Economic expansions, like loans with dubious credit quality, can keep rolling over for a long time with continuous market manipulation from central banks and others. Throw in an improvement in consumer confidence, a fall in interest rates and a stock market recovery, and you have several of the reasons why DoubleLine CEO Jeffrey Gundlach has reduced his U.S. recession odds for 2020 from 65% to 35%.

That said, the world remains an increasingly strange place. At one point late this past summer, more than half the bonds outside the U.S. in the Barclay's global aggregate index were sporting negative yields. Trillions of these bonds, or about 33%, still are.

Around that time, Gundlach was visiting Europe, where he was asked if he would buy bonds selling negative interest rates or avoid bonds altogether. He said he would not advise anyone to buy bonds with negative yields.

One piece of good news in this story is that Federal Reserve Board chairman Jay Powell has said he would not fight the next recession with negative interest rates. Gundlach has been a critic of Powell on many issues—particularly his decision to raise rates four times in 2018 and then cut them three times in 2019—but he applauded the Fed chairman for taking negative rates off the table. Instead, the U.S. central bank is more likely to resort to asset purchases and other forms of market manipulation when the economy heads south.

But over the short term, the picture is improving, even though the yield “is de-inverting,” which Gundlach noted often happens before a recession. Consumer confidence is ticking up and the Leading Economic Indicators should look better as it goes up against easy comparisons in 2020’s first quarter.

The Global Yield Drought
Global yield starvation contributed to the dramatic decline in interest rates this year, Gundlach said on a webcast. Foreign investors are willing to take unhedged dollar risk for now. He added that the dollar has remained largely flat in price despite a flood of assets into U.S. Treasurys and other financial instruments. If the greenback were to head south, the same foreign investors who flooded into U.S. markets this year could all try to get out at once, and problems could be exacerbated in a stampede for the exits.

Other disparities between America and foreign financial markets also could create more severe imbalances going forward. For all its problems, the Eurozone is barely running a deficit—Germany is actually running a surplus.

That helps explain why U.S interest rates are much higher, Gundlach said. America simply has a much greater supply of government and corporate bonds to sell and buyers demand more.

For Americans so confident their economy is far superior to Europe’s, this stark fact is sobering. Perhaps U.S. growth is better largely because of its ability to sell massive quantities of debt—and sooner than later the chickens are likely to come home to roost. President Trump “seems to be happy” running the same kind of spending deficits “he railed against as a candidate.” Expectations that the Democrats might be any different in today’s world are questionable.

The Reckoning Is Coming
Gundlach has said for years that the coming decade will be one of reckoning for America as the problems of Social Security, Medicare and trillion-dollar deficits—which the Congressional Budget Office predicts will become the norm after 2022—all converge simultaneously. In yesterday’s webcast, he predicted that the federal budget deficit could hit 13% of GDP in the next recession.

All these factors are reasons why Gundlach believes the initial move in interest rates will be up, not down as normally happens when the next recession strikes. Then the Fed is likely to engage in asset purchases and other manipulative moves.

However, Gundlach had more kind words for Jay Powell than he has had in the past. Powell realizes that if the U.S. were to join Germany and Japan and move to a negative interest rate regime, the global financial system “couldn’t survive.” At the same time, the Fed chairman has said he won’t raise interest rates until inflation appears in a significant and persistent way.

The topic of the webcast was the investment company’s flagship DoubleLine Total Return fund. Gundlach pointedly noted that the $54 billion fund holds no corporate bonds, and that’s no accident.

“The quality of the corporate bond market has collapsed” over the last 50 years, he said. About half the world’s junk bonds and total corporate debt resides in America. When the next recession comes many more bonds are likely to get downgraded to junk status. “When bonds get downgraded, their prices do not go up,” he added.

Already, a quick scan of how different classes of bonds performed in 2019 reveals some strange signs are surfacing. For example, bonds rated double B have outperformed those rated triple C by a wide margin. The last two times this happened were in 1994 and 2001, both years when the equity markets struggled. This is “telling us something” and could be “the first robin of spring.”

It's not the only canary chirping in the coalmine. Back in September, rates in the overnight Repo market topped 2% when the 10-year Treasury was yielding 1.7%. Something there clearly isn't right.

The 2020 Election: Hillary?
Four years ago, Gundlach earned a reputation as a clairvoyant amateur political pundit, predicting President Trump would win the election one year before it was held. This year he isn’t nearly as certain.

Former Vice President Joe Biden seems “to have no chance,” even though he remains stuck in first place at 28%, the bond manager said. The way Biden struggles “to formulate paragraphs in debates” is sad. And at 28% he should be rising, not flatlining.

Massachusetts Senator Elizabeth Warren “has completely petered out,” Gundlach observed. Only a few months ago, betting markets gave her a 52% chance of winning the nomination, now she is at 15%, down 70%. “Once you take a dive like that,” she's toast, Gundlach says.

Vermont Senator Bernie Sanders seems to be enjoying a rebound at Warren’s expense. But Gundlach thinks that, as the details of left-wing Democrats’ plans to socialize much of the economy sink in, victory-starved Democrats will look elsewhere.

That brings in former South Bend Mayor Pete Buttigieg, the “best candidate on his feet since Ronald Reagan.” Buttigieg’s biggest problem may be that he is 37 years old but looks 21, like “he is running for student council president,” Gundlach comments.

As for former New York Mayor Michael Bloomberg. Gundlach doesn’t believe the job of New York mayor is a good stepping stone to presidency. Though Gundlach didn’t say it, another former mayor, Rudy Giuliani, might agree. Gundlach also said Bloomberg’s comments that he likes regressive taxes on the poor because it gives society a chance to modify their behavior in areas like soda consumption aren’t going to be received favorably by the American public.

That leaves the Democrats with their strongest candidate in his view, former Secretary of State Hillary Clinton. However, Gundlach doubts she’ll enter the race.

So the best case scenario is that President Trump is re-elected, like about 70% of sitting presidents. Gundlach said that what Trump really has going for him is that “the Democratic race is a complete mess.”