DoubleLine Capital founder Jeffrey Gundlach enlisted the help of his Chicago investment partners to put on a private economic discussion and modern wing art viewing at The Chicago Art Institute June 3. The Windy City's own CNBC star, Rick Santelli, moderated the discussion, which included CNBC frequenter and research hound Jim Bianco. The three touched on the Fed, global economics, the dollar, inflation and risk and opportunity in today's topsy turvy bond world.

A two-hour reception and private viewing of the Art Institute's modern art wing followed the 90-minute discussion and Q&A that included financial advisors and industry folks. DoubleLine's lavish spread of top-shelf liquors, spirits and hors d'oeuvres was reminiscent of the heady days before the dot.com crash and similarly before the housing bubble burst.

Gundlach surrounds himself with sensory excellence, and his thoughts can make one's head hurt trying to interpret them. Gundlach speaks in metaphor, analogy, philosophy, and economics -- occasionally doused in a thin veil of humor to those who get the joke. Gundlach speaks with such conviction that it often seems that he is stating the obvious, but there is nothing obvious about the DoubleLine founder.

Negative Bond Yields

"Negative bond yields seem like the most ludicrous thing you can possibly imagine...you lending me that money makes me a better credit rating," Gundlach started. He likened a negative yield spread to "one of those optical illusions." Gundlach set the stage for the next big financial crisis as he sees it, and he laid out the landscape for the challenges in the bond investing world right now.

Gundlach knows that most people would wonder why trillions of dollars are invested in negative European debt, so he explained that big money cannot just leave its money in cash. "I would short bonds with negative yields with 100 times leverage, but you can't do that," he said.

This brought him to the reason that people, collectively, still like U.S bonds: "Negative bond yields, and low bond yields in Europe, had become the answer to why U.S. bonds are a good buy,” he said.

Gundlach Follows Up

On a June 9 webcast, he said facetiously, “I would like to borrow several quintillion dollars at negative interest rates," to hammer home just how mind blowing negative bond yields are. He followed this with, "Just take my advice, and don't buy bonds yielding less than zero."

While it is true that institutional and managed money can't sit on cash, other reasons do actually exist as to why investors might consider holding bonds with negative yields. An investor could bet on deflation, could be speculating on currency, or a government could be trying to control who owns its debt. Some investors might think that bond prices will rise, but this thought does not describe the management sentiment at DoubleLine at all. "The explosion to higher yield momentum virtually guarantees that yields are going up," opined Gundlach. "The bond markets have had a lot of chop with little change in yield."

Gundlach also cautioned against investing in emerging markets in local currencies. He mentioned that the dollar-denominated emerging markets index was up 2.8 percent through June 8, but that if you are invested in it in local currencies, "you are getting massacred, down 8.2 percent." Then he joked that investors who really want to get their heads handed to them are invested in German bonds. He told advisors that currency trends tend to last ten years.

Liquidity And The Structure Of The Bond Market

On stage at the art institute's Rubloff Auditorium, the three interest-rate commentators conversed about the structure of the bond market. Jim Bianco said that while the liquidity in the bond market is a problem, "it is not the problem," and added, "The structure of the bond market is the problem." Bianco explained that exchange-traded funds, such as the humongous one representing 20-year U.S. Treasury bonds, "is 70 percent more sensitive to a price movement than at the height of the crisis." He is concerned about trading limits being imposed on the bond markets.

Bianco labeled modern bond traders as "a Cisco router with a bunch of wires coming out." Gundlach volleyed, "Come to my trading floor, and tell that to my traders."

"All these algorithms come to the same conclusion at the same time," Bianco continued.

Rick Santelli, moderating, chimed in sarcastically, "But that's just going to bring boatloads of liquidity, right?"

Gundlach did acknowledge what he terms the "robo-advisors" and said, "It's a spreadsheet, and that's just going to be another driver of group investment think." He commented on Bianco's point about the extreme price sensitivity in Treasury ETFs and discussed the "gappiness of the Treasury market and lack of liquidity." To emphasize the changing structure of the bond market, Gundlach said, "You used to see a portfolio turnover of 400 percent with successful bond trading firms." He contends that now one of the primary drivers of alpha has been rendered useless.

Bianco stated that there is no bond trading liquidity when traders needs it because, "It's all zero percent sell and 100 percent buy or 100 percent sell and zero percent buy." This brings to mind a DoubleLine website publication which explains that lack of liquidity does not impair DoubleLine because its expertise lies in capturing inefficiencies in pricing that cannot be captured in the stock market because of the transparency and available liquidity.

Inflation And GDP

"Inflation is a very squishy number," said Gundlach. "We look at real GDP and nominal GDP, and we deduct this inflation number." Then, Gundlach proceeded to explain a new idea he formed a few months back. "Core CPI is 150 in the U.S. In the U.S., the primary driver of U.S. CPI right now is shelter. If you take out shelter, U.S. Core CPI and European Core CPI are exactly the same." Therefore, he decided to begin to look at "nominal GDP" which he calls "remarkably stable" at about 4 percent since 2010. "Year-over-year, nominal GDP is an incredibly good indicator of the 10-year yield."

Gundlach said that nominal GDP has been dropping ever since about 1982, but added, "The bad news I have for you is that nominal GDP is above the 10-year yield." He still calls July 2012 the "orthodox low of bond yields" and lauds himself for calling it such at the time.

A Secular Shift In Bonds

Gundlach contends that we are never returning to the old paradigm of dropping nominal GDP driving down bond yields. "A secular shift is underway," he said, seemingly based on the stable low nominal GDP coupled with the run up in bond yields over the past three years. He pointed out that Japan has already decided that they want inflation, and that Europe is deciding that they want inflation. "We are going to go a full pendulum swing," he said. "We will go from inflation is the boogeyman (starting in the 1970s) to 'we want inflation.'"

Corporations, during this time, have pushed out maturities, said Gundlach. "The demographic time bomb continues to tick," as he is often fond of pointing out. To distill from classic Gundlach, the baby boomers basically finished childhood as consumers hungry for housing, automobiles and autonomy. Millennials begin adulthood wary of home buying, more drawn to renting, avoiding big purchases such as automobiles and hesitant to cut the proverbial cord with mom and dad. Millennials and a fair amount of Gen X-ers shack up with mom and dad, mooch off of them and even hang with the “rents.” How this relates to bonds is that today's young adults do not view taking on debt as a means to their end, so do not expect the younger generations to help solve the liquidity problem.

DoubleLine's take on "the high-yield bond market and secular interest rates" coincides neatly with that "wall of maturity (coming) in 2019,” because if we are almost three years into the secular shift in bonds, there are at least seven years more, but probably at least 15 years.

Without saying the word "bubble,” because he doesn't need to, Gundlach speculates that with the wall of government bonds maturing and needing to be refinanced, a run up in Treasurys could basically send junk-bond yields into the stratosphere. "It's a problem for two years from now, possibly 18 months," he said. "Quantitative easing makes junk bonds underperform Treasurys," Gundlach said.

Using terms like "stable nominal GDP" and "secular shift" avoids the type of run on his own bond funds that alarmist language like "bubble" and "froth" could bring. By rose coloring it to make people forget the instances of real GDP going negative and oversimplifying it by removing housing to arrive at a stable real output of an almost healthy 4 percent, everything suddenly sounded peachy. Though, everything is not calm if one looks at the fact that the Barclay's Aggregate Bond indexes are all negative or near zero year to date, except for the high-yield bonds up around 3 percent through May 2015.

Going for the comic gold, Gundlach could not resist the urge to quote what he labels a "reductionist argument" from Ernest Hemingway's "The Sun Also Rises" (1926). He quoted, "'How did you go bankrupt?'” Bill asked. “'Two ways, '” Mike said. “'First gradually and then suddenly.'" Comparing the secular interest rates and secular shift to "going bankrupt," whether gradually or suddenly, is bad news any way you slice it.

As a guest on Anthony Scaramucci's April 19, 2015, "Wall Street Week" show, Gundlach said, "Investors might think junk bonds returning 2-3 percent in 2014 while other bonds are down is repeatable." On the show, he likened investors bragging about buying negative bonds that go even more negative to "picking up dimes in front of a steam roller" because, he said, "When it goes wrong, it's going to go wrong in a big way."

Gundlach's "Wall Street Week" quoted data unearths that only $50 billion of junk bonds is maturing in 2015 and 2016. His same data reveals that come 2018-2019, $350 billion of Fed debt rolls off the balance sheets, $300 billion more of junk bonds, and another $300 billion of bank loans. So, it is documented that Gundlach told Scaramucci and guests that "investors should be investing down in high-yield bonds" while acknowledging their usefulness as a "carry trade" as long as the stability lasts. However, he said that the historical corporate borrowing default rate of 4 percent that investors have seen over the past 30 years could balloon upward. He also warned that if interest rates are rising in a few years and investors do not have the current desperation in their searches for yield, bond prices will inevitably fall.

"Nominal GDP was never less than 3.9 percent when the Fed started raising interest rates, and now it's at 3.9 percent," Gundlach said on the webcast. He also mentioned that he is watching for a rise in hourly wages as a gauge that interest rates will rise. Looking at the Fed's position right now, Gundlach sees the Fed as "stuck in an impossibility" like M.C. Escher's famous "Ascending and Descending" drawing in which the staircase looks both continually ascending or continually descending.

QE Monster

While neither Gundlach, Santelli nor Bianco think that the Fed will raise interest rates in 2015, they also do not think that central bankers will take care of the looming problems. "Quantitative easing of this magnitude has never happened before," Gundlach said. He added that "there is no easy solution for this monster that has been created." He warned that volatility will only continue to rise and that there will be inflation which he calls "clearly good for equities" but "not good for bonds."

On June 9, Gundlach said, "QE has a counterintuitive effect on bond yields," and "With European QE, I expect that yields will rise." He told advisors that he is "virtually certain of a rate rise by Halloween of next year," upon which he said the bond market will rally.

As a financial planner in the audience, who also happens to be a trained business and financial journalist, I lucked out by getting to ask my question on mic, while DoubleLine gathered the notecards with everyone else's questions.

My question: "Jeffrey, you just said that inflation is the enemy of bonds. You, Jeffrey Gundlach, are a bond manager, first and foremost. How are you going to position yourself to become a winning bond manager in a rising interest-rate environment? (Note: Rick Santelli commented while filtering through the notecards for the next question that he would choose an “easy one.”)

Gundlach answered by touting himself as the best of the bunch and highlights his consistency in outperforming his peers with less volatility. He even goes on to call it "a vintage year over at the DoubleLine funds" on his June 9 live webcast. On June 3, Gundlach said that DoubleLine manages funds to capitalize on rising interest rates and that these funds are doing well. He also differentiated between absolute return and relative return. It is possible to have a capital loss on paper but to have made money on an investment overall. Gundlach quoted an old joke with the punchline, "I don't have to outrun the bear; I just have to outrun you!" which coincided with one of his opening remarks about bad bond yields elsewhere making U.S. bonds look good. If inflation and rising interest rates are the bear, maybe this U.S. bond manager thinks he only has to outrun zero and negative yields.

"Rising interest rates aren't as scary as you think if you have a reinvestment component in your portfolio," he said. This sounds good, until I remembered the fixed-income trio discussion 30 minutes prior about the total lack of liquidity and structural snafu of the bond market. If successful bond managers used to turn a portfolio at a rate of 400 percent per year, and now they can't easily get the trades they want, the managers are going to have to change the game. Otherwise, they may fall victim to the inherent truths of bond trading amidst an ever-changing patina colored by QE and broad-based balance sheet expansion, electronic Robo trading, and investors' current insatiable hunger for yield.

Gundlach clarified his strategy further on his June 9 webcast by saying, "Get very scared (of rising interest rates) if the 10-year Treasury gets above 260." He told advisors that DoubleLine will use this indicator of "260-ish" to determine duration in portfolio holdings.

Repackaging The Risk

In insisting that there is no logical reason for the Fed to raise interest rates, the DoubleLine founder said, "They want to get off zero so they can at least do something; they just repackage the risk." We know from Janet Yellen's November 2013 confirmation hearings that the U.S. Fed would never push interest rates into negative territory because she said at the time that if this were to occur, Americans would stash their money under their mattresses. It is safe to assume that with almost $12 trillion in retail deposits at U.S. banks, that there isn't much cash under our mattresses. Even though for many investors, real return taking into account inflation, equate to negative. Investors have money. It is sitting on the sidelines. Surely DoubleLine knows that people desperate for diversification and promising investment opportunities have their cash “parked.”

Gundlach explained that the government has already repackaged the risk with quantitative easing, balance sheet expansion and zero interest rates. Santelli likened this risk repackaging to wallpapering over live termites.

Profiting Off Of Inflation And Rising Interest Rates

Jeffrey Gundlach has already reinvented himself by going from a behind-the-scenes bond manager at a company owned by a French bank to arguably the most successful bond entrepreneur of this century. While the DoubleLine founder, CEO and CIO may seem like a reluctant star, he knows he is on a roll, and it is likely we have only seen the beginning of his capabilities.

Reading between the lines, it becomes clear that Jeffrey Gundlach will not be satisfied outrunning his northwest-quadrant peers in an M.C. Escher world. It seems more likely that he is trying to set the table to have DoubleLine feast on some bear. His team at DoubleLine has been training hard together for the bear marathon for five years and counting.

While inflation and rising interest rates are not good for bond buyers, they could be profitable for DoubleLine as debt issuers and originators. It is true that one cannot easily short bonds and certainly cannot short negative yielding bonds with leverage. However, DoubleLine issuing junk, non-rated and private debt is a convenient proxy for shorting bonds with negative yield with leverage by becoming the debt dealer.

To make a supply-and-demand analogy, a person is not likely to make much money selling cannabis in his neighborhood. But, to become the dealer or issuer to the drug cartels solves the liquidity problem because the dealer is the one creating the liquidity and profiting as a result.

In terms of possible bond issuance, DoubleLine has already stated publicly that it supports funding public infrastructure projects. The company has new funds set up for commercial real estate financing, collateralized loan obligations and securitized collateralized loan obligations.

In recent weeks, DoubleLine has confirmed its intention to offer middle-market commercial property bridge loans of a two- to five-year duration through a new partnership with Los Angeles-based Thorofare Capital. Thorofare will originate the loans, which DoubleLine will buy for its related portfolios. Just last week, Bloomberg's Lisa Abramowicz reported that DoubleLine will offer its first collateralized loan obligation (CLO), reported by Abramowicz to be a $400 million offering in conjunction with Morgan Stanley. Last year, a leading technology provider of CLO data announced that DoubleLine had licensed its customizable software.

In recent months, DoubleLine has registered with the SEC as a commodity pool operator, and as an Equity LP to offer equity strategies. In the alternative investment space, DoubleLine has incorporated a handful of new CRE and CLO companies, as well as a CMBS Fund, a CMBS servicing company and an Equity Healthcare Fund. Key DoubleLine brokerage employees have recently switched to Foreside Fund Services, according to Finra’s BrokerCheck. Foreside is a specialist in distribution and compliance services for the alternative investment industry. Previously, DoubleLine had an almost five-year partnership with Quasar Distributors, a subsidiary of U.S. Bancorp that specializes in mutual fund solutions.

Jeffrey Gundlach assured advisors of his experience and tenure (via webcast) versus "a lot of people running hedge funds that have never seen an interest rate hike" as well as "a lot of senior people in this business that have only seen declining interest rates." He makes it seem like much of his competition run their portfolios in a vacuum.

"I am not afraid of the high-yield bond market in 2015 or even in 2016; I am fairly copacetic on the high-yield bond market," said Gundlach. He said via webcast that he has long-term skepticism. Gundlach sees companies possibly borrowing at 15 percent come 2019-2021. He says that default rates could go from the historical 4 percent to 8 percent if companies have to roll over loans, driving some portfolio yields less than Treasurys. Gundlach says that by that time, we could see a $1 trillion to $2 trillion deficit spurred by the demographic problems, and he includes Obamacare in the anticipated entitlement blowup.

The bottom line, he said is, "It's OK to be dancing in the high-yield bond market, but I suggest we all dance near the door." Jeffrey Gundlach can dance anywhere he wants because he seems to be building dance halls throughout the financial services industry.

Lisa A. Ditkowsky, CFP, is an investment advisor representative at LPL Financial LLC in Evanston, Ill.