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«It feels like an echo of the late nineties»

Jeffrey Gundlach, CEO of the U.S. investment management firm DoubleLine, is concerned about the growing amount of speculation in equities and draws parallels between today’s markets and the dot-com boom.

Christoph Gisiger, New York

Optimism towards equities is in high season. After a strong year-end rally the stock market started 2014 at first a little bit shaky. Nevertheless, the S&P 500 marched to a fresh all-time high this week. Jeffrey Gundlach doesn’t share the wide spread confidence in equities. «In the over thirty years I’ve been in the financial investment industry, I don’t recall a single year where I saw the year begin with the consensus being so solidified in its thinking across virtually every asset class», says the charismatic CEO of the U.S. investment management firm DoubleLine. He’s concerned about the growing amount of speculation and draws a parallel between today’s markets and the dot-com boom of the late Nineties.

Mr. Gundlach, on Wall Street you’re well known as an influential bond investor. But you are also a connoisseur of art. What does it say about the mentality of today’s financial markets when a painting like Francis Bacon’s Triptych sells at a record auction price for more than $140 M.?
The art market is an interesting way to look at what’s happening to societal trends. On the headlines the art markets looks like it is incredibly strong. Pieces like the Triptych or the Scream of Edvard Munch are trading for huge prices. But when you move down and look at things that aren’t so iconic, the art market’s weak.

How come?
What’s really happening in the art market reflects this: The very expensive things in the world have had incredibly high price gains. Look at real estate in London, real estate in Hong Kong or penthouses in New York City. They’re up massively in value in the last few years. And then as you move down, things are much less robust in terms of price gains. So for a lot of the art that I own, my Californian paintings for example, prices are down substantially in the last ten years. They fell in 2008 and 2009 and have never recovered. It’s like an L-shape: It went down and it sits there. It’s a price point that doesn’t attract billionaires. It’s a price that attracts people who have a little bit of extra money. And those people are being squeezed tremendously by zero percent interest rates. They worry about their retirement. Rather than spend like $ 200’000 on some painting, they want to keep their money.

So what does that say about social trends?
It shows that in the middle things are nowhere near as strong. The stratification of wealth is getting more and more extreme. And then you can ask who owns the equity market? People who have a lot of money. The average middle class person owns very, very little. It doesn’t really matter if they put in a little money into the equity market and it goes up. They just don’t have enough in it.

What’s next for stocks now?
There is tremendous optimism and great belief in the equity markets. I think the stock market today is very similar to where the gold and silver markets were in March to May of 2011. They just kept going up. I remember going to meetings where people were like «Ah … I think we should buy gold and silver». At that time Silver was at about $42 and it went to $50 but then dropped to $20. That’s how I think of the market today.

What’s your advice for investors?
I’m not interested in buying equity markets now, particularly not the ones who have done the best like the US. I feel like putting new money to work in equities today is like buying silver at $42 in the spring of 2011. It may go higher. But just like silver at $42: You’re seeing a great amount of capitulation. It does feel like an echo of the late nineties in terms of market behavior. People are saying: «I can’t see any justification for the market not going higher, everything points to the market going higher». Well, I remember a similar mood in early 2000. At that time, an equity manager working for me said: «This is a stock market Nirvana. I have never seen better conditions for the stock market». So I said: «That probably means that things can’t get any better». It reminds me of a triple-A rated bond: There’s only one way for it to go: get downgraded.

What could cause such a downgrading?
What troubles me the most psychologically in the markets right now is this logic that as long as there is Quantitative Easing, stocks will go up. And if the Federal Reserve drops Quantitative Easing, stocks will go up, too, because it means the economy is strong. It makes me wonder. Fascinatingly, commodities and particularly gold peaked right about when the Fed started QE3. It’s just fascinating that commodities have been doing nothing but going down ever since the third QE-program started.

How do you explain this?
That is not a coincidence. I am convinced that there’s cause and effect. The explanation is that gold was popular when there was no confidence in stocks and there was no confidence in real estate. So gold was kind of the only game in town. Big money interests and finally, late in the game, small money interests went into gold. And then real estate bottomed right at the peak of gold. Suddenly confidence in the real estate market started to return. So money shifted from gold into real estate. I’ve seen that in my own clientele.

Isn’t it encouraging that housing is doing better now? What makes you so cautious?
What irritates me is margin debt, the money that people borrow to buy more stocks. Not surprisingly, it is extraordinary highly correlated to the stock market because it’s actually one of the main drivers of the market. It’s at an all-time high in terms of absolute level and it’s at a very high level versus GDP. That is something to be concerned about. But what really matters is when it turns down, because it goes up in a very persistent trend and when it drops that’s when you have forced liquidation because of margin calls. There is no indication of that now because margin debt is still moving higher. But people who are saying there is no speculation in the participation in the equity market have to explain how they can make that statement.

How concerned are you about new bubbles in the financial markets?
When you look at history there is quite a high correlation between bubble talk and the top of the market. Today a lot of people say that maybe there is a bubble. But more commonly, the talk is about why it’s not a bubble. So they use the word bubble and say: «But these are the reasons that there isn’t a bubble». I just read something this morning about someone who monitors how many times the words equities and bubble are referenced in the media. And it’s like the late nineties again. So the optimism is there, the margin debt is there, the bubble talk is there.

Are these all sings for the first negative consequences of the super easy monetary policy? Even the Federal Reserve is now starting to discuss the risk of financial bubbles, as the minutes of the last FOMC meeting are showing.
Fear and greed – these are very powerful things. But the most powerful of all is need. Need to get a return. When you need it you have to take a risk. It’s like when your rent is a $1000 and you earn $500: You’re going to get evicted. So you go to Vegas and you bet on black. If you lose you’re going to get evicted which would have happened anyway. But if you win you don’t get evicted. So based on need people do things.

At least, long term interest rates are already a little bit higher than half a year ago. What’s your outlook for the bond market?
Most people, all they do is to extrapolate what has happened. So they say bonds will move to higher yields and stocks will go up. Last summer the reason interest rates went up a lot was money flows. There was forced liquidations in leveraged investments. I think that has largely played out. So I am not that afraid of the Fed scaling down its bond purchases. The markets have become a lot calmer since the initial period of fear in summer. Also (ALSN 198.20 +2.06%), I am not so sure that tapering bond purchases is really going to be that bad for the bond market. It was one thing when the yield of the 10-year Treasury note was down at one and a half percent like in the summer. But inflation has dropped and yields are up by around one and a quarter percent point now. So the market seems to be taking it more in stride and certainly the equity market doesn’t seem to be very worried about things.

So what are interest rates going to do in 2014?
While many people think Quantitative Easing is an inflationary policy, I don’t see that at all. What I see is that the Fed has created a huge shortage of high quality investments. They are all sitting on central bank balance sheets now. And maybe there will be some sort of an event that causes demand for treasury bonds. A lot of people think that doesn’t matter because who wants them anyway with these low yields? But what if you have a need to buy them, because you’re short and money is leaving? So you must cover your short. So we could actually see one of the most unthinkable things happen this year and that is a basic pain trade that forces people into treasury bonds. And that’s why in my diversified bond fund I still own 20% treasuries.

What would be a harbinger for the market’s mood turning around?
The thing that I am most fascinated with – and I have done nothing with it – is Amazon. I just can’t get over how little money they make and yet how valuable the company is. The stock price never goes down. It just goes up and up and up and they never make any money. Investors are so patient with Amazon because they think it’s all going to happen. They’re constantly investing in a company that makes no money and hope that one day it will pay off. That’s their bet. I’m surprised that is has been sixteen plus years and they’re still willing to wait. As long as Amazon keeps going up, market confidence and belief in the future is in high season. If it starts going down, it means the patience has run out. And that probably means the patience has run out for the market in general.

Also, there’s a lot of optimism about Europe. What’s your take on the situation over there?
It’s really amazing how, over the last two years, the concern about the Euro and the European Union has disappeared. All ECB president Mario Draghi had to say was: «We will do whatever it takes». My impression is that the policies that have been in place for the last couple of years are very popular among the elitists but not very popular among the average person. So I think at the upcoming elections in May it’s possible that elitists get undermined and something from a popular standpoint could kind of float up to the surface. This risk could potentially cause some sort of volatility. The European markets have been incredibly strong last summer and relatively weak recently. It just seems to me that the demographic problem in Europe is huge. You look for fear or concern but there isn’t any. It’s surprising to me how there appears to be no concern in the global investment community about the situation, particularly in France with the French banks. I don’t own any European stocks and I particularly dislike European bonds because they are really expensive versus US bonds.

How are you positioned personally against this background?
I can divide my personal wealth into three categories: Financial assets, real assets and my ownership in DoubleLine. Looking at the first two: I have about 60% of those assets in real assets like real estate, gemstones, artwork etc. So that leaves 40% that is in financial assets. Of that 40% I now have 30% in cash which leaves 70% that’s actually in assets. Of that I have 50% in DoubleLine products.

This takes us back to the art market. Where do you spot opportunities here?
I actually was participating at the most recent auction season in New York with the Triptych and all that. And it was the first season in ten years that I had bid on nothing and completely avoided it. Prices may go up a little bit further but I am not interested in being the incremental buyer at the price levels of a lot of assets today. It will probably go higher in the short therm. But who knows what the top is? The high end art market in particular is being driven by the great wealth creation in China, Russia and South America. It’s a totally different culture. These people can’t get rid of their money fast enough, they just don’t trust it. So they want to buy something that they think is real. That’s why there is huge demand for very high value: real estate, art or diamonds. Two years ago, I liked the art market, I liked the real estate market and I liked the gemstone market. I don’t dislike them now. But they have been going up a lot. Someone else can take the ride from here.