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.”)