DoubleLine Capital Founder and CEO Jeffrey Gundlach sits down with Yahoo Finance Live's Brian Sozzi to discuss 2022 market concerns, the Fed, inflation, interest rates, the yield curve, and the Consumer Price Index for urban consumers.
- Yahoo Finance's Brian Sozzi sat down exclusively with DoubleLine CEO Jeffrey Gundlach in Los Angeles at DoubleLine HQ as part of their annual DoubleLine roundtable prime event. Here it is, DoubleLine.
JEFFREY GUNDLACH: There's been a relationship that's undeniable between the Fed's activity, not just the Fed funds rate, but also the quantitative easing and the bond buying. And the bond buying has every time, supported equity markets. Weirdly, when they do bond buying, yields go up. A lot of people don't think that that should happen. But it has happened without exception.
And so now-- now that the Fed is really, following the bond market per usual, they have forced to start to talk about raising interest rates more, talk about getting out of the quantitative easing business as early as March, which is pretty rapid. Now, there's even talk of quantitative tightening has already started.
We've gone from a completely dovish profile at the Fed with zero interest rates for years with quantitative easing as far as the eye could see at $120 billion per month. And suddenly, when yields started to rise at the two year and the five year, the Fed always has to follow the bond market.
So we now have today, here, we have the highest two-year yield of the past year. We have the highest three-year yield. We have basically a tie on the five-year yield.
And so what's happening is the yield curve is sending a bona fide recessionary signal. You have interest rates going up at the short end and going down at the long end. That's the one investors really have to watch out for.
It's one thing when the yield curve flattens, because one end of the curve is anchored, and the other one either goes-- either goes down, or this one goes up. But when they go like this, which is kind of a pivot, that's a very strong signal.
It's not there yet. But it's starting to get into the territory where you have to follow it very, very closely. So with the Fed not doing quantitative easing starting March, well, the relationship between the size of the Fed's balance sheet and the market cap of the S&P 500 is what I call gun lock's law of financial physics, because it's worked so well.
It did deviate a little bit during 2020 and '21 a little bit, because the action by the Fed was so aggressive. But that's what investors should worry about. The valuation of stocks is also worrisome in the United States. If you look at the CAPE ratio, Dr. Shiller's CAPE ratio--
BRIAN SOZZI: One of my favorites.
JEFFREY GUNDLACH: --that is very elevated, nearly around 35 or so if you look at the rest of the world. It's half of that. So the US has been very, very strong.
And we're at the point of kind of extremes, where the valuation has been before, but it usually hasn't ended real well. And with the Fed in the reverse gear that they've been in for nearly two years now, that's going to cause headwinds for investors, I think.
BRIAN SOZZI: Do you think the Fed at some point, raising interest rates this year-- does that lead to an economic slowdown?
JEFFREY GUNDLACH: Absolutely. The bond market is already suggesting an economic slowdown. It's, I wouldn't exactly say on the horizon, but it's-- you can't just not think about it anymore like you could a year ago.
So yeah, I think also that one of the things that investors maybe don't have a keen understanding of is ever since rates peaked in the '80s, every single economic cycle, every single economic downturn has begun with the Fed funds level ever lower. It's always breaks the economy at a lower level.
So the one that broke the economy back in 2018 was about two 2%, 2 and 1/2%. My guess-- and when you look at the yield curve-- my guess is that the recessionary signal will be that the yield curve may flatten significantly below 2% on the yield curve. You might actually get very little movement up in long rates. And the Fed will follow the market. And the message sent by the kind of large sell off in bonds today, the Fed is likely to start raising rates and follow through on that.
And at the long end of the curve, it seems like the Fed-- ever since the 30-year treasury yield kissed 2 and 1/2%, seems like the Fed has been defending the long end of the bond market. And for several months now-- it's coming out a year-- it seems like whenever it gets to 2%, weird things happen. It just stops.
The 30-year treasury today-- it's going to be really interesting to see, because it hasn't closed above 2% in a long time. And every day that goes-- in the last several months, that intraday, you get a yield of like 202, 203, lo and behold, something magical happens. And it closes the day at like 198.
And so it almost looks like there's yield fixing going on, which is one way of explaining these negative real yields that we're dealing with. These are the most negative real yields in the history of the record book. Yields are much more negative than they were, or about as negative as they were under Jimmy Carter.
One of the thing that I find remarkable about our current situation-- and I always thought this would happen. I've been talking about this for about 15 years-- is that we're starting to get lots of things that look like the late '70s and early '80s, but almost in the mirror.
BRIAN SOZZI: How so? You mean, high levels of inflation?
JEFFREY GUNDLACH: Well, we-- higher levels of inflation, low real yields, geopolitical problems, kind of a malaise feeling in the White House. I mean, a lot of these things are the same. And yet, interest rates were super high then.
And now, they're super low. So we have the same condition, very-- very negative real yields. I mean, real yields basically, the Fed funds rate is negative 6.8% right now, because Fed funds is at 0, and the CPI is 6.8%. So very negative real yields.
But this time, it's because the inflation rate is much higher than the yields. Before, you know, it was-- it was-- it was a situation with very high inflation that was being fought by the Fed. So we're starting to get back into that mode of thinking we need to fight inflation.
But we're starting at such different levels in terms of economic valuation, you know, stocks versus GDP, sort of Warren Buffett's indicator. These things are really elevated. But what's odd about the situation is as overvalued as stocks are by historical comparisons using the S&P as a proxy, thanks to the meddling by the government, they're actually cheap to bonds.
So it's a tough choice for investors, because you look at stocks and the PE is in sort of a danger zone. And yet, bonds have these wildly negative yields. And inflation is going to continue to go up, at least in the next couple of months.
BRIAN SOZZI: Where do you see inflation this year--
JEFFREY GUNDLACH: Well--
BRIAN SOZZI: CPI?
JEFFREY GUNDLACH: Well, OK, we have to look at different measures of CPI. CPI is at 6.8% right now year over year. The one that's rolling off for last December is 0.2. So the way things are going, it seems pretty likely that we're going to get a 7 handle on the CPI soon.
But the CPI of course, is a strange construct. It's not calculated the same way as European CPI. If you use the European CPI methodology, our CPI right now, would be at 7.8%. So it's calculated a little bit differently.
Also there's this strange thing about shelter that's almost a third of our CPI. And shelter includes largely, something called owners equivalent rent. And owners equivalent rent is not a real thing. It's not like you're going out there and measuring rents.
What you're doing is asking people that don't rent out their house, if you did rent out your house, what do you think you'd rent it out for versus last year? As if a regular homeowner that doesn't rent out their house has any idea. I probably couldn't estimate what I could rent my property out for within-- within 20%. I have no idea. I've never looked at it.
But the owner is equivalent rent that they come up with is-- the most recent reading is 3.5 year over year. But there are other indices. There's the Zillow index. There's another one that eludes my-- my memory right now.
But they're running at-- well, they were up at 23% year over year a few months ago. Now, it depends which one you look at. But maybe, they're only at like 14%. But even so, it's like 10 full percentage points higher than what the government uses in its CPI calculation.