Reflecting on the post-election landscape, Jeffrey Gundlach expects a split government to emerge, with a Biden presidency, Democratic House and Republican Senate. That outcome explains the gains in U.S. equities this week, but stocks are now “really overvalued.”
Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, a leading provider of fixed-income mutual funds and ETFs. He was interviewed via webinar on November 5 by Alex Shahidi, who is a managing partner and co-chief investment officer at Evoke Advisors and ARIS Consulting, a Los Angeles-based investment advisor, as part of its master speaker series.
Earlier this week, Gundlach reiterated his “low-conviction” prediction that Trump would win the presidency in a likely tight race. Today, he acknowledged that was unlikely, but was confident that the Republicans would maintain control of the Senate.
He said he was surprised how deeply and evenly split the country is. He was not surprised by how wrong some of the polls were, citing one that predicted Biden by 17% in Wisconsin and national polls predicting Biden winning by up to 10% of the popular vote.
Gundlach did not validate Trump’s claim of illegal voting, but said that it was “weird” the Wisconsin turnout was 90%. “Not even that many people think Elvis is dead,” he said, tongue-in-cheek. (The claim that Wisconsin's turnout was unusually high has been debunked.)
The down-ballot losses incurred by the Democrats, such as the House seats they lost, were “predictable,” he said, as a result of the weakness of Kamala Harris. He called Harris “socialist-like,” and that led many to hedge their bets. Voters were worried that Biden may not make it four years, and don’t want a socialist agenda.
The markets under a split government
We should not be surprised that markets like a split government, according to Gundlach, with the houses of Congress controlled by different parties.
“The market views the election and split government as a positive,” he said.
But there are two controversies rising from the outcome.
Bond yields fell logically because there will be less fiscal stimulus due to the split government, resulting in less of an inflation threat. “The Fed won’t see an inflation scare and it will be easier and more willing to do asset purchases,” he said.
But gold and bitcoin are up. Those two assets are highly correlated to each other, and their moves up represent a flight to safety. That is “weird” given falling bond yields, Gundlach said.
The second controversy is ominous for equity investors.
The U.S. market is “really overvalued,” he said. Mainstream economists are predicting U.S. real global growth will be 3.7% and the total world will grow at 5.2%. That says the U.S. is “way weaker” than the rest of the world, according to Gundlach. The U.S. stock market has also “wildly” outperformed the rest of the world for most of the last decade.
He cited a number of metrics to support his view of U.S. equity overvaluation: market capitalization-to-GDP is the highest of all time; P/E ratios are higher than in 1930, before the Depression; and the Shiller CAPE ratio is near 30.
Gundlach focused on the widely held concern that the S&P 500’s advances have been narrowly concentrated in just six stocks – the FAANGs plus Microsoft. The other 494 stocks are where they were two years ago, he said.
“Narrow markets are not very attractive,” he said. “Beware if the super-six stop outperforming.”
He called the Fed’s injection of liquidity into the markets, through quantitative easing and asset purchases, “a money spray” that has fueled market speculation by retail investors.
Prior to the election, he expected a stimulus package in January, but now said it won’t be as big as if Democrats had won the Senate.
“Republicans won’t give money to blue states,” he said, “which are the hardest hit.”
Monetary policy and economic risks
Gundlach expanded on concerns he has expressed in the past about fiscal discipline at the federal level.
He predicted a “very large decline” in the value of the dollar in the years ahead due to growth in the fiscal deficit.
We are in dangerous territory with the Fed because it went “rogue,” he said, by buying corporate bonds and effectively lending to corporations. He claimed those moves were in violation of the Fed’s 1913 charter.
We are “close” to monetizing our fiscal deficit by creating unlimited lending facilities, he said. Monetization, which he defined as “full money printing” by the Fed, would violate its charter. Monetization always leads to hyperinflation, according to Gundlach, as it did in the Weimar Republic and Zimbabwe.
It also leads to social change through a “potentially bloody revolution,” he said. “It is hard to see how you don’t ultimately go there.” We cannot pay back our total unfunded liabilities of 750% of GDP without enduring two generations of austerity, he said.
Either we default on our liabilities (e.g., by raising the Social Security eligibility age) or we devalue, according to Gundlach.
The other risk for the Fed is negative interest rates, he said, which are not likely. That policy has not worked in Europe or Japan; in both cases, their financial sectors were “devastated” after negative rates were implemented, he said.
But the biggest risk is the temptation to go to “pure money printing,” he said.
What will be the next big move in interest rates?
For the last several months, he said, rates were too low. Various Indicators were showing that the yield on the 10-year Treasury should be 1.25% to 1.5%.
During that time, the 10-year yield increased from 0.55% to 0.79% and the 30-year from 1.22% to 1.54%.
At some point, the Fed will use yield-curve control to pull rates down, he said. Based on the expectation of a smaller stimulus package, he said rates will not go much higher. In the near term, rates will go down in a flight to safety, and gold will go up.
Betting on higher rates is not a very good bet, he said, unless the Fed “completely changes its tune.”
Corporate bonds are overvalued because of Fed buying activity. Junk bond defaults are rising and the fundamentals will get worse with the COVID flare up, he said. A junk bond ETF will have substantially negative returns “through the fullness of the default cycle,” he said.
Investment-grade bonds are no more attractive, he said, with a yield of 1.6% and a duration of 9. Spreads could widen because of a growing fear of default, which could lead to downgrades of BBB-rated bonds.
“You could have a pretty monumental underperformance in the corporate bond market,” he said.
“The Fed has solved the liquidity problem for corporate bonds,” he said, “but hasn’t fixed the solvency problem.”
Investors have to go where there is “pain and danger,” he said, which includes the CMBS, ABS and CLO markets. He warned that regular investors “cannot do this on their own,” and this is the focus of DoubleLine’s investment activity.
Our dysfunctional destiny
Gundlach expanded on his comments earlier this week on the societal dysfunctions facing American society.
“If you think 2020 was weird,” he said, “2024 will be a real horror show.”
The problems causing society to be divisive will escalate: income inequality, mistrust of institutions and the uneven effects of the stimulus. He noted that high-wage jobs are back to their pre-COVIID levels, but low-wage jobs are down 18%. Small businesses are “suffering” – 24% of small businesses operating at the beginning of the year are now closed.
He supports Neil Howe’s paradigm of a fourth turning. We will face a “societal shift” as we did after WWII, and those shifts happen at regular 75-year intervals. We need to reinvent our social and cultural institutions by 2027 at the latest, he said.
Some of that is already happening, according to Gundlach, and can be seen in rejections of exhibits by museums, calls to tear down statues of Lincoln, cutting of police budgets and challenging police methods, concerns over the Electoral College, and members of Congress who, Gundlach claimed, would strike parts of the Bill of Rights.
The Constitution will get a “tune up,” he said, which could be minor or major, before the 2024 election.
Democracies don’t survive, according to Gundlach. They fail when there is too much wealth inequality. The property relationships cannot keep up, he said, and the losers get “fed up.”
He warned that if there is movement in the judicial system that “brightens the sky for Trump,” there will be unrest. It will be way worse than others during the Trump era, with protestors and counter-protestors – an outcome to which he assigned a 40% probability.
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