Jeffrey Gundlach: Hope Is a Poor Investment Strategy | Fox Business

Well, I noticed that there's a family resemblance between what the financial alchemy that's been going on in some of the private markets and the financial alchemy that went on in the mortgage market 20 years ago. What I mean by that is we took triple-B rated securities 20 years ago and somehow we made AAA rated securities out of them, and Wall Street found a way to pocket the difference by basically selling lower quality assets in disguise as high quality assets. And it was based upon ratings. It was based upon the rating agencies. Moody's and S&P were dominant in those days. And they were giving away investment grade ratings on securities that were ultimately worth zero in a fairly short order. And they gave AAA ratings to securities that dropped down below 40 in the depths of the problems. And so now we've got something that's sort of similar. We have ratings that are going on in the private credit market which are kind of dubious. And we have price discovery which is almost non-existent. And we have portfolios that are being held...

evaluations that are now we have historical data going back about a year, at least maybe 18 months, that are now being observed by the Department of Justice as being a little bit sketchy, with one prominent player in the private credit space earlier this year had a portfolio that was marked at 100. Lots of loans in this portfolio. We're not talking about Nvidia stock which can be very, very volatile. We're talking about a large portfolio of loans, and they were marked at 100, and then one night they changed their mind and marked the entire portfolio on average down from 100 to 81. That means either every loan was marked down 19 points, or half the loans were marked down 38 points, or a quarter of the loans — since I keep hearing that mostly everything's fine — maybe 75% of the loans are rock solid and 25% had to be marked down, so they were marked down to 24. So which is better: that everything was great but we had every loan go down 19 points, or everything is mostly great, we have 25% of loans going down 76 points? And this is being looked into because of course there's incentives.

Whenever you have incentives, you can predict what type of behavior will follow. And the incentive of course is to be slow in realizing problems because you're going to be able to bill your clients, people in your fund, at 100 instead of at 81, which makes your fee almost 25% higher. And so this is sort of an issue that there's no transparency. And I always say that when these financial alchemies come around, it always starts out with good intentions and maybe some very good results and even risk-adjusted returns. But it's like the Old West is the analogy that I've become fond of. The Old West, you've got a town, agrarian town out on the frontier, and there's maybe a thousand people there, and they're all living off the land and they're all god-fearing, and there's not a lot of crime. I mean, there might be a murder of passion now and then, but people don't even lock their door. And you got a sheriff. He's like Gary Cooper in High Noon with a heart of gold, and he doesn't have that much to do because it's a society of trust and morality. And then all of a sudden something happens and a lot of money is perceived to be capable of being made because they discovered gold two miles away from this town. And all of a sudden a lot of people come pouring in trying to make a fast buck. The fast money people, and a lot of them are decent people, but some of them are scoundrels and rapscallions, and they're coming in to make a quick hit and get out. And that is almost inevitable when you get to these financial alchemy periods. So, we've got illiquid securities that used to be sold to what was called perpetual capital and endowments and long-dated pension plans, and slowly, slowly they've started to morph into funds that were offering liquidity. They call it semi-liquidity.

Well, it's just there's a lot of people making a lot of money and that leads to a slippage in standards. But everybody that was there say 10 years ago, they still want to keep playing the game because they've done very, very well with it. But other people can come in and start doing things that should be called out, but nobody wants the party to end. So even the ones that were there during the morality days, they want to defend kind of the reputation of the entire class. But there's things that are just so obvious. I mean, you got these long-dated assets and they're giving quarterly liquidity to a certain limited amount, but the fact they're giving it at all is troubling. And I think that the inner workings of all this don't really get well described. It was sold to the retail market through intermediaries that were paid very hefty commissions. Yeah. And those intermediaries, when you have somebody trying to sell you on a new allocation, they don't start out with the negatives. They start out with the attractive aspect of it. They might say that it's lower volatility, which is a myth. It's lower volatility if you're not marking it to market, just like a CD has fake laundered lower volatility. They had good results. They had much better results than private markets during the 2020 to 2022 period, particularly 2022, where you had the worst public bond market results of all time because interest...

And so the 30-year Treasury bond got marked down over 50% in the year 2022 alone. And it's still at that level. Amazingly, the drawdown on the long bond starting from 2020 is still 50% because the long bond is still over 5%, which is near its highs. It's actually within 10 basis points of the high of this cycle.

Well, what we're living on right now is hope, and hope is a very poor investment strategy. But sometimes when you're in a pickle, you have to go to hope. So when you march your portfolio down from 100 to 81, and I bet you everybody believes the next markdown will be — not up, the next remark won't be up but down. So you're just hoping that this software issue ends up not being as bad as people think, or maybe people change their attitudes about it. You're just trying to buy time. Yeah. It's kind of like Kevin Warsh is just trying to buy time with the Fed. And I don't blame him for this. He's brand new, but he's got these task forces he's setting up, and I think that's intentional. I think he knows that inflation is coming down. We just had a real weak inflation CPI report recently, down 4/10 on the headline for the month. And so we know that inflation is going down on a general basis, although still probably hovering around three and a half percent. But as long as we're getting sequential better looking numbers on some of these inflation indices, Kevin Warsh can hold off. And these task forces — I think I'm not a fan of the — I think the problem with the way many organizations are managed is it's run by committee, just like the FOMC is run by committee. And it used to be that everybody kind of fell in line behind the chairman, but now we're getting all these dissenters, and we're getting close to the point where they might even vote against the chairperson depending on how it's managed. So he's trying to buy time. Inflation is going his way, but now we're going away from one committee that's probably too large to now five more committees that are subsets of that one. So now we're going to have five more committees, and we all know that committees are just a way of slowing down decision.

Yeah, I think that's right. But you what you said, Charles, you just alluded to something that's very important, and that is if you looked at a scatter chart that we create — I think was created by JP Morgan Asset Management, and so I want to give them credit — but they took a scatter chart, they just had on the y-axis ISM manufacturing prices paid, and on the x-axis ISM manufacturing employment. And as you would expect, when you have low ISM prices paid and low ISM employment, you'd be at the lower left of that scatter chart. You would think the Fed would be easing almost all the time when you're down there because you have no inflation and you have very weak employment. And vice versa, when you're up at the upper right of that chart, you would have high prices and high employment, and you would think the Fed would tighten. And I took their chart, did one thing. I enhanced it with one idea, and this is up on my X feed at Truth Gundlach is the handle, and I showed that chart's on there. And what's fascinating is that during Volcker was the only time period during the 80s — '82 twice and '85 — where you actually had the Fed hiking with the lower left, so low inflation and low employment. They were hiking because Volcker wanted to get rid of the inflation. And the only examples in the upper right of that exhibit are Arthur Burns, who was basically browbeaten into over-easing. And the fascinating thing is there's only one dot in the upper right where there was actually an ease and not a tightening, and that was Volcker, believe it or not. So Volcker really was his own person. But interestingly, where we sit right now on that scatter chart as of the most current data prints, we're in that upper right. They should be hiking based upon this data and not even thinking about easing. But you're right, all things are not equal anymore. There's a new sheriff in town at the Fed. And I like the fact that he's doing new ideas. I've been saying for years, and I can prove it, the Fed has been following the two-year ever since we had Bernanke. It's just a following of the two-year. There is no need to even listen to the Fed. But now Warsh, I think, is not going to follow the two-year. And what I like about that is that's what Volcker did. That's how he got rid of inflation. Volcker, when the two-year Treasury was at 15% in the late '70s, early '80s, he hiked rates to 20% when the two-year was at 15. And with the two-year still at 15, he dropped rates down to like 14 and a half. So, he was absolutely leading the two-year and not following it. And I like that. I like the idea that we have someone that's just not an automatic pilot. I think that's Kevin Warsh. And I'm optimistic that he's going to be a better Fed chair than Jerome Powell.

Well, I certainly don't think that that should be allowed. I remember my uncle made the Xerox copier commercially viable. He basically invented the commercial photocopier. And he spent the last 20 years of his career fighting the Japanese that were stealing all of Xerox's photocopy technology. They would basically — he'd have to go to Tokyo and sit in a trial, and what they were doing was taking every exact thing exactly the same and turning one part from metal to plastic. That's it. And so he was miserable about that. And I think that's what the Chinese are doing. And it's not surprising because the Chinese have so many students in our university system that get trained in some of these technologies, and they go back and they share that information, of course, with the Chinese companies. I think that clearly this is something that needs to be addressed.

Well, it's a really interesting situation. Stocks are all over the place, particularly single name stocks which are really in a crazy volatility period, while the VIX is only at 17. Meanwhile, bonds are stable as a rock right now. My best indicator, and this is hard to believe, the 10-year Treasury should be — and this has an R-squared going back 40 years of 0.93. It's an incredibly good indicator, the 7-year moving average of nominal GDP and the German ten-year. I don't have time to go into why that works, but right now that says that the 10-year Treasury in the United States should be at 4.62, and right now it's at 4.63, and there hasn't been any volatility in this now for about two years. So I think in bonds you're just trying to avoid credit blowups at this point and earn something like the five-year Treasury yield plus a spread, so you can get maybe around a 6% bond portfolio. But I want nothing that's triple C, nothing that's weak single B. I want things that have real honest-to-goodness credit fundamentals. So this will be interesting. I think the stock market's probably started a rise period. Now, I think as we go into earnings, I think we're going to get some good stuff out of some of these companies, and that's what I think started the rallies. People don't want to be short going into what's perceived to be a good earning season.