Sense on Cents

Jeff Gundlach did not become one of the most highly regarded and respected money managers in the business by accident. His long term track record managing TCW’s Total Return Bond Fund (TGLMX) is nothing short of spectacular. Gundlach presented at a conference yesterday. Inside sources shared with me that he received a standing ovation for his thorough yet sobering commentary. MarketWatch provides a review of this Sense on Cents Economic All-Star’s outlook in which he is calling for a serious bout of deflation and a resulting rally in the dollar.

Alistair Barr of MarketWatch writes:

The stock market’s recent rally is likely to run out of steam soon and equity prices may collapse again, Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund giant TCW Group Inc., said Wednesday.

The benchmark Standard & Poor’s 500 index is “extremely unlikely” to climb above 1,100, before collapsing again, he said during a conference call.

“You’ve made 90% of the money you’re gonna make in this rally,” Gundlach said, advising investors to sell on strength when the S&P 500 is above 1,000.

The S&P 500 closed at 1,033 Wednesday, leaving it up more than 50% since early March.

Gundlach, who also runs TCW’s flagship Total Return Bond Fund (TGLMX 9.98, -0.01, -0.10%), had spotted cracks that subprime mortgages were forming in the financial system by June 2007 and was among the first to warn that an era of easy money would come to a bad end. See full story on Gundlach’s warning.

His new concern is the massive debt being accumulated by the U.S. government as it tries to stimulate an economy that’s been mired in the worst recession since the World War II.

“We’re basically borrowing money and calling it economic growth,” he said on Wednesday. “It’s not real economic activity.”

Debt-fueled government stimulus, such as the “cash for clunkers” program, may keep the U.S. economy growing for one or two years, but then growth will probably “just die,” Gundlach said.

Cash for clunkers, in which the government gave up to $4,500 to new car buyers if they handed in old gas-guzzling vehicles, illustrates another of Gundlach’s concerns, that of deflation.

“Deflation is so strong that you can’t even sell cars unless you slash prices 20% through government subsidies,” he said.

Gundlach is similarly bearish on credit markets and commodity prices, arguing that “a turning point is close at hand in these markets.”

One of the few areas he’s bullish on is the U.S. dollar — but not for good reasons.

Gundlach sees such large debt defaults in coming years that he thinks the trend will cut the supply of dollars, pushing up the currency’s value.

“We’re standing on the edge of a major default wave,” he said. “Defaults are the elimination of dollars. You could eliminate so much actual wealth that this could be the source of a strong dollar rally.”

I wholeheartedly agree with his economic assessment and said as much yesterday in responding to a reader’s comment here at Sense on Cents. I wrote:

How do you fill the gap left by consumers who borrowed too much? Have Uncle Sam step in and borrow too much. One way or the other it’s all borrowed funds which will have to be paid back at some point in the future…

People can call it growth, the appropriate term is leverage. As I wrote above , leverage should not be confused with brains when the market is rising, but it is death when the bull becomes a bear.

In regard to the markets, I view them more as a sideshow while the real action is the race between the Fed and Treasury pumping liquidity into the system to stem the ongoing and increasing wave of defaults. Mr. Gundlach clearly believes this wave will ultimately overwhelm Uncle Sam and our economy.

I respect Mr. Gundlach too much not to give his concerns serious consideration. In fact, I believe the rally in U.S. government bonds over the last few months is sending a warning signal of deflation on the horizon. Recent downward price action in the DJ-UBS Commodity Index may also be an early warning sign. Price action in the equity market would appear to be inconsistent with these markets, but it has been for a while.

For those interested in reviewing Mr. Gundlach’s entire 47-page slideshow, please click on the image below:

Thoughts and comments always welcome.

LD

This entry was posted on Thursday, September 10th, 2009 at 8:39 AM and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.