Not only will Donald Trump win the November election, but his victory will propel U.S. economic growth higher, according to Jeffrey Gundlach. Trump will fuel a debt-driven increase in government spending, which Gundlach said will push GDP growth to levels reminiscent of the Ronald Reagan era.
Gundlach did not endorse Trump or say whether he would vote for him.
Gundlach spoke to investors on June 14 to provide updates on the DoubleLine Total Return Fund (DBLTX). He is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, known for its fixed-income mutual funds, closed-end funds and ETFs. Copies of his slides are available to download here.
Trump will move ahead in the polls, Gundlach predicted, despite criticism from the media for his protectionist trade policies. That narrative will put pressure on “risk assets,” Gundlach said, but as Trump’s inauguration approaches, the market will rally “for reasons people won’t understand.”
“Donald Trump will be an economic success,” Gundlach said. He will increase borrowing and if the economy “goes south,” Gundlach said, Trump could even follow through on his statement that he would make a deal with our creditors. Rates could rise and drive down prices on government bonds, according to Gundlach, but Trump could initiate QE4 to buy back those bonds at 70 cents on the dollar, a move that would be tantamount to cutting a deal with our creditors.
Gundlach referred to the presumptive Republican nominee as “Ronald Trump,” a name coined by the media to reflect the similarities to Ronald Reagan’s economic policies – increased government borrowing that led to high GDP growth.
Trump will push federal debt levels higher, Gundlach said. “However imprudent that might be from a long-term point-of-view, when you create jobs, build bridges and build walls, it will have the illusion of economic growth.”
A Trump presidency would create a “huge bump” in GDP, he said. If, hypothetically, government borrowing were to increase by $1 trillion, GDP would grow by an additional 5%, Gundlach said.
Let’s look at Gundlach’s comments on other topics, which ranged from the pervasive effects of negative interest rates to the potential for a U.S. recession.
Global negative rates
“We are in a world of accelerating volume of negative interest rates,” Gundlach said. As of March 31, 23% of global GDP was governed by negative interest rates, and that number is higher now. But those polices have failed to move markets or economic growth higher, according to Gundlach.
Global markets are down substantially from recent highs. Gundlach said that the Shanghai index is off 46% from its high in 2007 and from a year ago, German markets are down 20%, France is down 20% and the U.K. is down 15-17%. The U.S. is down 2% this year and has been the strongest performer of major markets; performance in most other markets meets the technical definition of a bear market – down 20%.
“Negative interest rates are not leading to economic growth,” Gundlach said. Every year since 2011, growth and earnings forecasts by analysts have been downgraded from when the forecasts were initially made until the final data was reported. The forecast G7 and global GDP is lower for 2016 than 2015, and could end up being “significantly” lower he said. That forecast includes 7% growth for China. But, according to Gundlach, China comprises 16% of global GDP, and if it grows at 0%, global GDP growth would decrease by an additional 1%.
Gundlach presented data for several major markets that compared the responses to the announcements of QE and negative interest rates. In all cases, markets reacted more positively to news of QE programs.
“Negative interest rates haven’t worked as a tool for countries to weaken their currencies,” Gundlach said. That has been true in Europe and Japan, where currencies strengthened versus the dollar following the introduction of negative rates.
“One of these days central bankers are going to respect the empirical evidence,” Gundlach said. The reason negative rates don’t work as intended, he added, is that they are the “definition of deflation. Central banks are trying to fight deflation with deflation.”
The U.S. has 60% of all positive-yielding debt. At the other extreme, Japan has 58% of all negative-yielding debt. Gundlach said when its banking sector went to negative interest rates, its banks “absolutely cratered.” Europe faces the same problems; he said that Deutsche Bank and Credit Suisse are trading at all-time lows.
“Negative interest rates make it impossible for them to make money,” he said. “These banks are being bled to death.”
The Fed and the probability of a recession
Gundlach spoke before the Fed met on June 15 and correctly predicted that it would not raise rates. He also said that a recession in the U.S. is unlikely over the short term.
The Fed initially set up two goals to dictate when it would raise interest rates: 2% inflation and 5% unemployment (originally, Gundlach said, the latter target was 7% but the Fed gradually “moved the goalpost” to 5%). Unemployment has been at 5% for some time, he said. But the Fed has changed its preferred metric from the core PCE to the CPI, which has been at 2%.
The Fed won’t hike rates further in June, despite achieving its two goals, he said. The Fed realized things are “a lot more complicated than the two-parameter model,” Gundlach said.
The probability of negative interest rates in the U.S. is “just about zero,” he said, particularly in light of the fact that the Fed is talking about raising rates.
The Fed is “greatly at odds with the bond market’s thinking,” Gundlach said. It says it will raise to 3% by end of 2018, but the forecast based on the bond-futures market is that rates might reach 1% by then. The bond-futures-based probability of a Fed rate hike was 0% for June and is 25% for September.
There are signs of inflation, Gundlach said, but not related to economic forces. Average hourly earnings have been going up, but not because of hiring demands by employers. Instead, he said it is mostly due to higher minimum-wage laws – a legislative, not economic, reason. “This is not good for the companies employing those workers,” he said, and it puts pressure on their margins. “This will squeeze corporate earnings.”
The fastest rising component of the CPI (and rising faster than nominal GDP) is housing (imputed rents), which will hurt corporate profitability, he said. “Isolated rent inflation is deflation for the rest of the economy and is particularly bad for consumer discretionary spending-driven businesses, like airlines.”
The good news, Gundlach said, is that “a recession is not upon us.” The government is estimating 2.7% GDP growth for the second quarter versus less than 1% for the first quarter. He added that the leading indicators are well above zero, as is the difference between the unemployment rate and its 12-month moving average. Quarterly unemployment is above its three-month moving average, which he said has remarkably predicted the beginning of prior post-war recessions.
“We are not close to a recession,” he said, “a year or two away.”
Other assorted forecasts
Gundlach maintained his prediction that Britain’s proposed exit from the European Union – “Brexit” – will not happen. However, if it does, he said other countries will follow and that interest rates in Spain and Italy have been rising to reflect that outcome. An exit, Gundlach said, would be the “beginning of the end of the Eurozone, which Britain never fully embraced.”
“The psychological impact of a Brexit will be enormous because it calls into question the value of the Eurozone,” he said. “Negative interest rates are bad enough to worry about.”
Junk bonds face trouble, according to Gundlach. He said risks from defaults and recovery rates are greater than investors acknowledge. Earnings among junk-bond issuers have been exceptionally weak, even outside of the commodity sector.
Oil prices won’t go higher than their current level in the mid $40s per barrel, according to Gundlach. He said inventories are “near a local high” and higher than a year ago, when prices “rolled over.”
Gold will go to $1,400, a price level that Gundlach previously has predicted. “It is the one thing that will do well when risk hits this summer,” he said. “Confidence in central bankers is in a bear market.”
Puerto Rican general-obligation (GO) municipal bonds have done well, Gundlach said, with about a 7% return, mostly from coupons. But investors will have “a very rough ride,” and he owns them only in high-risk funds.
He advised continuing to hold mortgage REITs but warned of the risk of the Fed following its “dot plots” (i.e., following through on its proposed rate hikes).
His boldest predictions, though, were the Trump victory, the positive impact it would have on the economy and the opportunity for investors.
Trump is a 3:1 underdog now, but Gundlach reminded the audience that one year ago the odds against him winning the presidency were 500:1. “The trend is his friend,” Gundlach said, “in spite of his unconventional campaigning.”
“When the Trump inauguration is nearing and you are scared to death,” he said, “that is the time to buy.”
Read more articles by Robert Huebscher