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I want to start there give considering the fact that you've talked about how the US is going to go bankrupt and how it's on our unsustainable fiscal path, are we seeing that priced in or is there still a reconing to come.
Well, it's certainly behaving differently than it was for the last four decades.
I mean, what we've seen is.
In the last of fifteen years, there's been a number of corrections on the s and P five hundred, and in every single one of them, when the SMP goes down more than ten percent, the dollar indexed the trade weighted dollar index goes up. This time, the dollar went down when the SMP five hundred went down almost twenty percent.
That's strange. Things are behaving differently.
Usually, when the Fed starts cutting interest rates, rates.
Across the yel curve go down.
The ten year t y almost always goes up immediately following the first Fed rate cut, and then it keeps rallying for a while. This time, the tenure yield went up, and the yield curve is steepening. So I think what we have is recognition that the interest expense for the United States is untenable if we continue running a two point one trillion dollar budget deficit and we continue to
have sticky interest rates. One thing that people fail to appreciate is how much the average treasury payment has gone up. The average yield, the average coupon on treasuries was below two percent. The entire treasury market, all thirty odd billion of it, you a resolved together.
Some of them are old.
You know, they were issued with higher interest rates, but it was below two percent. Now it's pushing four percent. And as long as bonds are maturing, and there's trillions and trillions of dollars of the maturing, a lot of them were issued back in you know, two thousand and nine, eighties, other time periods. Even if you just issued them in twenty nineteen. Some of these are starting to come doe.
And they were issued with coupons of a quarter of a percent, and now it's four and a quarter of percent, so it's four hundred basis points higher. So this problem continues to build, and there's an awareness now that the long term treasury bond is not a legitimate flight to quality asset. It's not responding to lower interest rates. It's not really responding to an inflation rate which is now
two and a half percent. Probably going to go higher on the inflation rate because the ones that are rolling off from a year ago, I mean the cumulative I think headline CPI that came out today it was a point one to eight, but the one that was rolling off I think was zero point one. And if you do the next two months, those three months together that quarter, the cumulative rise from a year ago is point one. So we're likely seeing the low point in near term inflation.
So yeah, I think there's the reckoning is coming, is that we have to somehow figure out how we're going to deal with thirty seven trillion dollars. I mean, we're actually going to hit the thirty seven trillion number for real. It's still thirty six point nine to five trillion, but it's going up quickly.
So yeah, there's going.
To have to be some pretty creative thinking, and the market's starting to believe that. So the private previous group talked about the capital flows, and one of the reasons that the US is underperforming at this point is so much money came into the United States since say twenty fifteen or so or twenty oh five, and it's there was a net investment position. Foreigners were investing more in the US than the US was investing outside the country. To the tune of three trillion dollars. That was about
fifteen seventeen years ago. It's now over twenty five trillion dollars is the net investment position, and the dollar is falling. So it's not inconceivable that some of that twenty five trillion dollars that came in over just a couple of not even.
Two decades could go out.
And so this is a moment where finally you had the setup where non US investment, even if you're a dollar based investor, you should be thinking about increasing your allocations to non dollar investments.
And it's already working. It's already working. So there's so much to unpack there.
I want to talk about the idea that there could be this twenty five trillion or some of it that was wait, exactly whatever it is, three trillion. You get trillions of dollars moving out of US assets. How high or what kind of behavior do you have to see in a thirty year bond.
To like it? Again?
Given the fact, even very vocal.
I've I've been fit sure about this for a long time, and I've come to the idea that as the FED eases and when the economy really does weaken more than the treasure will continue to go up at the long end. And so for now we're very uninvolved in the long term treasury bond. But there will come a moment where you have to pivot because there's going to be a response, and I've got many ideas of what that response might be, but one of the leading candidates would be quantitative easy.
So you get to a point where the rate is so uncomfortably high, what is that number, I'm going to guess six percent, where they say this is going to be something that we're going to be running a five trillion dollar budget deficit with all this bond issuance when we go into a recession, and so they'll pivot. I
believe this is a sensible idea. There's other ideas too, but the leading candidate is they will announce quantitative easing on buying long term treasuries, and when they do, you have to you have to very quickly, and hopefully you do it the day before they announced it. But we don't have access to the day before stuff. That's that's
for the primary broker dealers. But you would need to buy long term treasuries as much as you possibly could, because when that gets denounced, it will be just like when they announced buying corporate bonds in COVID, where all of a sudden the corporate bond market went from down twenty points to right back to where it started in just a matter of a few days.
You could get a.
Twenty point rally on the long bond if they announced that they're buying long band could that would be one hundred basis point drop.
You said that if the Fed were to cut rates that might cause a selloff in thirty year treasuries.
It's already happening.
They started cutting rates September of twenty twenty three, and the long bond has gone up in yield significantly since then one hundred basis point Do.
You think that will happen again?
Well? Why not?
I mean, it's a paradigm shift. We have a tremendous paradigm shift that's going on where money is not coming into the United States, where the long line is not a flight to quality asset. Gold suddenly is the flight to quality asset. People I think Costco is selling gold retail and they can't keep it in stock, you know. And gold has gone from it was living at eighteen hundred dollars an ounce not very long ago, and once it broke above two thousand, it was just straight up.
And now it was basically a.
Third of ten thousand, thousand, three hundred thirty three and thirty three cents.
It was actually what I looked at yesterday.
So it's I think gold is a real asset class. It's no longer for lunatic survivalists and wild speculators. It's viewed as an asset class. And central banks have been accumulating gold. Gold was so was stuck in the mud because for a decade or more central banks were selling it down.
They've bought it all back, so you buy gold.
I've owned gold since it was three hundred dollars, and I also owned some gold miners personally.
But they bought it all back. It's amazing.
They sold it at like three hundred, four hundred dollars and they're buying it back at three thousand dollars. See, central banks are not very good long term investors.
Well maybe they could use advice from you. One thing that we've been hearing about in a number of the panels this morning has been about the corporate debt market. And one thing that I've gathered from talking with people at Double Line and reading your outlooks is that you've reduced your allocation to below.
Investment grade credit systematically over a two year period.
To the lowest level I believe since the inception of Double Line.
That's right.
We have higher quality portfolios today relative to strategy style at any time we run closed down funds that are leveraged. We have the lowest leverage of all time.
We had.
We had forty five percent leverage us versus net assets, and one of our funds were at seven and we're just we're there because we want to be a liquidity provider. When you get paid to be a liquidity provider and you're not. Now, the spreads are very uninteresting in the in the credit market, just as the valuation of the S and P five hundred is incredibly uninteresting.
You know, when we had the big sell off in April.
If we were like, yeah, we were kind of asleep at the switch.
The market was really overvalued.
We really shouldn't have We really should have been thinking more cautiously. Well, it's more overvalue today because the S and P five hundred is down one or two percent and earnings estimates have been cut significantly.
So if you look at the.
Forward pe, it's higher now than it was at the all time high back in February or early March.
So what are you sort of anticipating?
What kind of anticipat a great buying opportunity? I don't know when it's going to happen, but it's getting close. I feel that the environment feels a lot like nineteen ninety nine relative to AI. Is just mapover dot com for AI. I also think it feels a lot like two thousand and six, two thousand and seven. You know, it's funny. One of the hardest things to do in the investment business is to learn and fully appreciate how
long everything takes to happen. It takes forever for the problems to actually show up, it takes forever to the defaults to finally arrive. But people anticipate changes with great enthusiasm, so AI, of course, was embraced with great enthusiasm. Electricity was all the rage back in nineteen hundred because people realized that electricity could change the world, and I think we can all agree electricity change the world in ways they're bigger than AI will change the world.
In my opinion, electricity is like amazing. But there was a huge boom in.
Electricity stocks in the first decade of the twentieth century. But electricity stocks boomed so much that their relative performance peaked versus the stock market excluding electricity stocks in nineteen eleven. If you own electricity stocks, you've been underperforming the non electricity stocks since nineteen eleven. That's a long time, and that's what happens. That happened with the dot coms too.
That was the nineteen ninety nine thing. Sure, it turned out that some of those stocks were great investments, but that enthusiasm becomes very excessive. They see the possibilities, but it takes long time for the possibilities to arrive.
It's taking a long time for the tariffs to arrive.
So do you think that the tech stocks that have been not performing are going to lag behind in terms of the ninety nine performance? Sort of the corollary of all of the credit investments tied to the AI build out also.
Momentum trade and momentum trades always overshoot on the upside, and then once the momentum is broken, the late comers to decide that their first loss is their best loss.
And it turns into a seller's market.
You talk about two thousand and six, two thousand and seven, that's a credit event. And when we took that poll that my colleague Danny was pointing to, private credit seemed to be the spot where people expect a faults to really pick up.
Yeah, do you agree?
Do you think that that's sort of the epicenter some risk?
Sure, it's private credit is analogous to private credit today, is analogous to the CDO market in the mid part of the OS, where there's just tremendous issuance, there's a tremendous acceptance.
There's all kinds of I was listening.
Briefly to kind of private creditors panel here and there's a lot of there's a lot of phraseology that I heard that reminded me of CDO panels in two thousand and six, two thousand and seven. Just complexity, ill liquidity, I don't know, very large, you know, tensions between investor classes, these things. Private credit is extremely heavily invested in, you know, Harvard University.
Who has a fifty three billion dollar endowment.
Supposedly they had to come to the bond market twice because they couldn't have they did enough money. They have fifty three billion dollars and they can't pay They can't pay for repairs, they can't pay for operating expenses. They came to the bond market looking for a couple of two and a half billion dollars. I think they got one and a half billion dollars. And then they came back again. And I think it was last week it was announced that Harvard is thinking about selling some of their.
Private equity interests at a discount.
Obviously, because when you're when you're a forced seller, you're not going to your cost, and so there's a lot of over investment. When I speak to Rias, you know Peel that manage a kind of hire net worth retail money for the past three four years, the UH one of the very first questions, without exception, what about private credit?
And I say, are you heavily invested in private credit? Yes?
And everybody is, and I say, so, you know, what's the argument? And I was giving a speech down in Texas and the woman before me was from a fund that's very heavily involved in private credit, and she basically gave a sales pitch for private credit, and basically a three pointed sales pitch, none of which are the points really sell me. The first is that it's less volatile. It's a sharp ratio argument, so you know, and it's only we all know. It's only because they don't mark
them to market. I mean, everybody knows that. So it's just like private private equity. It's S and P five hundred goes from one hundred to fifty. They mark their private equity down twenty points, and then they both recover over time, they both go up to one hundred.
So look at that.
They have the same return, but one had S ANDP had double the volatility. And then some that argument is not valid. It's they aren't marked to market. So you know, the next argument is somewhat valid. Historical performance. Private credit
had some very good years. It was quite cheap, you know, five or seven years ago, and you use a historical argument that the performance is good, and it's true, but as we all know, as they say in the disclaimers at the commercials, you know, past performance is no guarantee of future results, and public credit I think has outperformed private credit for a few quarters.
At least now, so it's already changing.
So I think that there's a lot of overinvestment in private credit, and the liquidity is not very good, and I just don't think the excess reward is anything close to what it used to be. So I would view that as a place where there would be forced selling. Harvard could turn into a foreseller, and Harvard, you know, they at least used to have the best reputation. Yale had this great reputation for investing in private markets, and that lured in a lot of me too behavior because
they were emulating the results of Yale. But there's once one university is in publicly acknowledging that they have liquidity problems.
I've got news for you.
If you have a cockroach in the kitchen, there's never one cockroach, so there's more.
It's always it becomes systemic.
It doesn't mean everybody's overinvested and overly locked up. But in two thousand and eight, I was raising lots of money for distressed mortgages, you know, the stuff that was defaulting like crazy. It got to such a price that it was just truly unbelievable. I mean, there were securities that were trading that life at one hundred had never really had much volatility, and they were being liquidated at prices of.
Thirty cents on the dollar. And you could use.
Assumptions that were just nobody believed would happen. You could say, seventy percent of these mortgages to fall and we recover thirty cents on the dollar, and it's a twenty four IRR. And I said this to the Stanford University Endowment, the head guy, and I said, I can prove to you that your worst case is going to be a twenty four IRR because I'm going to use you. Tell me what assumptions you think are absurdly punishing, and I'll use them.
And you got twenty four ir at. Let me finish.
And he says, I can't argue with you. You make a very compelling point, but I can't invest with you. And I said why, He said, I have no money. We're all locked up. We're getting called because everything's so cheap. Everyone's calling their money now. You know these are draw funds. Now we're calling your capital. And he said, I can't even make those capitol calls. And I said, come on, I really love Stanford Endowment. What a great name for the client list. Give me ten million dollars.
I don't have ten million dollars. I have no money. These are large endowments and if they if they need money, they have to sell.
You say markets. Everyone knows markets have fear and greed that drive them. And everyone knows that fear is stronger than greed when it really push comes to shove. But the actual strongest driver of investment behavior is need.
Sometimes people need back.
In nineteen ninety three, interest rates were perceived to be low, and I went to one of my university of endowment.
It was the treasurer. It was their operating money, and he.
Said, I just met with the president of the university and he says, I have to make six percent for the operating money. And he said, I told him it's impossible to get six percent without tremendous risk because treasury interest rates are at three And he said, wrong answer. You're going to get six percent. Just find out how you're going to do it. And of course, in nineteen ninety four, interest rates went way up, and everybody that had done that sort of thing like Orange County, California had.
There was a very famous default of Orange County, California.
And you know, so their need is very powerful.
But it's bad enough when you make the determination, you say, I have this goal, the six percent goal, I need to make it.
I'll give it a shot.
But the other side of that is even more powerful when you're forced to sell. It doesn't matter what the price is. You don't have an option. If you have to sell to pay the bills.
What are you going to do.
If you're preparing for that kind of moment, are you sitting mostly in cash a little gold?
No have.
We manage a lot of other people's money, and a lot of it is in.
The fixed income market.
We're just protecting and waiting for much better opportunities.
I think about it. You know, markets take the stairs up.
In the elevator down, which means they go up faster than they go they go down faster than they go up. And so when it really when it really breaks, it's not down a couple of points, even what we saw in April, that's not a real break of the credit market. A real break the credit market is bonds drop thirty points and everyone thinks they're cheap, but they have to sell, so you have an opportunity at some point to buy bonds down. I don't know, let's just say it. Let's
just say it's twenty five points. How your bonds yield about two and a half percent more than treasury bonds. So if it takes ten years for that twenty five point opportunity, you're going to break even.
And it's not going to take ten years. It's not going to take five years. Leave. But the other the panel before me said, I think is true.
I think twenty seven twenty eight are going to be are likely to be a window of tremendous opportunity because I think by then the treasury problem will be even more in focus than it is today, and I think that it'll weigh it'll weigh upon market behavior. We need we need to restructure a lot of things in our system.
We need to restructure.
We need to structure institutions, we need to restructure political parties, we need to restructure our finances. All these things are have been in place. It's the it's the waves of history, you know. Neil Howe calls of the fourth turning. He wrote a book called the fourth turning the mid nineties, predicting the credit crisis around two thousand and six using demography pretty good. And I know him pretty well and we talk about it and we have the same concepts,
and that is that societies start with a pact. They have an economic system that produces things, and then they have so that's the means of production, and then they have the property relations that split up the rewards. And when it starts out, and this would be say right after World War two or after the Civil War, it starts out that everybody kind of buys into how the system works. But there's a fundamental problem with this kind of duality of proper relations and the means of production.
Means of production change in revolutionary ways steam engine, radio, television, telephone, internet, AI, they're just explosions of innovation. But the proper relations they don't change very quickly.
In fact, they're.
Barely evolutionary in the way they change, because over time there's this becomes a wealth inequality.
Which which of course we're in an extreme where the people that benefit from the.
The property relations they don't want them to change because they're winning.
So when you have tremendous.
Concentration of wealth and power, the proper relations become calcified, and meanwhile the means of production are causing all kinds of disruption and to make intensifying the wealth inequality.
And then suddenly the whole thing says, this doesn't work.
We have to get the proper relations to a right place where this isn't a feudal system where there's the lords.
And the serfs.
But that's what we have, and so we need to rejigger all of this stuff. And the treasury debt problem, the interest expense unaffordability is another offshoot of all this. It's all the same thing is that we need institutions that people believe in.
We're almost at a time and I can speak with you for an hour, but I want to finish with the idea that is this United States problem or is this a global problem? Can you hide by going to invest in places like say Europe or Japan?
You can, You can hie to a certain extent. I don't think it could become immune. I think the way to invest in periods like this, I think are to go with long term themes, and a long term theme that I think is one of the most bankable and it might take in thirty years this will be a
great success. And that is you should buy. You should invest in India because India has a similar profile today to where China was thirty five years ago when they had tremendous population, labor force visibility of labor force growth, tremendous problems, a gummed up legal system.
Corruption all over the place. But those are things that can be fixed. And you see what China went from one twelfth.
Of the US GDP to seventy eighty percent of US GDP and they certainly produce more goods in the United States, so in a certain sense they're bigger. Well, India has the same demographic outlook as China did then, and India has a benefit for supply chain being moved around, for manufacturing can come there. They're very technology, they're not they
have a long history of being a significant society. So I don't know how long it's going to take, but that's one that you buy and you just do yourself a favor and don't open the statement because if you do.
When there's trouble, you're going to sell it right because it'll be down thirty percent.
So just just hold it for your for your grandchildren's college fund, and that'll work.
So there are places to hide. But I think gold is.
It's proven to be a source of growth. If you were a bitcoin person, I would recommend instead of being a bitcoin person, you would take the same unit of volatility by buying gold and leveraging it probably twice. See it's interesting that gold has outperformed.
Bitcoin here today even though bitcoin's done very well, and for.
The last twelve months, bitcoin has outperformed gold, but they're both up forty plus percent. Those are the places to be, and then dollar based investors should be investing in foreign currencies.
The S and P five hundred has stopped outperforming.
The MSCI Europe and it's underperforming in a major way on a year to day basis. And that took a while to happen, but things always take longer than people think. But it's happening in real time. And the next one will be selected emerging market equities as as the United States, because the emerging markets will have the same benefit broadly as India does most specifically. But you also win on the currency translation if you're a dollar based investor, so.
We are for the first time in a long time, starting.
To introduce foreign currencies into our funds, even ones that are owned by dollar based investors.
We're not all in.
We want to see the dollar break through a certain trend line and resistance lines and stuff like that, but we're pretty close.
Jeffrey Gunlock of Double Line Capital, thank you so much.
It's a pleasure speaking with you.