be at a higher interest rate because the fed has been on the suicide mission of raising interest rates so the interest expense on that $7 trillion of treasuries is going to be -- maybe the rate will be at 3% like it is now or maybe 4% and you might even see we have an expense that goes up $100, $140 billion. So kind of the … of our government is coming back to haunt us ultimately. In financial markets, these things go on so much longer than they should Ross Perot ran for president running infomercials about we were doomed on the deficit and there was a book written in 1992, that same year, that was somewhat sponsored by the Peterson Foundation called bankruptcy 1994. And the idea behind the book was we have this compounding curve and this debt problem that is going to come back and really cause us problems. Well, he was early. He was early by at least 26 years. But he's right, you can't keep going on with the debt finance scheme, and I'm worried when the next recession comes we could be looking at, well heck, we're supposedly in a good economy and the next two months we're running $1.6 trillion what if we go into a recession what's the deficit going to be $3 trillion? And does that mean interest rates don't go down during the next recession, which is an idea I've been noodling around for a long time maybe they go higher with I've had a call the next two years that come 2021 the ten-year treasury will be at 6%. I get a lot of pushback a lot of debt deflation is out there in the twitter-sphere absolutely wrong the economy can't handle higher interest rates. Interest rates might have a life of their own. It might not matter what the market can handle or can't handle.
SCOTT WAPNER: they haven't to this point. It's been somewhat surprising that rates have remained where they are you said 3%. They hit 3%. 3.25%. Here we are below 2.9% today.
JEFFREY GUNDLACH: yes, on the ten year. I was focusing on the three year when it broke above 3.25% that was incredibly important frankly, I didn't think we'd go back below 3.25 once we broke above because it seemed like such an important level. Here we are back below 3.25. But not impressively not in a way that would be consistent with a big decline in the global stock market. There's a thing called the death cross. It's a 50-day moving average goes below 200 a day particularly when they're both declining. Presently about 80% of the countries in the MSCI World Index are in a death cross 80%. It's amazing. And there was a chart that got a lot of play put out by deutsche bank about how many risk assets globally are in officially bear market down the arbitrary 20% number that, again, i don't really ascribe to but so commonly used at that they used it and the highest in the data series going back to 1901. It's like 90% of the risk assets around the world in dollar terms are in bear markets. So it's a pretty widespread and coordinated set of weaknesses.
SCOTT WAPNER: Are you saying that by embarking on this suicide mission that the fed shouldn't raise interest rates this week?
JEFFREY GUNDLACH: I don't really think that's the main thrust of my idea this week, yeah, they shouldn't raise them this week.
SCOTT WAPNER: They shouldn't?
JEFFREY GUNDLACH: No I don't think they should. The bond market is saying, fed, you've got no way you should be raising interest rates look at the 2s, 3s, five-year part of the yield curve which are flat at 270 I guess that corroborative of a hike. But it is basically saying in the year 2019 you're going to have a cut, this big, but a cut that was priced into the yield curve and in 2020 another cut. The problem, though, isn't that the fed shouldn't be raising rates. The problem is the fed shouldn't have kept them so low for so long.
SCOTT WAPNER: Sure.
JEFFREY GUNDLACH: The problem we shouldn't have had negative interest rates like we still have in Europe. We shouldn't have done quantitative easing which is a circular financing scheme. The problem really is the deficit. The fed is kind of helpless here. The fact that the deficit is so out of control this late in the economic cycle, we have never before had the fed raise interest rates while the budget deficit was expanding it's never happened. Because usually the budget deficit expands in response to a recession. It's a way of stimulating to get us out of recession. Instead, we did it as a last gasp of keeping this economic recovery going by making it completely deficit based.
SCOTT WAPNER: So this morning, President Trump once again Tweeted about the Fed. Quote, "It's incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris burning, China way down, that the Fed is even considering another interest rate hike. Take the victory," he stayed. Stan Druckenmiller, today, Op-Ed "Wall Street Journal": The Fed should quote "Pause its double-barreled blitz of higher rates and tighter liquidity." So they're right, you agree with them?
JEFFREY GUNDLACH: I do agree with them. I've been saying this pretty much all year, the double-barreled was actually -- he may have borrowed that from me, that's how I've been talking about – it's how I've been phrasing it all year – that we've really been tightening interest rates in a way that's more than people understand. There's a duo of economists at the Atlanta Fed called Wu and Xia, who did a study a few years back 'What was the effect of quantitative easing?' If they hadn't done the quantitative easing and instead had taken the European model and gone to negative interest rates, how negative would those rates have had to be to have the same stimulative effect as the quantitative easing? And they concluded – and I don't know if they're right or not it's very hypothetical – but their conclusion was that the quantitative easing amounted to 300 basis points of further cuts. So if they hadn't done quantitative easing, to have the same stimulative effect, the Fed funds would have had been negative 300 basis points. Well let's just say they're right. Since they did about 2.5 trillion of quantitative easing and it was 300 basis points, 2.5 trillion divided by 3 is roughly $800 billion. Okay? So $800 billion is -- $800 billion divided by 4 means that's what quantitative easing is one cut. So 100 basis points is $800 billion. So divided by 4. 25 basis points is $200 billion of quantitative easing. Well so far we're pushing towards $400 billion -- we're not there yet but we're soon to be there -- of quantitative tightening. That means we've had would more rate hikes from quantitative tightening if Wu and Xia are right. So the Fed hasn't just raised rates in that context eight times. They've raised them ten times. And the quantitative tightening is stated to be as high as $600 billion over fiscal '19. So that's another three rate hikes. So if they were going to follow their dots and raise rates so many times, there's another three on top of that. So the amount of tightening has been underappreciated, I think, and Stan is right as he often is – he's one of the greatest investors ever for, him and Chanos, the two titans of the hedge fund industry. They're right that we are seeing the bond market react in a way that is historically very predictive of the Fed should not be doing this. And yet, we have this strange dynamic that they've almost promised a rate hike here in December. And then the President shows up with his Tweets trying to bully them into not doing it and it puts Jay Powell and the team in a very tough position. Because they're damned if they do and damned if they don't.
SCOTT WAPNER: You know what people are going to say if this week they don't hike. They're going to say Powell bowed to Trump's pressure and the criticism that he's taking.
JEFFREY GUNDLACH: Could well be. It's either that or probably also the stock markets and the global stock market's pressure as well. The argument that I have to laugh at, though, that I hear on financial media is people get up there and say if the Fed doesn't hike, it's going to be super bad for the market because people are afraid the Fed knows some super-secret bad news what a joke. What a joke. The Fed doesn't have any supernatural powers. They know what we know. They don't know any more than we know. They have 700 Ph.D. economists, which is an amazing number, but they didn't see the lending problems back in 2006. So they didn't have supernatural powers back then. I doubt they have them now. I think if the Fed doesn't hike, it will be the stock market is weaker and also the global economy is slowing down. I mean, things like the Citigroup data change series, every region is now negative. Even the United States has flipped slightly negative. And what that does is it says, "What's the economic trend relative to the last 12-month average?" and now it's below everywhere. So yeah, I mean the data is definitely slowing. And the last quarter of GDP, the President loves to talk about this as the greatest jobs economy ever which is completely untrue. There were more jobs per month under Obama's last two years than there have under Trump's first two years. You know, he likes to talk about how great it is but the last quarter, GDP of 3.5% real, was all inventories just about. If you take inventories out, inventory building, real GDP was 1.2 in the third quarter. That's it. Down from a massive number in the quarter before that because that quarter had a lot less inventory building. So the economy is definitely slowing down. Unemployment claims weekly are kind of bottoming out. The one thing that's still really good are the leading economic indicators. In the United States, the PMI Surveys, the sentiment surveys, they're all still really strong and not suggestive of recession.
SCOTT WAPNER: You've said as recently as last week that there aren't inflationary -- excuse me, recessionary winds --
JEFFREY GUNDLACH: The only one --
SCOTT WAPNER: -- Blowing.
JEFFREY GUNDLACH: There's a couple things that are on the radar screen now. At the beginning of this year there were literally zero. Now there's a couple. One is this weird yield curve that we have with 2s, 3s and 5s – exactly the same. I wouldn't call this inverted because they're pretty much the same yield. But hat's somewhat concerning when the yield curve flattens out. And also consumer expectations are really bad right now. If you -- consumer confidence, their awareness of where things are today is still very strong. But if you compare expectations for the future it's amazingly weak compared to where they are. In fact, if you subtract expectations for the future from feelings of current conditions, they're more negative than prior to the great recession. So consumers seem to be smelling something that isn't going right and it probably has something to do with interest rates and home prices having gone up so much more than wages. What you see in the surveys of "Is this a good time to buy a house?" University of Michigan does this survey, it's pretty weak. It was very strong at the beginning of the year and now it's not very far off where it was prior to the last recession.
SCOTT WAPNER: So given all that you've said, why isn't this simply a growth scare? Why isn't the economy doing better than you think? We had a Rapid Update, a CNBC Rapid Update that Steve Liesman does last week. Fourth quarter GDP ticked up 3%. Next year, 4%.
JEFFREY GUNDLACH: Yeah, retail sales were strong.
SCOTT WAPNER: So why -- maybe the economy is better than people think?
JEFFREY GUNDLACH: No. I don't -- I think it's a debt-based economy. So it depends -- when retail sales go up because people borrowed more money, is that really good? I mean if you meet an old buddy of yours from college and you say, "How are you doing?", and the guy says, "I'm doing great, I've got a huge mortgage, I have a second on top of that, I have four credit cards all maxed out, and I have this brand-new watch, I am killing it." And he says, "How are you doing?" You go, "Gee, I don't know. I mean, I paid off my mortgage, I don't have any credit cards. I've got a million dollars saved." Which one is doing well? I mean, the one that's consuming a lot might feel good in the moment. Like our consumers feel good in the moment based on the current confidence surveys, but their expectations for the future are weak. Well that sounds like the guy who is your buddy in college. It doesn't sound like you who has actually saved and are in a position to invest in the future. So I don't really think the economy is all that great. I think that when the deficit expands by hundreds of billions of dollars and you get a couple percentage of GDP, that's just debt. All you did was borrow money and, of course, it leads to short-term economic growth. But how are we going to keep this going when we have $1.6 trillion? 8% of GDP nearly is what we're growing our deficit at. You noticed there was a kerfuffle in Europe about -- Italy was going to run a budget deficit and all of the Mandarins were berating them for being irresponsible. Well, France is at 3.4%. Look at these elitists, in France 3.4% budget deficit berating Italy for being at 2.4%? But the U.S. is at 6 plus if you look at the real numbers. You know, if Europe -- it's a very large budget deficit that we're running, and that's what's driving our economy and the corporate economy is also leveraged up at record levels. Record levels that previously have been harbingers of recession. You can't blame the CFOs at America's companies. They were given incredibly low interest rates by the extreme stimulus policies and debt causes a yield starvation, the collapse spreads, corporate yields were by far the lowest in history and of course, they leveraged up and borrowed money to buy back stocks and leverage up the corporate economy further. So we have a very high vulnerability to interest rates and we're seeing that already. When we spoke a year ago and I said "If yields go up to 3%, stocks are going to take gas," that doesn't seem like a very high interest rate, does it? It is when you have zero knit into the marrow of your economic bones, which is what we basically did by leaving the rate so low for so long.
SCOTT WAPNER: So then you believe and agree with what Janet Yellen said last week about corporate credit, what Paul Tudor Jones and others have been warning about, and you yourself have warned about?
JEFFREY GUNDLACH: I've been warning about corporate credit for a long time. I said in 2017, September, that when rates go up, the worst performing bond sector will be investment grade corporate bonds. And, boy, was I right. I mean, corporate bonds have been bad this year. In fact, I did a webcast last Tuesday, I haven't looked at the numbers since then, but emerging market dollar denominated debt has stronger -- had stronger year-to-date returns through last Tuesday than investment grade corporate bonds. And that's amazing when you think about how emerging markets broadly have suffered with the stronger dollar and the tariff talks. Investment grade corporate bonds have been bad. And at this juncture there's some chance of them recovering a little bit if rates rise because the spreads are wider anyway, but if rates rise significantly, the duration, the interest rate risk of that sector, is very, very high. And if interest rates have the impetus to fall, which I -- it doesn't seem like they do, because they're not acting well with the correction on the stock market, something bad has to be happening in the economy for interest rates to fall from here. Something really bad has to happen – deflationary or recessionary. And that's not good for the default positioning of the corporate bond market. So corporate credit is – I'm negative on corporate credit – well I've been negative, basically maximally negative for about a year.
SCOTT WAPNER: Leverage loan market?
JEFFREY GUNDLACH: Leverage loan market is less scary to me. I know it's been weak lately with lots of outflows. That's because the market's reprising in the Fed. Leverage loans had a strong bid as they should have as the Fed was raising interest rates. They float. I mean, the leverage loans, there's portfolio that is yield 6%, even 7% if you lower credit. That's pretty good when you look at the screen of treasuries yielding 3%. But leverage loans started to say, "Uh-oh, maybe the Fed's not going to keep raising interest rates and maybe the reason they're not is this weaker economic data." So we're not going to get a coupon hike with the Fed and I might be worried about a recessionary situation, well, they've sold off a little bit. But they're still the best performing bond sector year to date.
SCOTT WAPNER: What does it say to you -- and "The FT" had interesting article yesterday or the day before: "Not a single company has borrowed money through the high yield market this month." The first month that that's happened since November of '08.
JEFFREY GUNDLACH: It's been a long time. Yeah, zero issuance.
SCOTT WAPNER: What's the message in that?
JEFFREY GUNDLACH: Well, rates are higher. I mean they had so many opportunities to borrow money at lower interest rate levels and then spreads blew out in October. High yield spreads went out by 100 basis points, maybe even 125. And so they're probably saying "Maybe we'll get a better opportunity to do this." The market is not all that liquid right now and it's not that easy, like it was, to float debt. There's a lot more concern with rates going up, and spreads going out. So the market isn't all that welcoming to corporate debt borrowers. And that's the message. Now, maybe they'll be a significant issue in the first quarter of the year, perhaps. And we'll see if the market can handle it.
SCOTT WAPNER: Alright. We're going to step away for a quick break. We'll come back. We have much more ahead with DoubleLine's Jeffrey Gundlach from out here live and exclusively in Los Angeles. We're back right after this.
SCOTT WAPNER: Welcome back to Los Angeles. We're live from DoubleLine headquarters on their trading floor with Jeffrey Gundlach 12:30 in the east. 9:30 a.m. Locally. Let's talk about the risks out of dc you mentioned some of the policies in D.C. What about the midterm election results? What about the prospect of more earnings, the Mueller report, impeachment, all of that into the prism of how you see risks in D.C. affecting the markets.
JEFFREY GUNDLACH: None of that sounds like a positive. The midterm elections I thought would lead to and maybe it's still possible but so much contention I thought it would lead to perhaps even more spending from infrastructure. Because the president has talked a lot about infrastructure and he wanted to do a big build out and it seemed the democrats were sort of on that same page I think Nancy Pelosi was very in favor of that idea maybe they just are so – so much anathema maybe they could never get along. But if there's one thing they could do together it's probably some sort of an infrastructure build that could just lead to more debt. It could lead to a short-term stimulation of the economy when it comes to the hearings and the like, I'm starting to – to treat that with i wouldn't say a great deal of concern but i was pretty dismissive of that prior to the midterms. That seems to be building in a way that's problematic in terms of building uncertainty. The whole Mueller thing and almost the promises of forever investigations, that just strikes me as being unhelpful.
SCOTT WAPNER: You still -- you see the scene from the oval office last week.
JEFFREY GUNDLACH: Oh, the ambush sort of –
SCOTT WAPNER: The President, Vice President, Schumer, Pelosi –
JEFFREY GUNDLACH: It was like the Vice President wasn't really there but, yeah, Schumer, Pelosi and the President I thought was theatrical for sure. I'm not sure what the purpose was.
SCOTT WAPNER: Do you think infrastructure and things like that are possible after that setting and scene?
JEFFREY GUNDLACH: That's why I prefaced my remarks the way I did. That scene was pretty remarkable in terms of the contentiousness. Maybe nothing happens at all except focuses on these investigations and that just strikes me as being a negative we talked about the dollar was strong and all that. I believe that the dollar peaked out January of 2017. I said so at the time. It was at 103 on the Dixie index and dropped all the way down, and there was tremendous bullish sentiment on the dollar in January of '17, and it dropped by about 15% from there down to the high 80s and rallied into the 97-98 zone which I think will be the high for the dollar. I think the dollar -- the next big move on the dollar I've been saying this for a long time I think the next big move for the dollar is down. It has a lot to do with the deficits, it has a lot to do with the twin deficits. The dollar correlates very well with the size of the twin deficits in other words when the deficit goes much bigger in broad strokes the dollar goes down and I think that the dollar could be under siege from other blocks and countries wanting for the dollar not to have reserve currency status exclusively anymore. And clearly with the budget deficit at 6% of GDP going higher there's no way that we would have the dollar at this level if we didn't have the global reserve currency status. China has been making moves definitely to try to come into that club. They've been buying oil futures in their own currency this year for the first time and got up to double digits. That's a mechanism to show you're of that stature there was an official at the ECB. I can't remember who he was but he was saying we want the euro to be a global reserve currency good luck with that one given what is going on in Europe but it is just the sentiment of it that leads me to believe the next big move on the dollar is down. I think what I've been talking about the last few months remains an important theme and that is the outperformance of the United States stock market was truly almost historically unique during the middle part of this year. The global stock market topped out January 26th and then they all fell together, the U.S. and the world, into may and then a very strange thing happened after being so coordinated for a year, the U.S. stock market went on to make new highs while the global stock market went to a 12 month low. From May until early October the U.S. stock market went up by over 10% the global stock market went down almost 10% i said in my September total return webcast, I said this is very unusual. If the stock market heads back down and takes out that low of September then I think the U.S. will have to join it. Boy was I right, the global stock market took that out and Oct 4 us stock market gave it up and now since then they have been moving together again and I think that is important because the non-U.S. stock market is substantially cheaper than the us stock market. Particularly the emerging markets in Asia and elsewhere but i think the ones in Asia better, very cheap to U.S. stock market. It's interesting that since we've had this market turmoil over the past couple of months kind of quietly and without getting anyone's attention the emerging markets have been outperforming and I think that's a relative good sign for their prospects if I'm right that we are in a bear market scenario.
SCOTT WAPNER: You like the emerging markets?
JEFFREY GUNDLACH: Relatively.
SCOTT WAPNER: We sat here a year ago and you said you love India.
JEFFREY GUNDLACH: I've loved India for years.
SCOTT WAPNER: India outperformed the other emerging markets slightly.
JEFFREY GUNDLACH: It's down. I don't look at India as -- I've been recommending that for many years and it's a multi-decade call I tell people look don't open your statement. If you buy India, don't open the statement because you will probably have substantial drawdowns along the way but the demographic situation and the need to absorb hundreds of millions of young people in the labor force is reminiscent of where China was three decades ago and I think that's going to be a long-term outperformer. Yeah it is down about 7% year to date. You are right it has outperformed some of the other emerging markets but that's more of a secular call.
SCOTT WAPNER: Speaking of China, how do you think the trade war plays out? How do you see it? Does it get worse from here?
JEFFREY GUNDLACH: I think it gets worse I think China doesn't want to be told what to do by President Trump, and President Trump loves to bully people. So that's a bad situation. You have irresistible force and immovable object kind of working against each other, so i think they're probably going to ratchet up the tariffs, I think. I know we put it on the 90 day delay but i think that's a problem. You can see the PMI for net export orders is tanking globally. Germany is falling off a cliff that indicator was at an incredibly powerful reading entering into this year it was over 60, PMIs over 60 are really strong and it's completely collapsed it is down way below 50 now even the us has gone negative on that PMI. That clearly shows that the tariff situation and the trade wars are having negative impacts on actual economic activity and it's going to get worse it we ratchet up another level.
SCOTT WAPNER: You don't think China will blink? They've already made some moves that suggest they may be inching closer to that.
JEFFREY GUNDLACH: Maybe, I hope so. I don't believe hope is a method in Investing i think you see identifiable risks and you need to take them seriously and since the slight back off i think that is something positive, given the personalities I'm not optimistic that that's going to resolve itself without first causing more pain. A lot of these things they shouldn't happen like the fed shouldn't raise interest rates, but maybe they feel compelled to we probably shouldn't be running a trade war. I did a remote with you, hey, in elementary school they taught us about the 1930s and that it's a bad idea for the fed to prematurely tighten and do tariffs, in the '30s which extended the great depression. Here we are again and the fed is kind of raising interest rates and the bond market says you shouldn't be doing it and tariffs are never good for economic activity globally the good thing for the united states on tariffs, trump does have one really valid point, and that is that tariffs don't really hurt the U.S manufacturing and U.S. output as much as they hurt other countries because we have about the most disengaged economy of any developed country in the world, only 8% of our GDP is exports. It doesn't really hurt our output that much but it hurts our consumers we're getting a free ride by getting lots of cheap goods. If we raise price through tariffs that's bad for our consumers, bad for the standard living of the United States. It's bad for the global economy. It might be worse for non-U.S. countries than for us. It's particularly bad for our inflation rate. If you raise the price of shoes or t-shirts, none of which are really made in the United States, that's inflation I kind of think one of the reasons bond yields have failed to react in a typical fashion to the weakness of the global risk markets is because we see the potential for a higher inflation rate should tariffs continue to materialize. There has been better wage growth. But wage growth being in excess of GDP is not really all that great for profitability and another reason we have a headwind and why I think we're in a bearish setup for the stock markets.
SCOTT WAPNER: We'll step away quickly again. A quick break and come back live with Jeffrey Gundlach, get some of his best ideas for 2019 also talk about a new product, an investment product DoubleLine is launching. That news is up next.
SCOTT WAPNER: Back live from Los Angeles, exclusive here at DoubleLine headquarters with Jeffrey Gundlach. Why don't you tell me about this new mutual fund you've launched combined with, is it colony?
JEFFREY GUNDLACH: Yes, yes.
SCOTT WAPNER: Colony Capital.
JEFFREY GUNDLACH: We started about five years ago a rules-based equity fund that was based on Dr. Schiller's work, the DoubleLine enhance cape fund. And basically it's rules based that fund picks equity sectors of the S&P 500 using the cape ratio evaluation methodology and then we run a collateral pool in fixed income and we have 2 ways of getting return. One is Schiller's rules work and also we have if we outperform labor which we've been able to do. We have the L fund that's the best performing fund in America the last five years. On the back of that we were approached by Colony and they said we have a rules-based idea, too. We are a big real estate firm. We have decades of experience in real estate. We've come up with a way we think we can outperform the general capitalization based real estate way of investing in brick and mortar REITs it is a very big universe there's over 200 REITs in there and they're tremendously diversified. It's not just malls and retail stuff. There are data centers and the new economy that are all in REITs. They came up with this belief based on their private market activity over the last few decades that many REITs that people are attracted to actually perform very badly and one of the things is the yield on REITs is often a false promise of future return the highest yielding REITs tend to be very risky and they end up having subpar performance. They are very leveraged REITs tend to do very badly. They came up with a methodology for selecting about half or 30% of the REIT universe and investing only in that subsection rather than just all of them. And they came to us because if they knew we were doing something on the equity side in that regard that had done very well and said take a look at this. So I gave it to our analytical team and Jeffrey Sherman
SCOTT WAPNER: So Jeffrey Sherman and you are going to be co-portfolio manager.
JEFFREY GUNDLACH: it will be the same thing as the Schiller Fund. And he went through and his team tortured the data and looked at it. And came to the conclusion there seems to be something there and it shows pretty substantial outperformance versus other REIT investing and so we'll be doing that we think that it will do the same as the schiller fund did which is way ahead of typical stock picking or indexing types of nonsystematic investing so we are optimistic on that also investors have a really hard time investing in real estate. Of the big institutions that have the wherewithal because of their great size to buy buildings themselves fully a third choose not to do it because it's just a pain and it's very illiquid and takes a lot of effort. I think liquid real estate is an interesting idea and that's what this fund offers. You can get in and out of it without having to hire a broker and sell a building so it also adds that liquidity factor which I think is uniquely attractive.
SCOTT WAPNER: It is an interesting time in real estate, commercial real estate given where the economy is that you think it is and where interest rates are going. How does that factor in to this?
JEFFREY GUNDLACH: Yeah, well, it may not -- it's a relative performance thing. It may not be the greatest time to be investing in risk assets broadly. It may not be -- it's certainly not the bottom in commercial real estate. But, as Sherman likes to say, when we launched the Shiller Fund we weren't exactly wildly bullish on the equity market and yet the equity market has done great and the fund has substantially outperformed. So we'll see what happens. I think the key is to offer products you know, when you have the, you know, the partnership that we have been approached with from Colony. And we don't want to pass on this – what we think is a really exciting opportunity.
SCOTT WAPNER: So given everything we've talked about, and we've covered a lot of topics, what is your best idea for 2019?
JEFFREY GUNDLACH: Capital preservation. I've been saying that for a number of months now, that this is a capital preservation market. I have investors that come to me and they say, "What exactly is wrong with just buying the two-year treasury?" and I say, "I agree with you." I mean, what exactly is wrong with the two-year treasury yielding 2.70, when the three-year treasury yields -- the ten-year treasury rather is 2.85, the S&P 500 yield is less than that, of a T-Bill. I think we're in a bear market. I mean I still think that it's an interesting time to own commodities, which have actually done pretty well. I talked about them with you a year ago. And it feels like commodities are doing terribly, but amazingly through last Friday, when I looked at it -- or it was last Thursday, the last time I looked at it, the Bloomberg Commodity Index is actually up over the last twelve months. Bonds are down, stocks are down. Global stocks are really down. I mean, there are plenty of stock markets down over 20%. Many, many, many, on a global basis year to date here. This has been a capital preservation year. I did say in January that I thought U.S. stock market would go up into the summer. I looked like an idiot in February because it wasn't going up. But I said it might go up as much as double digits and then it will end with a negative sign. And that's indeed, what happened. I thought that would be the case because I was bearish on the bond market as you mentioned. I thought the ten year would go above 3% and when it did it provided a tipping point. I still think yields are headed higher in the United States. And I think it's mostly, mostly supply based. And lack of demand. So that, I think, is going to be challenging for a lot of parts of the risk market. So it's a capital preservation environment. I really think a short term – as unsexy as this sounds, a short term high quality bond portfolio is probably the best way to go as you head into 2019.
SCOTT WAPNER: You think inflation is going to get out of hand, out of control? I mean --
JEFFREY GUNDLACH: No. Absolutely not in the near term. In fact the opposite is going happen in the near term. We have a model on the headline CPI which has been accurate given its simplicity and that model shows inflation is quickly going into the mid-ones because of oil, because of the energy price decline, down to 50 bucks a barrel now on WTI. However, core inflation is likely to stay higher than it is now, actually. We have models on that too that suggest that should head up into the mid-twos and it's in low twos right now. So it's going to be this dichotomy between headline and core. And it will be very interesting, because the Fed likes to parse their words, it will be very interesting to see how they deal with this. Because when the headline inflation rate right goes down to 1.5 you wonder if they can tighten anymore because they've got this 2% belief or whether they'll talk about transitory again. "Okay, we're down in the mid-ones but it's transitory because we're looking at core." It's going to be a very tricky time. I don't envy Jay Powell at all. He's got a very difficult situation he's dealing with, with all that's going on. Also, I think – we haven't talked about but I think it's important, a point that I've thought to myself coming in this morning I wanted to bring up, it's the quantitative tightening globally, I think is really an issue. The correlation between the world stock market and the cumulative size of the big four balance sheets: the ECB, Bank of England, BOJ and the Fed, is remarkable since they started quantitative easing back several – quite a few years ago now. It basically went up exactly the same. When the balance sheets took a pause on expanding, the stock markets globally took a pause. Then thanks to the Fed's embarking on tightening, the cumulative size on those big four balance sheets tipped over at the beginning of this year. And what happened to the global stock market? It tipped over starting on January 26th. But now the ECB seems committed that they are going to stop buying bonds, which means they are going to start quantitative tightening. This is an extremely important event if, indeed that correlation which has held up so beautifully even this year continues to hold up, it means that we have a very big headwind for the Morgan Stanley global stock market index and all these countries that are in death crosses and bear markets. It's a lot of negative pressure and I think that's super important and leaves 2019 to be even more of a capital preservation environment.
SCOTT WAPNER: Let me go back to our headquarters. Joe Terranova is one of our traders on the desk today. Joe, do you have a question for Jeffrey Gundlach?
JOE TERRANOVA: Yes, I certainly do. Jeffrey, you mentioned capital preservation. Last couple of years we have heard so much about the movement towards passive strategies. You're obviously a very successful active manager. Somebody listening to you today and hearing about capital preservation and being taught to just be a passive investor, how do they implement that strategy?
JEFFREY GUNDLACH: I'm not at all a fan of passive investing. In fact, I think passive investing is a mania, or reached mania status as we went into the peak of the global stock market and U.S. stock market. I think, in fact, that passive investing and robo-advisors, which I think tie together, are going to exacerbate problems in market because it's hurting behavior. So I wouldn't advise anyone to be a passive investor. I think you should invest -- capital preservation, I'm not going to tout my funds but I think the -- capital preservation means high quality, lower volatility, lower duration bond funds. Also I think that capital preservation probably means investing somewhat in a small percentage in commodity strategies, which I think will hold up reasonably well with weaker dollar. So I'm pretty committed to the idea of a weaker dollar for the longer term. And so that means that the worst thing you can do is what everybody has done: crowd into S&P 500 index funds. Because that's most expensive market, it's the one -- it was the last man standing and it's the one -- the reason it was last man standing had something to do with the popularity of passive investing and herding mentality and you know, what leads you to the upside leads to you the down side. So my strongest advice is not to invest in passive U.S. equity funds.
SCOTT WAGNER: Interesting. I do recall it. I believe it was IRS owned in the spring where you talked about a bubble in passive and all that money flowing into ETFS and other places that helped push the stock market up. And when that money started to come out, one of the reasons you thought the market was going to go up and then down was that it was going to -- that bubble was going to burst in passive. And then we were going to be big ramifications from that.
JEFFREY GUNDLACH: Well, the interesting about passive versus active, which I find really hilarious, is that we have sitting side-by-side a fondness for passive investing in the U.S. equity market and a loathing of passive investing in the U.S. bond market. One of the things that was the most popular entering this year was unconstrained bond funds. I mean talk about active. I mean, you don't know what they are doing. And I was cautionary about the broad category of unconstrained bond funds because nobody knows what the managers are doing. Some of them own stocks. Some of them are long. Some of them are short. And you can see year-to-date this massive dispersion in the unconstrained bond universe. There are some bone funds down 5% and 6% in the unconstrained category year to date. And there are some funds that are up 3%, 4%. So what are you exactly buying? But it is weird you can live in a world where two diametrically opposed ideas are extraordinarily simultaneously warmly embraced. Passive in equity, and not just active in bonds, but uber active. Right? Do anything, not even a benchmark, not any type of guideline constraints. So it kind of shows you that there's no such thing as a one size fits all solution. In the '90s people loved passive bonds and they loved active equities. And now 25 years later, it's exactly flipped and as night follows day mark my words it will flip back again.
SCOTT WAPNER: You reference -- and in the few moments we have left I want to talk to you about a couple of stocks you've talked about in the past, and you talked about them earlier, being Apple as being sort of the last straw.
JEFFREY GUNDLACH: Last man standing in the U.S. stock market was Apple. And it was – yeah, when they announced that they weren't going to tell you how many phones they sold any more, that can't be a good sign. I think -- I've been marveling at consumers' willingness and anxiousness to flip their phones to the new model. To roll it over so quickly. I mean, I don't know. I mean I'm a luddite so maybe I don't have the gene for this. But these tiny changes to these phones.
SCOTT WAPNER: You still have a StarTac flip phone or --
JEFFREY GUNDLACH: I actually have a Blackberry. It's of almost no value, because I can't do my e-mail any more on it. It's been discontinued -- Bloomberg discontinued it. It's actually a phone. That's all you can do, is use it as a phone. But I just think that the rollover cycle for phones, I think it was 18 months was the replacement cycle and I think it's pushing three years, I wouldn't be surprised if it turns into five years. And that's the fundamental problem that Apple has. Now it's a cheap stock. It's certainly not in any kind of trouble. But the fact that it's rolled over is not really so much a commentary, I'm not really making a commentary on Apple the company, I'm making a commentary on how emblematic it is of the market topping.
SCOTT WAPNER: The other stock that you talked about – and we have a minute left -- was Facebook. You said at Sohn that it was a short.
JEFFREY GUNDLACH: And I said short for reasons that were so obvious, they were staring you in the face, that what you thought was a community of safety and warmth was actually a diabolical data collection monster that would ultimately fall victim to regulation and when they fall victim to regulation, sectors collapse. Also the eCommerce bubble looked the same as all the other bubbles, and we don't have time to enumerate them, and now that it's rolled offer, I think it's just done. So I think Facebook has really systematic problems. I said short it at Sohn. And boy, was I right.
SCOTT WAPNER: It's down 13% since then. I want to thank you very much Jeffrey Gundlach for having us back out here.
JEFFREY GUNDLACH: Good to have you Judge.
SCOTT WAPNER: it's been nice to visit once again. Maybe we'll be back next year to see how this all played out.
JEFFREY GUNDLACH: And maybe the Bills will make the playoffs next year.
SCOTT WAPNER: We shall see. There's hope for everybody. Jeffrey Gundlach, DoubleLine. And that does it for us, our exclusive interview. I'll send it back to our headquarters now. "Power Lunch" begins right now.
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