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Transcript The End Game

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

Date: November 14, 2019

Jeremy DeGroot: So let’s just talk about your views on where rates are going from here.

It relates to the excessive amount of debt and what the economy can handle. It’s a, “Can’t handle higher rates,” economy. Right?

Jeffrey Gundlach: It sort of feels that way; doesn’t it? Yes.

The whole thing is that because of the debt-scheme that we’re running – and here we are in a growing economy with deficit or national debt-growth to GDP (Gross Domestic Product) being at levels historically associated with the depths of recession.

Jeremy: Right.

JG: this is a stimulative-type of –

When you go into a recession, it’s obvious that the deficit will absolutely explode. You’d have not just 6% or 7% of GDP. It might be 12% in the next recession. You just can’t float that many bonds.

If the Fed (Federal Reserve) and the central bankers were to disassociate and go back to free market, I’m absolutely convinced that rates would rise in the next recession at the long-end. They’d rise at the long-end, because we have seen the market is already rejecting the level at which the Fed is setting rates.

Look at the repo (repurchase agreement) market back on September 17th. I mean here’s the Fed setting the Fed funds rate; everything is fine. Then out of the blue one morning, the repo rate goes from 2% to 10%. What’s that saying? It’s saying that there isn’t demand for this 2% under natural market forces.

The Fed comes in and now they’re pumping in hundreds of billions of dollars in reserves. They like to say that it’s not quantitative easing. It’s kind of funny how this semantic game has changed.

They called it “quantitative easing,” because they didn’t want to call it, “monetization.” That’s why they called it “quantitative easing.” Now they don’t want to call it “quantitative easing,” because that sounds like we’re back in the soup again. Right?

I think interest rates bottomed in 2016 at the long end, and then they started to rise. They were rising at about 100 bps (basis points) per year, and I thought that was an appropriate clip. Then the Fed did a 180-degree u-turn in January from where they were in December. In just a 4-week period! They went from this ridiculous sequential rate-hike thing that we’re talking about for the next couple of years. Then quantitative tightening — $50 billion a month for as far as the eye can see. To exactly the opposite.

J Powell, at one of his more-recent news conferences – it’s funny – his philosophy on press conferences is like the shape of a funnel. Say less and less and less and less at every conference. Because when he was very fulsome in his remarks back in the fourth quarter of last year, he got a lot of egg on his face. He was just so totally wrong on –

Jeremy: Balance sheet on auto-pilot, here.

JG: But he did say, when asked a fairly specific question of, “Will we go to negative interest rates in the United States?” He was pretty forceful in saying, “No.”

Jeremy: So we know that means it’s going to be, “Yes.”

JG: Well, no. But he says they’re going to do large-scale asset purchases, which is quantitative easing on steroids.

Jeremy: Yes.

JG: I believe that’s what they’re going to do. Which means they’re not going to let rates rise.

Jeremy: Right.

JG: So we’re in this weird situation right now where rates have bottomed for the year. We thought that back in August. They’ll rise to the point that inflicts concern in the minds of the Fed. Then they’ll start to manipulate them lower.

You have to have this idea about long-term interest rates. They have to rise to a level that really motivates action. Then you have to play them for going down. It’s a very tricky environment.

I think the 10-year treasury should be at 6% in the next recession, if the market would let it price that way. But that would just be so devastating to the economy that they won’t let that happen.

Jeremy: If we can then think about the term, “End Game,” there never is an end game. But the question is, they won’t ever let that happen. Yet it’s not sustainable. So eventually the bond-vigilantes will overwhelm the central banks?

JG: The world is so full of things that are, long-term, obviously fatal. But in the short-term, it doesn’t seem to matter.

Look at the negative interest rates in the ECB (European Central Bank). This is absolutely fatal to the insurance industry.

Jeremy: Right.

JG: And the banking industry.

In the United States, we have this problem. We have this deficit. But people have been talking about this for decades, and it’s not going to be a problem. Well, it’s going to be a problem when you have this massive amount of economic trouble in the next recession. You’re going to have to counter it with inflationary policy.

Inflationary policy will be universal basic income. It is amazing how the frog is being cooked in the pot relative to this “free money,” concept.

When Bernanke said, “Helicopter Money,” back in the day, he said we’d never have deflation because we have the printing press. People were horrified. I mean they thought, “This is unbelievable! We’re in Zimbabwe over here – What are we talking about?”

Now there are people running for president that are getting donations and still on the debate stage that are talking about universal basic income – right now! They’re talking about it!

In the next recession, I think there will be such a backlash against the Establishment and the policies that we’ve been running that I think there will be an inflationary monetization scheme, where you actually send money to people.

GW Bush did that twice, you know. He sent people money. People don’t remember that. It was a few hundred dollars. It went to like 98% of the population. The idea was to go buy a tie or something.

Jeremy: Right. Cash for Clunkers, too!

JG: Cash for Clunkers. That was sort of a giveaway problem, too. Although you had to surrender the car you didn’t want. It was[n’t] really kind of a free-money program.

Jeremy: Maybe it’ll be Cash for Lawn Furniture, soon.

JG: Could be! That’d be great!

Jeremy: I don’t know. It’s a policy idea.

JG: You’d have to pay someone to haul it away and maybe they could pay you.

I think that’s kind of the endgame, unfortunately.

Jeremy: Which would suggest stagflationary. I mean a whole different economic regime.

JG: Totally different.

Jeremy: Inflation expectations are extremely low. Yields are low. No one can see inflation coming for these good reasons.

JG: Just like people couldn’t see inflation ever going away in the 1970s.

Jeremy: Yes.

JG: People thought it was the dragon that would never be slayed. That’s why in 1984, there was a 14% long-term interest rate. The CPI was below 4%. Below 4%. People didn’t want to buy the 14% treasuries, because they were convinced that this 4% inflation was very temporary.

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Each of the funds may invest in foreign securities. Investing in foreign securities exposes investors to economic, political, and market risks and fluctuations in foreign currencies. Each of the funds may invest in the securities of small companies. Small-company investing subjects investors to additional risks, including security price volatility and less liquidity than investing in larger companies. The International Fund will invest in emerging markets. Investments in emerging market countries involve additional risks such as government dependence on a few industries or resources, government-imposed taxes on foreign investment or limits on the removal of capital from a country, unstable government, and volatile markets. The Alternative Strategies Funds will invest in debt securities. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in mortgage-backed securities include additional risks that investor should be aware of including credit risk, prepayment risk, possible illiquidity, and default, as well as increased susceptibility to adverse economic developments. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. The Alternatives Strategies Fund will invest in derivatives. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management, and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. The Alternative Strategies Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. Merger arbitrage investments risk loss if a proposed reorganization in which the fund invests is renegotiated or terminated. Leverage may cause the effect of an increase or decrease in the value of the portfolio securities to be magnified and the fund to be more volatile than if leverage was not used. Investment in absolute return strategies are not intended to outperform stocks and bonds during strong market rallies.

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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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