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Transcript Recession Risk: Skating Through

With: Jeffrey Gundlach, CEO and CIO, DoubleLine Capital Portfolio Manager, Litman Gregory Masters Alternative Strategies Fund

Date: November 14, 2019

Jeremy DeGroot: Let’s move on to your economic outlook. As a fixed-income investor, it’s particularly important, as it is with any investor. But as an input to your investment process, clearly.

Then I guess just starting from the headlines, “Recession Risk,” on one of our more-recent webcasts, you put out a 75% probability.

Jeffrey Gundlach: That was in the summer. Yes.

Jeremy: Then it came down.

JG: It’s down.

Jeremy: Not to hold you to be precise. Frankly, when someone says, “40%,” how are you going to – well – “You were wrong; you were right.”

JG: That’s kind of where I am, now. Around 40%. Maybe 35% now, even. Data’s gotten a little bit better.

Jeremy: Qualitatively, the odds are less-than 50/50.

JG: Like I said, we have a meeting every week to talk about the environment and strategy and macro. We go through like 200 charts.

A section that we always go through is of these indicators that we’ve developed over the course of probably 20 years. We think they reliably give you at least an idea about where you are in the economic cycle. We go through those.

They’ve gotten worse, for sure, in the past 20 months or so. The nirvana period was back in January of 2018, when everything was looking very strong. All synchronized global growth. That was the narrative. And it was true!

But one-by-one, that’s fallen apart. There are parts of the world now that are anything but strong. I mean the German manufacturing economy is a disaster.

There are things like the PMI (Purchasing Managers’ Index) surveys that do manufacturing services. Above 50 is expansion and below 50 is contraction. It’s pretty reliable. But prior to recessions, you see a falling-off-the-cliff sort of behavior of those surveys before the front edge of the recession is reached. And that happened this summer, but it has partially reversed, which is a positive thing.

Also, high-yield bond-yield spreads have remained fairly relaxed. I’m not looking at that as a highly-important indicator right now. I think it has a lot to do with yield-desperation around the world.

The leading indicators year-over-year from the conference board – there’s never been a recession in the United States without those leading indicators first going negative.

There are false signs. False positives on that. But it’s a necessary condition for a recession. It’s right now at 0.4, which is down there. It was up at 7% year-over-year about 15 months ago. Now it’s at 0.4.

The good news is that the numbers that are rolling off in the next few months are negative numbers. So it’s going to hook back up. That was looking a little dicey and it’s gotten a little bit better.

There are the surveys of consumers that are notorious for tanking. It’s almost definitional when the consumer decides that things aren’t so great anymore, they stop buying.

But the best indicator of those that was really reliable is comparing consumers’ attitudes about a year from now to the attitudes today. Weirdly, consumers can be very confident feeling good about today and be confident about a year from now. But invariably the year-from-now confidence starts to erode even when the “today,” is okay.

You get into this great big gap. That developed in a way this summer that’s highly suggestive of a recession in the next 12 months. That’s why I was way up at 75%, with the inverted yield curve and the leading indicators coming down, and looking like they might go negative. And some of the surveys – CEO confidence in particular.

But a lot of these things with PMIs have gotten a little bit better.

However, since we have this political season, we might skate through. There are levers that I’m sure the administration plans on pulling to try.

Let’s just say you wanted to sculpt economic growth so that it was a little weaker in 2019 and it got stronger in 2020. What might you do? Put on some tariffs so that consumers reduce their spending?

I bought some outdoor furniture this summer, because I needed it. I got the bill and it was really an eye-opener in real-time. It said, “$2,000 plus tax plus shipping plus 25% tariff.”

Jeremy: Really?

JG: Right on the bill.

I was thinking I could well-imagine some consumers going, “Huh. That’s an extra like $400 or something.” Maybe $500. “Maybe I can wait it out for next season and keep the old shabby stuff for another year.” Because the president keeps saying we’re close to a deal.

So we’ve got this 25% staring us in the face. Yet we have this rhetoric that it might be temporary. So maybe you curtail consumer spending. And retail sales were negative a couple of times this year. The most-recent month print came out negative.

So maybe you push the spending forward.

Then maybe in say – I don’t know – April – you announce, “Tariffs are off!” Then suddenly you might get this burst of patio-furniture buying. Right? That helps things out.

Another thing you might do is you might weaken the economy through this tariff mechanism in order to get the Fed (Federal Reserve) to soften rates a little bit. Because we all know that monetary policy works with a lag. So you get the Fed to cut rates maybe – I don’t know – three times? Just to pick a random number. Because that’s what they’ve done – three times!

Maybe that helps the growth.

Then also, Larry Kudlow has been twice now — including this week –

Jeremy: I know you’re a fan of his.

JG: I like Larry, actually. I mean –

Jeremy: Not what he says, but you like him?

JG: I don’t like the fact that he went from, “Tariffs are the worst thing in the world,” to, “China’s paying the tariffs.” But he’s done that because he’s sort of required to with his job.

He’s talking about Tax Cuts 2.0. They have two suggestions that they’ve floated out there. One was a few months ago in the summer, when things were looking pretty bad.

Remember, in the summer, people were talking about a mid-meeting. An emergency 50-bps (basis point) rate-cut being appropriate. That was actually in the air at that time.

But Larry Kudlow said they were thinking about a payroll-tax cut. Which Obama did to help cushion the global financial crisis in ’09. That is just full-on stimulative. It goes up to $139,000 and you cut a few percent. That would go almost directly into spending.

This week he didn’t talk about payroll-tax cuts. He talked about a 15% middle class income-tax rate. That would be a cut. Of course, that would be a way of potentially stimulating things. Now I doubt they can get that passed.

But it is for the middle class. When an election’s coming up, it might be tough to run against the Trump Administration on being all for billionaires and corporations when they’re cutting middle class tax rates.

All those things together could help ski us away from recession. But certainly, things are far less copacetic in terms of economic indicators than they were in the first part of ’18. But happily, they’re better than they were in about the end of August of this year.

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A basis point is a value equaling one on-hundredth of a percent (1/100 of 1%)
A Below Investment Grade bond or Junk Bond is a bond with a rating lower than BBB
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. Changes in the CPI are used to assess price changes associated with the cost of living; the CPI is one of the most frequently used statistics for identifying periods of inflation or deflation.
Curve Steepener A strategy that uses derivatives to benefit from escalating yield differences that occur as a result of increases in the yield curve between two Treasury bonds of different maturities. This strategy can be effective in certain macroeconomic scenarios in which the price of the longer term Treasury is driven down.
Drawdown is the peak-to-trough decline during a specific record period of an investment, fund or commodity.
Gross Domestic Product (GDP) is the market value of the goods and services produced by labor and property in the United States.
A Leverage Ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. 
The NYSE Composite Index is an index that measures the performance of all stocks listed on the New York Stock Exchange. The NYSE Composite Index includes more than 1,900 stocks, of which over 1,500 are U.S. companies.
The Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. It summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting. 
Quantitative Easing (QE) is a monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.
Quantitative tightening (QT) is a contractionary monetary policy applied by a central bank to decrease money supply within the economy. 
A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.
Yield Curve: A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. The curve is used to predict changes in economic output and growth.

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