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Bond King Jeffrey Gundlach shares the biggest risks for 2023- and why investors should prepare for recession

DoubleLine’s Jeffrey Gundlach warns investors:

China is a bigger problem than Russia for the U.S.


Prepare for a recession


Cutting entitlements will fix the national debt problem


Video Transcript

- All right. Joining me now is Jeffrey Gundlach, DoubleLine's founder and CEO. Jeffrey, it's always a treat to get some time with you, especially in your new Tampa office here. So much to talk about volatility creeping back into the markets. As you step back, what do you think is the biggest risk to investors looking out over the next few months?

JEFFREY GUNDLACH: The inflation outlook perhaps darkening from what was kind of pivoted to an investors psyche, or state of relaxation. I commented on the last Fed meeting after Powell's press conference. Even Powell seemed sort of relaxed.

I mean, he actually said something that was really great. I gave him a lot of credit for it. He was asked a few questions, and his answer wasn't--

He didn't try to come up with some tortured quasi answer. He just said, "We just can't know that. We don't know that. And we're just going to have to wait, and see what happens."

Which is a truly honest answer. You don't hear that much from public officials. And he seemed to be very confident that the path that had been in became embedded in consensus economists, and ratified, even over ratify to a certain extent by the treasury yield curve, that inflation was going to proceed in a way that would be incrementally positive after what last year, it was month after month after month of the date of being disappointing on the high side.

And so that was looking pretty good. And the bond market rallied a lot. I mean, we had the two-year treasury getting pretty low.

It was almost going below 4. I think got to 403. And I thought that if the two-year treasury could somehow bust through 4%, that would be the moment that the Fed would start to have to take things seriously the dichotomy between the Fed plots, and the bond market, which was really sort of telling the Fed to stop.

But then they did that weird CPI revision, which is one of the strangest things because it doesn't change anything. And yet it changes everything at the same time. We had six months in a row, where the CPI, the headline CPI averaged 16 basis points a month. That's not very much. That's only about a 2% inflation rate.

So for six months, it was working. And then they revised that up to 24, which is pretty good. I mean, it's almost double not quite.

And then the headline was running at like 26 or so. And now it's at 34. And so it's starting to be like, uh-oh, maybe we're not going to get that gentle deceleration, and then stopping at that level.

And since then, we've had bond yields just go down a little bit today. As of yesterday, the two-year treasury had risen almost 75 basis points. Since the Fed meeting, which was February 1, I mean, we're only talking about 12 trading days.

So just annualize that when you think about it. And then we had the 10-year treasury March all the way up back towards 4% from 340. These are big rate moves.

And so what's ended up happening as a year 2023, that started out. As we expected, it would be strong because a lot of investors, or amateur investors don't understand is that markets often change direction at year end. And it's not because of some strange astrological phenomenon. It's because of flows.

When you have a big move in markets either up or down, there tends to be repositioning at the end of the year. So when you have losses everywhere, which, of course, characterized 2022, the only thing that was up was certain commodities in 2022. You have tax loss selling.

And it got really brutal in November. And we predicted it would. Really brutal in November and December.

And then all of a sudden, people are all done, and they come back in January, and they are reverting capital. And you often get a complete reversal. So it's not surprising that the NASDAQ, which was the dog of 2025 turned into the hero of 2022, turn into hero of 2023.

And the Dow Jones, which had been the best one, not really doing very much. In fact, as of today, the Dow Jones Industrials is now negative on the year on a price basis.

And so we had a rip roaring start. We had high yield did well, emerging markets did well, everything. But commodities did well. So it's a complete reversal.

But now, we're getting pretty close to where we started the year. A lot of things.

- Investors start preparing. Should they start to be preparing for hard economic landing?

JEFFREY GUNDLACH: We've been preparing a DoubleLine gradualistically. So I always say don't listen to what I say, look at what I do. And we started de-risking, if you will, at the end fourth quarter of 2021.

And what I mean by de-risking is increasing treasury exposure, decreasing incrementally. We don't do this all in one day. Credit exposure.

And when we get maturities on lower tier credit, we reinvest at a higher tier. So we've been upgrading our portfolio systematically. We entered 2022 with one of our lowest interest rate risks of all time, particularly relative to a passive index.

And we ended the year almost at the same interest rate risk, as the index, which is an increase for us. And some of our funds of about four years of interest rate risk, which is called duration.

So we started the year at about 2/4 on our biggest fund, and we ended the year at about 6. And we've extended, again, last week. So we've been upgrading in the treasury market, and increasing treasuries.

And this is in preparation for-- it doesn't matter if it's a soft landing or a hard landing, it doesn't matter. People are always asking me this question. How bad the recession is going to be?

It doesn't matter. As long as we're going into recession, you have to have certain degree of protection. It won't matter.

If it's raining 1/2 inch an hour, you need an umbrella. If it's raining 2 inches an hour, you still need an umbrella. In your case, you need an umbrella. And so I think that needs to happen.

The really interesting question is what the big risks are is, what is it that investors think they know people who have a lot of experience like me that we think we know because we've been around, in my case, for 40 years that might not really be you think it, but it's not true? And I think the number one candidate for that is over the past 40 years until 2022, interest rates did nothing in broad brush, but fall.

They either fall, and then maybe they retrace a little bit with some economic cycle. But then they go to new lows. And so everybody's only experienced falling interest rates.

So will the markets be the same for the next 20, 30, 40 years as they were for the past 20, 30, 40 years when the backdrop of falling interest rates is potentially replaced as it has been so far with rising interest rates? I think one of the key questions on that is, what will defaults look like in the non treasury market, particularly the corporate bond market, the junk bond market?

Because the junk bond market has no experience prior to really 1980. So the entire life cycle of the junk bond market has been falling interest rates. So have any junk bonds really ever matured? They either defaulted or got refinanced?

Refinance over and over and over again. Well, what happens when you can't refinance them anymore? And you actually have to pay them. That's not a problem for this year or next year in the high yield market.

But what about the bank loan market, which is floating rate? Those companies that were paying a spread maybe of 300 basis points over SOFR, the short term interest rate, they were paying 3%. Well, it's going to be 8 pretty soon. And they get it they get the bill on Fed day, right?

There coupon goes up within three months after Fed day. And so you're having a massive increase in the costs to these companies. And at the same time, the percentage of bank loans that have been of poor quality below a certain rating. So that they're the lower tiers has gone from about 40% to 50% to more like 72% to 75%.

So what's going to happen when you get parts of the economy in a recession, and the payments from these companies going higher? I think the answer is it will be higher defaults. So another thing that's interesting is there are indices on the same topic. They're indices of lending conditions. There's surveys.

Deutsche Bank does one that's pretty helpful, and it's a survey of large lending institutions. Are you easing your standards, or tightening? Your credit standards.

And there's a very high correlation between tightening credit standards of a certain magnitude, and the default rate on lower credit, lower tier credits 9 to 12 months later. Well, we're already at that level. The tightening of the surveys has reached the level that has proceeded past significant default cycles.

And this one metric indicates that the default rate should be about 8% coming late this year on an annualized basis, or early next year. You put that together with the economy put together with the credit quality being low. And we could see some real interesting painful outcomes that are coming in the next recession, whether it's very severe or not.

- I went back and looked at when we talked to you in January 2022, and your LA offices.

JEFFREY GUNDLACH: What do I say that was wrong.

- Well, no. You were right. You were really one of the first one to I think sound the alarm on a growth slow down, and how that might impact stocks. And all of it really turned out to be correct.

So now, I hear you talk about a potential for a hard landing. What does that mean for the broader stock market?

JEFFREY GUNDLACH: I think the stock market is in a protracted bear market. It started really in the fourth quarter of 2021. Finally, the NASDAQ gave it up, and then finally, the high fliers in the NASDAQ.

And we've been talking about that this was going to happen. Because the difference between the S&P 500 and the S&P 495 was pretty remarkable. I mean, the equal weighted S&P did almost nothing, and the actual S&P was going straight up. So that market rolled over.

And we've been in sort of a negative mood all that time. But I just think that with interest rates having risen and other rising again, it's very negative for the stock market when you have rising interest rates against these valuations. And especially real interest rates, which stopped rising back in around October and November, which was the catalyst for the recovery in risk assets in the fourth quarter. But it looks like real interest rates might start rising again.

- Within your models, how far do you see rates rising? Do they break 6%?

JEFFREY GUNDLACH: I don't think so. I think the long-end may have peaked, you know. You had the long bond get up to around 4 and a quarter of 10-year up to about 450. We're not really close to that anymore.

The two year actually went to a new high yesterday. The high was 472 back in October. And it got up to about 474 briefly yesterday.

Interestingly, it didn't hold there. Today, it's back below that level. That's what we call a throw over from a technical basis.

And I'm very fond of following throw overs because it means the market is rejecting the push to a newer high. And so I don't think interest rates are going to go there. So fascinating is that since the Fed meeting, where the two year got to 403, the day after the Fed meeting, you know.

And now, it's risen quite substantially from there it's pricing in a lot more Fed hikes. And that's because that weird inflation revision. It's so strange.

All they really did is say, you know what? Shelter was at 32%, and move it up to, I don't remember, 35%, 36%. And used car prices, where it well car prices broadly are 8%. And now that's coming down.

And because of that, there's hundreds basis point increase in historical CPI, which is so weird because the history is the history, you know. What if somebody announced tomorrow that redid the CPI, and it's now at 25%? Would people feel different?

I mean the CPI is such a strange construct because it doesn't really apply to real life. Who buys a new car every month? Who buys a used car?

- Me.

JEFFREY GUNDLACH: Right. So for most people, I think shelter is more than 32%, probably more than 35%. So it's weird how the market had this violent reaction to something that is an arbitrary construct. But it has priced in about three more Fed hikes.

The terminal Fed rate. But yesterday was up at 535. I'm skeptical that it's going to get there. I think that in spite of the fact that inflation is going to be reluctant to come down, I just think the shape of the yield curve is the best indicator of the forward economy.

- And that is still predicting recession.

JEFFREY GUNDLACH: Absolutely. When it first inverts, you've got to be on watch. If it gets inverted, it gets this inverted as we have been now for months and months, and stays there, which of course, has happened because we've been there for months and months.

That's a pretty high probability indicator of recession. Also, the leading economic indicators are really low. And it's getting worse on a momentum basis. The three-month annualized is worse than the 12-month. That's really low.

The unemployment rate is the last one there that does not say recession. But it's very close to crossing over its 12-month moving average. And when it does, it's one of the best indicators of the front edge of a recession. And we're pretty close.

The unemployment rate has not gone up. It's actually hovering down at its lows. But it hasn't really changed much over the last 12 months. So it's getting close to its 12-month moving average.

Ultimately, the one that is the slam dunk on recession is if the unemployment rate crosses its 36. It's three year. It's 36 month or three year moving average we're pretty far away from that.

But that doesn't happen at the front end of recession it. It happens to suggest that you're in a more of a hard landing type of recession. The Fed themselves, on their plot in December predicted that the unemployment rate was going to end this year at about 4.6%.

I think they said up about 100 basis points. That's well above that 200, that 12-month moving average. So it's interesting.

And historically, when you get more than a 50 basis point rise in the unemployment rate, you've never avoided a recession. So the Fed themselves are maybe in a backhanded way. Maybe they don't even know. This fact that I just outlined, they're sort of predicting a recession themselves.

- Is the Black Swan, potential Black Swan event in markets this year, everything tied to the debt ceiling? How that turns out?

JEFFREY GUNDLACH: I think the debt ceiling is just a straw man. I have so many clients that want to call on the debt ceiling thing. And it happens every time.

And they always, what's going to happen? I'll tell you what's going to happen. They're going to do this every other time.

They're going to raise it at the last minute. It's going to-- and it's not going to be a big deal. One of these days, though, they're going to have to deal with this deficit.

I do feel for the first time in many years, that the politicians have-- they're looking out of the corner of their eye anyway. And some of them are saying in public, that they understand that this debt sort of is already unpayable in today's purchasing power, but certainly if you keep adding to it. It's unthinkable what might happen.

And I thought Mike Pence gave a great interview recently, where he took it straight on and said, "We have to do something about this." Because when you have this sort of attempt to never have a significant downturn in the economy, Fed to the rescue, zero interest rates, quantitative easing, what you're trying to do is avoid any type of hard landing ever.

But that violates, that type of activity violates gun locks rule of financial physics. And that is that the frequency of problems times the severity of problems equals a constant. So the more you try to reduce the severity of problems, you're going to end up ultimately having a very high severity.

- What's the answer?

JEFFREY GUNDLACH: The answer is you have to raise the age on these entitlements. You have to need means based them. I know I'm never going to get Social Security, nor do I care.

But there's a lot of people that don't understand that if you just raised the age of eligibility from 65 to 72, for example, you pretty much solve the problem. And when FDR set up the Social Security System, life expectancy was kind of below 65. And now, it's falling unfortunately. Thanks to fentanyl and suicides.

But which is kind of the same thing. In some cases, sometimes it's just a poisoning. But that's got to-- we're now at about 78.

And so why should you? People don't need to retire at 65. They don't need to get entitlements at 65. They should needs test them.

And at least that would stop the balloon from getting blown up bigger to the point where it's going to explode. So that's what you need to do.

- I love this tweet, and very informative as always. On January 17 of last year you said, "The 2024 presidential election is barreling down the tracks. Fasten your seatbelts." Take us through some of your thinking as it pertains to the markets as we head into that event.

JEFFREY GUNDLACH: Well, it's too early now. Way too early for the markets to be focusing in on this. But I've been predicting for quite some time that we're not far away from a presidential election, that nobody wins the electoral college.

In other words, it'd be three parties. And it looks like 2024 could be. It's not the odds on probability, but it's far greater than it's been in a while ever since maybe Ross Perot, or something like that. And it's because the parties don't exist anymore.

You know, the Republicans have been fighting since Trump showed up on the scene. And that hasn't stopped. And now, the Trump supporters are yelling at each other, that they're starting to hate each other.

And on the other side, I mean, you've got this radical part of the party, which has dominated much of the agenda. And then you've got all these really old people that just won't give it up.

And I think that the embedded supporters of the old people will be fighting with the younger generation. And that could lead to a three-party or even a four party type of a situation. So that would be a real problem if it got thrown into the House of Representatives.

- I imagine a big problem for markets.

JEFFREY GUNDLACH: Sure. I mean, because markets don't like uncertainty. And we've had over this 40-year falling interest rate period, and Fed to the rescue, and all that.

We've had sort of a one party system. I mean, there wasn't much difference between the Bushes, and Clinton, and Obama. Really it wasn't much difference.

And then Trump showed up, and he forced a difference. And it revealed, you know, Discord underneath the surface of American society. And it hasn't gotten any better obviously.

All you have to do is read the news. You have to have read two opposing news sources. And it's clearly, they're watching two different movies.

And you know, I hear politicians using the word like America needs a divorce. And then the old people say no, no. We just need marital therapy. We need counseling. We don't need divorce.

I think counseling usually doesn't work. So I think politics are a pretty big issue. And there's a lot of radical tax proposals of tax the rich, and all that. And then, what do we do? And why are we not taking on fentanyl?

Why do we have all this tons and tons of fentanyl coming in over the Southern border? Why don't they stop it? Why doesn't the political establishment stop it?

The only possible reason is because they don't want to which begs the question, unfortunately, why don't they want to. And there's all kinds of crack ball theories about that, oh, they're looking for constituents to vote for them. That I find to be a very poor strategy. Maybe they're doing it, but I don't think it will work.

What's to guarantee they're going to vote for? And some people think that they're getting money from the cartels. There's all kinds of weird theories. I know. I have no idea.

I can't even handicap what the correct answer is. But they don't want to stop it. And this is a real problem.

And also, we seem to want to be perpetually at war. Proxy wars primarily without American, with American soldiers either, on the periphery, or not really getting shot at, or now in Ukraine. We're just dumping tons and tons of money.

So I really think you said, what's one of the biggest risks. I don't know if it's a risk for this year, or not the months ahead. But I think China taking over Taiwan is a very significant risk.

They love the fact I'm sure that we are destroying a lot of our munitions in defense of Ukraine, which obviously, depletes our ability to arm Taiwan. So they'd love us to blow up all our stuff in Ukraine.

And so that balloon coming over, there's a lot of odd things going on, that one should think that the risk of a greater escalation of hostilities is the odds on case.

- Well, let's stay on the war topic. We are coming up against the one year, I wouldn't say anniversary, mark of the start of the Russia-Ukraine war. Markets have seemed to put this in the rearview mirror. Do they need to put it back in in front of mind?

JEFFREY GUNDLACH: I don't think Ukraine war is really the problem. The Ukraine war is a problem for the future because we're depleting our munitions, and we're wasting money on it, which is just another piece of the whole budget problem. I think Taiwan is the bigger problem because we have not been very good at articulating a stance on Taiwan, except off the cuff President Biden has said, we're going to defend Taiwan.

He said so. I said, will you come to defend Taiwan? He said, yes, that's the commitment we made.

I don't think we have the ability to do that. Where are we going to get the money from? We don't have any money.

We're running a huge budget deficit. It's still a massive percentage of GDP. And don't forget that zero interest rates really helped keep that deficit down because you were funding the deficits at nearly zero interest rates.

Now, we're talking $600 billion greater interest payments this year than last year. That's a lot. And what if the Fed actually does go to their plot of 5 and 1/4, and the market now says it might be 5 and 1/2? Well, that's going to make it $800 billion or something like this. This is real money.

And so that's just going to make the difficulty of dealing with the debt ceiling that you referenced earlier, and the deficit problem. Obviously, that much worse.

Jim Grant, Grant's interest rate observer. It was funny. I had been thinking about this, and talking about it.

And I hadn't communicated with Jim Grant. And then all of a sudden, his last essay, his last publication of 2022, the lead essay was on this topic of the government, it's now in the wrong part of the interest rate cycle with borrowing costs going up.

And I read it, and I said, this guy's been reading-- this guy read my mind. I mean, it was almost verbatim. Of course, he writes it better than I can articulate myself, but his points were exactly point by point in the order that I was thinking about them.

And that made me think, you know what? This issue is actually starting to get a reality in people's real-time formulation of policy. And so I think that's a big issue, and it's going to be a major-- I think it's going to be a major point for the 2024 election.

- All right. We'll leave it there for now. Always, always just great to get some time with you, Jeffrey Gundlach, DoubleLine founder and CEO. Thanks for having us at your new headquarters. We appreciate it.

JEFFREY GUNDLACH: Thank you, Brian. Good to see you again.