Most Popular ArticlesJune 9, 2009
“As investors we must understand the debt and liabilities of our government and its implications,” Gundlach said.
Gundlach expects the Chinese, Japanese and OPEC – currently the major owners of US debt – to be increasingly leery of our credit status. The government will be forced to increase taxes to fund spending programs, and Gundlach expects those increases to disproportionately fall upon those in higher wage categories. Marginal tax rates exploded during the Depression, from approximately 15% to 60%, to pay for the New Deal programs, and Gundlach foresees similar increases soon.
“Given the disparity in growth rates of income [between high and low wage earners], it is quite likely tax rates will go higher – much higher,” he said. He predicted that both income and capital gains taxes will increase, and he advised investors to incorporate rising tax rates into their portfolio strategies.
The equity and credit markets and inflation
Gundlach forecasted a “significant” downward correction in the equity market soon. “I don’t think we need to sell everything. It may a few months before the fundamentals of debt and low economic growth take over,” he said. “The correction might be half or so of the move that was made this year.”
The dollar and the commodities markets foretell whether the economy is on a deflationary or inflationary path, according to Gundlach, who said we are heading toward inflation. “The dollar has started what could be a big leg down and inflation risk is potentially coming into investors’ psyche sooner than expected,” he said. Commodities are having a “robust” rally and, coupled with a weak dollar, are saying “watch out for inflation.”
To hedge against inflation, Gundlach does not like TIPS, which offer low single-digit real yields. He prefers “high cash flow” assets, such as high yield bonds if they can be purchased their yield levels in March. They will be a cushion, he said, since inflation will lower default rates for corporations and households. He also advocated diversifying into commodities, land and foreign markets not exposed to US inflation.
Inflation in this environment is not due to capacity underutilization, but to money supply growth and the government’s printing press, Gundlach said. He discounted reports of positive news in the economy (“green shoots”) and said he would be alarmed if the massive short-term borrowing and stimulus had not produced some improvement in economic indicators. Gundlach sees the question as whether growth can be sustained when it is based on debt, and he said the answer is no.
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