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Gundlach: This Liquidation Cycle Is Like 1994 Again

Lawrence Lewitinn
Talking Numbers
Gundlach: This Liquidation Cycle Is Like 1994 Again

Flashback: Jeffrey Gundlach talking numbers about the bond liquidation cycle on Monday.

Two days ago, Talking Numbers spoke with Jeffrey Gundlach, CEO and Founder of DoubleLine Capital. Gundlach manages over $60 billion in assets. With his recent pronouncement today that the liquidation cycle has run its course, below is the transcript of his Talking Numbers interview where he describes the situation as similar to what happened in 1994.

On the rise in yields on the 10-year Treasury bond:

“This is one of these liquidation cycles that happens periodically. I think this is about the fourth or fifth one I’ve experienced in my career. And, what I mean is that it gets detached from any sort of fundamental news and just turns into: lower prices breed fear breeds selling breeds dealers worried there’s going to be more selling.

“So, Wall Street, when they’re asked to bid on securities that people have to sell to raise cash, they’re scared. They’re scared that they’re going to get stuck with a position that’s depreciating. And, so, they backup their bid to begin with which leads to more prices which leads to more fear which leads to more liquidation and we these kind of one-directional moves. And, once we took out about 2.40% on the 10-year [Treasury bond] -- maybe even 2.30% -- we went into one of these non-stop liquidations.

“Sometimes, these things end up getting a kind of momentum of their own that takes you to a place where something bad has to happen like some leveraged player gets taken out because the magnitude of the price change is so great that if someone is operating on leverage, they might be running through their capital base. And, sometimes, that’s what stops the liquidation cycle. That hasn’t happened yet, obviously.”

On whether this is a margin compression:

“What I mean by ‘selling-begets-selling is that it has to do with investors deciding they’re worried about, say, the bond market. So they want to redeem or get out and that causes selling. What ultimately happens is that the depreciating prices caused by voluntary selling by redeemers – that price action can become violent enough that it starts to become a problem for players who are on margin…. That’s where the leverage players end up into trouble.

In the mortgage REIT area, for example, I think there has been some pain with leverage. These are entities which are leveraged sometimes six, sometimes eight, sometimes ten times. It’s hard to imagine that all of them could be operating in good shape with interest rates on mortgage-backed securities having risen 140 basis points (1.4%) now from their low of the year that was set in the first quarter. Once you get a move of ten points on something that generally trades within a range of a couple of points, it’s hard to believe that there wouldn’t be some leveraged player that is feeling a great deal of pain. Those are the ones that end up with the involuntary redemptions and those could lead to the extension of the selloff. I think that’s partially what’s happened in the last several days.”

On how long the Treasury move will go:

“Well, we’re kind of in a ‘No-Man’s Land’ now. You took out trend lines, you’ve taken out pivot points. If you look at the charts, which is probably as good as anything at this point to look at, it seems like something in the 2.70% to 2.90% zone. This is reminiscent of when the Japanese stock market tanked back on May 22nd and when gold dropped $100 around that same time period in one day. This kind of a spike, this kind of a high-velocity movement in a short time period, it’s not going to instantaneously do a U-turn in a sustainable way. You might get a sharp, short-covering rally at any moment. But, the idea that 2.60% or 2.65% would, having been arrived at in this manner, represent the local high in that yield – that’s very hard for me to believe. Or, if it is the local high in yield, you’re going to spend some time backing and filling around these levels. I think that we’re going to be probably having a lot of volatility. But, to look for retracement in yields back down to 2% on the 10-year anytime soon is a false hope.”

On if it’s a liquidation in Treasuries:

“It’s something of a liquidation cycle certainly. There’s a metaphor for what’s been happening in the last couple of weeks. It goes back to 1994, when the Fed under Greenspan raised the Fed Funds Rate by 25 basis points (0.25%). It didn’t seem like much of a move but it changed … people psychologically, and ultimately their behavior. This time, it’s not the Fed Funds Rate, it’s the statements about quantitative easing. What it did is we got people to alter their behavior and to invest more than they’re typically comfortable in investing – in stocks, in emerging market bonds, in high-yield bonds – in all financial asset classes. Indeed, that was the intent, wasn’t it? That was the intent, partially, of quantitative easing – was to alter behavior, and to get people to invest more than they typically would. Hold less cash, for example, than they typically would. Well, when people are holding less cash than they’re typically comfortable with, and markets start to move against them, not surprisingly they say, ‘Hey, I went to get back to home here and get back to my comfort position.’ which means liquidation. It’s a metaphor with what happened with Apple.

“What’s happening in the market is that a one-sided overinvestment leads to off-sides market. Therefore, it is something of a liquidation cycle.”


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