Gundlach: "What Will We Be Talking About This Time Next Year"
From ZeroHedge:
Over the weekend, Barron's published its annual roundtable in
which prominent investors previewed what they expect out of 2017: "a
year of seismic shifts for the markets and, quite possibly, the world.
Or, as Goldman Sachs strategist Abby Joseph Cohen said at this year’s
Barron’s Roundtable, “We are breaking a lot of trends.” As Barron's dubbed it,
"this could be the year the movie runs backward: Inflation awakens.
Bond yields reboot. Stocks stumble. Active management rules. And we
haven’t even touched on the coming regime change in Washington, which
will usher tax cutters and regulatory reformers back to power after an
eight-year absence."
While there were many insightful observations by the group
of participants - whose sentiment was decidedly more bearish than during
last year's event - which included Scott Black, Felix Zulauf, Mario
Gabelli, Meryl Witmer, Brian Rogers, Oscar Schafer, and Abby Cohen, we
will focus on the predictions of Jeffrey Gundlach, if only due to his
track record from the similar Barron's roundtable one year earlier, in
which he turned out to be far more prescient than most of his peers, not
least of all because he "made the greatest prediction at last year’s Roundtable—that Trump would win the presidency."
The first question posed to Gundlach was also the broadest one: what are you predicting now?
People have forgotten the mood regarding stocks and bonds in the middle of 2016. Investors
embraced the idea that zero interest rates and negative rates would be
with us for a very long time. People said on TV that you should buy
stocks for income and bonds for capital gains. This is when 10-year
Treasuries were yielding 1.32%. Someone actually said rates would never
rise again. When you hear “never” in this business, that usually means
what could “never” happen is about to happen. I told our
asset-allocation team in early July that this was the worst setup I’d
seen in my entire career for U.S. bonds. It occurred to me that the
bond-market rally was probably very near an end, and fiscal stimulus
would soon become the order of the day.
Based on a comparison in July of nominal Treasuries to Treasury
Inflation-Protected Securities, or TIPS, the bond market was predicting
an inflation rate of 1.5%, plus or minus, for the next 30 years. Now, that is implausible, and kind of proves the efficient-market hypothesis is wrong.
More likely, the inflation rate would increase not in five or 10 years,
but one year, because commodity prices had already bottomed. The
Federal Reserve Bank of Atlanta’s wage-growth tracker is now up 4%, year
over year. Oil prices have doubled since January 2016, to around $52 a
barrel, which likely means that headline CPI [the consumer-price index] will be pushing 3% in April.
I expect the history books will say that interest rates bottomed in
July 2012, and double-bottomed in July 2016. At some point, the backup
in rates will create competition for stocks. Bonds could rally in the
short term, but once the yield on the 10-year Treasury tops 3%,
which could happen this year, the valuation argument for equities
becomes problematic. When the long bond [the 30-year Treasury]
was at 2%, bonds had a P/E of 50. Compared with that, a P/E of 20 on
stocks didn’t look all that bad. But if the 10-year yield hits 3%, you
could be talking about 4% on the 30-year, which implies a P/E of 25.
Something else happened in 2016: The Fed capitulated,
as I predicted a year ago. The Fed gave up on its forecast for higher
interest rates and lowered its dot projections for 2017, just when it
might have been right. [The Fed’s so-called dot plot shows the
interest-rate projections of the individual members of its
policy-setting committee.] In December, the Fed had to reverse itself
and raise rates.
Is an inflationary spike possible?
Fed Chair Janet Yellen suggested a few months ago that running a
“hot” economy might not be such a bad idea. But when unemployment is
low, wages are rising, and significant fiscal stimulus is likely,
inflation could exceed consensus expectations. Jim Grant, the founder of
Grant’s Interest Rate Observer, wrote a fantastic article a few years
ago likening the current environment to the 1940s and ’50s. Short-term
interest rates were at 3/8s in the late 1940s, and long rates were
around 2%-2.5%. Inflation was running at 2%. Everyone had been
predicting higher inflation rates, but after a long period of 2%, they
gave up. Then inflation spiked to 8%. It came out of the blue.
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