Achieving escape velocity from 2% or 2.5% GDP growth seems increasingly unlikely to both Nobel laureate Robert Shiller and DoubleLine CEO Jeffrey Gundlach. Both financial market experts were interviewed yesterday in New York by DoubleLine portfolio manager Jeffrey Sherman, who co-manages the DoubleLine Shiller Enhanced CAPE smart beta fund with Gundlach.
The United States has looked like one of the strongest countries in the developed world, “but I’m distrustful,” Shiller said. While Shiller acknowledged pockets of “animal spirits” can be found in areas like fracking and technology, the current economic expansion has seen fewer hot new innovations than past economic cycles.
Like many of the previous five years, 2015 was supposed to be the year U.S. GDP growth would reach 3.0%, but Gundlach said he had arrived at the viewpoint of Missouri, the so-called “Show Me” state. The Fed is “starting to believe in Missouri” as well, he noted.
Blame the harsh winter weather if you want, but since the economic recovery began in the second quarter of 2009, first quarter growth has averaged 0.6% while all other quarters have averaged 2.8%. Other culprits besides the weather have included Greece, the euro and Japanese earthquakes, but there is always an excuse. It “makes you start to wonder about seasonal adjustments,” Gundlach said.
Neither man disagreed with Fed Chair Janet Yellen’s remarks that equity valuations are high. Using his CAPE ratio, Shiller says it indicates equities should return 2% annually for the next decade, and that is better than he expects bonds to do. “My gut feeling is this doesn’t look right,” Shiller said, but “I haven’t met anyone who sold everything. People are worried, but no one knows what to make of [the markets] because interest rates are so low.”
Still, Shiller noted that it wasn’t 1929, when his CAPE ratio was 37, not the current 27, which is still very high compared to historical levels. Furthermore, interest rates were much higher than they are today.
Record low interest create distortions that both these perceptive observers find very odd. though in the last ten days bond prices have suddenly tumbled around the world, triggering some odd results. "We've lost 100 years of income on 10-year German bunds in the last week," Gundlach said.
In addition to such anomalies, Gundlach said some warning signs aren’t hard to spot. In the corporate bond market, new issuance of covenant-lite bonds reached a record of 70% of all new issues last year. Worse yet is some people’s interpretation of this phenomenon.