Jeffrey Gundlach -- Waiting for the Next Big Trade >> Jeffrey, great to get you back on Real Vision. It's been awhile, I think the last time we spoke was with Grant and it's really good to have you back. >> Yes, it's good to be back. It's been a long time as you say. >> Yes. For the benefit of people, you've had an incredible career and I'd love to hear, if that's okay. Just some of your career, how you started and how you got where you are today. Because a lot of the time you get interviewed for three minutes and it's really good to hear how you think and what you do to get to the conclusions you get to. >> Well, I got into the investment management business by accident. Actually, I didn't know what it was. I didn't really have a career going. I was trying to find myself, that was spent most of 20s, early 20s. I saw a TV show that was called "Lifestyles of the Rich and Famous," which is by this guy named the Robin Leach. I never watched the show. It just happened to go on. I had a TV set, it was black and white. It didn't have a dial on and you needed pliers to turn the station because it was all beat up. I had a wire coat hanger for an antenna. I only got three stations in those days, ABC, NBC, and CBS. Lifestyles of the Rich and Famous came on and they said, we were going to count down the top 10 ping professions. I thought, this will be interesting, since I'm looking for direction in life. Number 1 was investment banker, and they said, you have to be very hardworking and you have to be extremely analytical, but it's actually a very lucrative profession. So I decided then and there that I was going to be an investment banker. But I didn't know what that was. I went to the yellow pages, back when there were phone books. I went to the yellow pages and looked up investment bankers thinking that I would find some local investment banking outfit in Southern California and I would get a job there. But as it turned out, there aren't any listings in the yellow pages for investment bankers. But there were listings for investment management, and so I figured it's got to be the same thing. I ended up sending a couple of dozen resumes with a very aggressive cover letter to the firms that had a bold-faced ad in the yellow pages. I actually got three replies. Most of them didn't bother replying to me. One of them was for a job interview and I ended up going to that interview. They asked me, "You've got a very interesting mathematical background. What do you think you could apply that best to equities or a fixed income?" I said, "I don't know what those things are." The guy almost fell off his chair that I was interviewing with and he said, "Well, equities that's stocks, fixed income that's bonds." I didn't know what bonds were. I said, "Oh, I want to do stocks." It turned out that they need more help in the bond department for a quantitative person than in their equity division. I started in this tiny little bond department. It was really little. It was like four people in the entire bond department. It was really just a necessary evil. In those days, we're talking about the early '80s, there were a lot of what we call "balanced accounts." Pension plans would give their money to a manager and they would do stocks and bonds, and allocate between the two. It was really a stock operation. The bonds were a necessary evil. We just bought treasury bonds mostly, a few corporate bonds, all very, very low risk and mundane stuff. It just turned out that my background was perfect for understanding the kind of bond math stuff. Within a week, I'd say, I knew more than the people that were running the department because they were just placeholders really. I thought I was doomed because it was clear to me that they didn't know what they were doing. But as I learned later in life, that's actually opportunity. That's what opportunity looks like. When you're working for somebody, that's really in over their head, if you can help them out and lend a hand, you actually become very valuable. I started running money. Within six months, I was given the Chrysler pension plan portfolio to run, which is a few $100 million. Because it was a very sensitive account and everyone was afraid to screw it up, and so they ended up giving it to me with six months of experience. As it turned out, I was really good at it. I ended up just doing more and more stuff. I learned a lot about mortgage-backed securities, which were a very rapidly growing area in the late '80s. It turned out that I had a knack for it and started mortgage related investment program. About five years later, I was in charge of the entire fixed income situation, right from junk bonds through treasuries, mortgage-backed securities, and all that stuff. Those were good times because interest rates were relatively high, the markets were really inefficient. I mean, compared to where we are today, it was so inefficient. There are simple securities like Ginnie Mae's that would trade with a one point sort of discrepancy in the market, which is a big deal in bonds. Some would be offering a bond at 99 and you were able to buy it from somebody else at 98. You can just flip it from one broker to another, actually. You couldn't do anything like that today with all of our AI and electronic trading and all that. But that's what happened. I ended up, as luck would have it, I had the best track record for many years in the entire industry. After a while, that attracted a pretty decent client base. But what really set off my career into a retro rocket was calling the credit crisis. I was very vocal in 2006 about the stock market was going to crash and the subprime market. The quote was carried on five continents. I gave it a major conference in June of 2007. When people weren't fully aware of how bad things were about to become, I said, "Subprime is a total unmitigated disaster and it's going to get worse." That got picked up and within weeks really, Countrywide, which was one of the largest originators of mortgages in subprime was bankrupt. Of course, Citigroup essentially needed a government bailout. Bear Stearns went under and we all know, it's all in the history books. But because I was in the mortgage market primarily and completely sidestepped the entire debacle, it left me in a position, when things got really washed out in '08 and into '09, to deploy massive amounts of capital, tens of billions of dollars into the things that had been thought to be safe and then start to trade at $0.40 on the dollar because there was such a huge supply demand imbalance and such ugly fundamentals, I was able to deploy all that. I had this awesome year in 2009 as well, riding the bounced back. At that point, I think people realized that there might be something going on here that's worth investing in. That's when I really started to get a tremendous amount of exposure. Then we started the DoubleLine and we had the best results right out of the box in the industry for a few years and so it was easy for the clientele to just say, this DoubleLine thing is fine to me. That's how it ended up passing. >> Obviously, as you go through your journey, you're going to make mistakes. What was the first mistake that made you realize, okay, there's a lot of things I need to learn still. When you're going way back, talk about some of these mistakes, because that's where all the learning lies, right? Being right, you learn less from actually being wrong. >> Yes. It's funny. The very first big trade I did was actually the most successful trade of my career. I actually sold three-year treasury bonds equal seven percent which was thought to be really low. That was in April of 1986. . I actually sold at the top tick and the market just started tanking after that. Then it started to rally back. The big mistake I made was I ended up being long the market right before it started to drop again. I remember feeling that I was trapped in this trade. I remember thinking that I just knew that the market was going to drop, gap down like every day because it was doing that day after day after day. I was just trapped in this position and I was losing tons of money. I just remember actually I was in a Rock Band at the time. Was actually my first career, I was in rock and roll. I wrote a song that was called Wishing and Hoping and Praying. Because that was exactly what I realized I was doing in that trade. I was just wishing, hoping, and praying that the market would reverse the upside, even though with my bones I knew that wasn't going to happen. I started to realize that the phrase that a guy actually told me when I explained my situation to him, he said, ''Your first loss is your best loss.'' That's really good advice in investing markets. You're in the wrong trade, maybe your premise was wrong, maybe new information came out that caused a reversal. You just get to get out even though you're taking a loss. So the key thing that you learn from something like that, is you just have to act. You can't just be frozen in a position and you have to acknowledge that your first loss is your best loss and to get out. That was a big deal. The second biggest mistake I made was actually something I did not do rather than something that I did do. That was in 2003 or 2002 rather, in the aftermath of Enron and the scandals in the corporate bond market. There was incredibly high degree of flight to quality and the junk bond market was trashed. In all the accounts that would traditionally run corporate bonds, I went to my maximum junk bond position. But for some unknown reason, thinking that in my core strategy where I never took corporate credit risks, for some reason I didn't want to get my hands dirty or something with the corporate bonds and I didn't buy any. Even though I went to a maximum and more diversified accounts where corporate bonds were typical, if not consistent investment. Because of that, I missed the entire massive rally from October of 2002 till October of 2003. The return on treasury bonds was like zero, but the return on junk bonds was 30 percent. I missed the entire thing in the one strategy. So I told myself, I'm never going to be so foolish and narrow-minded again. The next time there's a big washout in credit, I'm going to go into junk bonds, even in this low-risk flagship strategy. What ended up happening though, was that the crashing credit was epicentered in mortgage-backed securities. So I ended up going massively along junky stuff in 2009, early in the year. But it wasn't in corporate bonds, it was in the things that were actually the cheapest, which were mortgages. So it's ironic, I still have never done in that traditional flagship strategy which I've been running now for over 35 years, I've never owned a corporate bond even till this day. When the corporate bond market crashes, wish it would have without the Fed. When the corporate market was crashing in March into April, I was ready to pull the trigger, but the Fed pulled the rug out from under the opportunity with their illegal bond buying activity in the corporate bond market. Which is in direct violation of the Federal Reserve Act of 1913. They're not allowed to do it, but this is just a different situation. So almost anything is possible as we've learned over the past 12-15 years out of the central banking community. >> How did you navigate the really difficult bond market of '94? I mean, that was a brutal pair of the bonds. Right? >> It was a big interest rate rise in a compressed time frame. The biggest problem of 1994 was that it came after a big interest rate decline, that brought short-term rates down about 3 percent which was thought to be absurdly low at that time. Because of the low interest rates, the mortgage market, which was the bulk of my investment activity, was refinancing in a very rapid fashion. In fact, it set records at the time. Those records were broken in 2003, but it was really high refinancing. That created a short-term maturity concept in the mortgage-backed securities market. If half the mortgages refinanced in one year, the securities that are backed by mortgages are definitionally very short-term assets with low durations. The yield curve was very steep in those days. The short rates were three percent, long rates were more at like six or seven percent or something like that. So when the rates started to go up, the refinancing went away. Because obviously the opportunity to refinance wasn't as attractive and suddenly the mortgage-backed securities market went from an interest rate maturity of about two years to one of about 10 years. So not only did you have to endure 300 basis point interest rate rise or about nine-month time period, but you also had the unfortunate experience in the Ginnie Mae type of market of extending and rolling up the yield curve. So the losses were pretty extreme. Then you had a margin call problems, you had Orange County that didn't own mortgage-backed securities. There's an urban legend that that's what they ran into trouble with, but it's not true. It was just Fannie Mae debentures. But they ended up rolling up the yield curve on them too, and they ended up liquidating those assets unfortunately, causing the low of the bond market in 1994. I had the worst year ever in my most aggressive strategy in 1994. I was down 23 percent in 1994. In my more traditional strategies, I was down a small amount. But in my most aggressive strategy, I was down 23 percent. But amazingly, in the first half of 1995, the market reversed pretty strongly. By the middle of 1995, by June 30 of the 1995 the entire 23 percent loss had been erased and I was actually up 53 percent in July of 1995. Because the market was trashed on supply demand problems. We are talking about government guaranteed mortgages. Some of them were trading at prices that anybody that didn't experience 1994, anybody that's only been on the market for 20 years, they probably wouldn't believe how cheap these securities were. I mean, the treasury bond market was yielding something like 7 percent or something. There were securities that yielded to the worst possible case, 16 percent that you could buy on the securities market. But there was just an overwhelming problem of selling, and that prepared me tremendously for the 2007/2008 period. Because it made me realize how much prices can drop when you have a supply-demand imbalance of that magnitude. Valuation makes absolutely zero difference when you're in a true brutal bear market, you just go to prices that you just can't believe. So when the market started to crack in 2007, one of my guys, he's from Latvia. I used to call him a crazy Russian billionaire. He wasn't Russian really, he was Latvianese. He certainly wasn't a billionaire, but he was certainly a little bit crazy. He still works for me, he's now actually the head of my agency's mortgage-backed securities division. But the prices of a lot of these adjustable rate mortgages had never gone below 100. They were perceived to be credit risk-free, triple-A rated. They were floating rate, so they had no interest rate risks to speak of, and they had never traded below 100. I'm talking about the triple-A rated prime mortgage backed securities. I'm not talking about subprime garbage, I'm talking about really good underwriting. They've never traded below 100. Then the margin calls started to come in the late summer of 2007. One of the greatest originators was Thornburg, a mortgage read, they were really good originator and they got caught in a liquidity problem. They got margin called one Friday afternoon. There were hundreds of millions of dollars these prime mortgages that were being margin called away. I decided, well, they were trading below 100 before, they were being talked at $0.97, which was the lowest price anybody had ever seen. I put a throwaway bid of '93 on a $300 million package of these mortgage-backed securities and I got hit. My crazy Russian billionaire guy, he says, ''This is way too cheap. This is the cheapest bond I have ever seen.'' Him saying that, triggered this crack of doom feeling all the way down my spine that reminded me of 1994 in the Ginnie Mae market when the price has got so absurdly low. I said, you're going to write that on the ticket, Vitali. Write it on the ticket, this is the cheapest thing I've ever seen because mark my words, the prices are going to go way way way lower. I said, we're putting a moratorium. We're not buying anymore until the yields. The yield at the time was like eight percent. So it was like at $0.93 on the dollar and with a six and half coupon or whatever, it was an eight percent yield. I said mark my words, these securities are going to go to yields in the teens. But I was wrong. They went to yields of 40 percent actually. But it was that experience from 1994 of how low the Ginnie Mae prices got that made me realize when things really go bad, they go way worse than anybody thinks and you get to this level where they're just completely fire-sale. We managed to navigate the global financial crisis probably better than anybody else in the fixed income business because of the institutional memory and experience. So one of the things that makes a good investors is actually, you talked about mistakes, you learn from mistakes. Absolutely, having an emotional memory and an institutional memory that you don't forget your mistakes is really valuable. My uncle invented the Xerox copy machine, and he is one of the greatest inventors of the 20th century, he's in the Hall of Fame. There's such a thing as the Inventors Hall of Fame. He was interviewed and he said, "A successful inventor is an accident-prone scientist that pays attention." That's the same thing in the investment business. You make mistakes, you're going to make them. There are probably 2,000 mistakes you can make. I've probably made all 2,000 of them twice, but thankfully, I rarely make one a third time. You have to have that memory, and a lot of it is actually emotional memory, what the market feels like, like this year. I was very bearish on the stock market in February, and I have fund that I run, is mostly my own money, and I was very short. I was actually 300 percent short the US stock market, and I covered those shorts on March 23rd. I didn't go along, I wish I had, but I covered the shorts. It was because the market felt total panic. It was that day when Bill Ackman went on TV and he was talking extremely negatively, even though apparently he was buying stocks at the time. But he was talking very doom and gloomy and it became a big topic for that morning. I realize that was the environment where you really have the washout. Again, it's that emotional memory that has served me very, very well and just accepting your mistakes and learning from them. >> I'm going to talk about your personal investing style as a business obviously cause you run a lot of managers and stuff, but your personal investing style, what is that like now? Do you chance? Are you very mathematical prices-based? Are you a feelings guy. How do you construct from an idea through to the execution? Because it's fascinating. People don't get to hear about how you do that. >> Well, I'm a big believer in cycles and charts and retracements and support and resistance and all that type of stuff, and I spend a lot of time analyzing off sides positioning. So sentiment, call buying, which is absurdly high, has been for months now thanks to retail and these slices and all these other retail products. I look a lot at sentiment and where things are. For example, I'm very negative long-term on the US dollar. I've been a dollar bear structurally since January of 2017, where I've been positive on the dollar for about 6, 7 years, then I turned negative in January of 2017. But I'm actually long the dollar now. Even though I don't believe in it at all as a good investment for the next five years, but the position against the dollar got pretty extreme about a month ago. It was a double bottom on the DXY index at about ninety-two down from a 103 in January of 2017. It just seemed to me that there was no momentum on the downside, there was just a lot of negative positioning. So for a trade, we went long the dollar. We haven't made a lot of money on it, we're in the black. >> You don't mind trading against your macro view from time to time when you see a specific opportunity coming. >> That's right. I will not go mega long the dollar, thanks to my macro view, but I am position moderately long the dollar. My macro view on the dollar, that is my highest conviction macro idea, is that the dollar is going down. I know I'm not alone in that view, although I've been of that mind for a while. It has a lot to do with this absurd deficit problem that we have gone into on steroids here in 2020. The correlation between the dollar going down and the twin deficit going up is extraordinarily tight, and the deficit is obviously exploding. Forget about the trade deficit, doesn't matter. It's trivial compared to the budget deficit, and the budget deficit is going to get worse and worse and worse. The dollar seems almost assuredly to be going lower. In fact, another thing that causes the dollar to go low is the Fed has really pivoted a lot over the past couple of years. You don't have anything resembling a strong dollar policy thanks to interest rates. I think the Fed has been quite clear that they want inflation to run significantly higher than two percent at least for a while, and they have no problem with that concept. In fact, they embrace it, and that's another reason to be bearish on the dollar. It hasn't been a money-making trade in any significant way, but I think that's the big trade for the years ahead. >> Do you mainly now run the whole portfolio as a pure macro view, because obviously, originally, you were mortgage-backed securities, you were much more in the weeds, you knew inside now every part. You now seem more macro in your view. You're multi-asset now, is that right? >> Yeah. I've really changed my role in investing very substantially over the past 15 years, most bet in the last 10 years. When we started DoubleLine 11 years ago, I was doing a lot of trading, a lot of micro stuff, a lot security selection, a lot of arguing about a quarter-point on trade and all that stuff. As the firm grew very rapidly, my time was not well spent doing those things because I've had a team working for me that I've trained for many years. Many of my people that work for me have worked for me for 20 years, and they will come to the same conclusion on the micro stuff because I trained them and we've worked together very closely for a long time. Let them argue about the quarter of a point and let them decide whether you want [inaudible] or corporate bond A or corporate bond B. But I'm trying to do is really get us in the tailwinds of the macro stuff. I've gotten a big team built around that. We have a very extensive meeting. We just had it this morning, lasts a couple of hours going through 250 pages of charts. It's very disciplined, but we evolve it of course as the world changes. But we go through and we basically rank every asset class in the world with a fair amount of granularity actually, and we decide that this is our positioning for really we're thinking about an 18-month to serve a time window as the big centerpiece of what we're doing. But then we'll adjust it for a multi-week counter trade or whatever. Not in a major way, but just try to add a little bit more value. I spent a great deal of time on trying to understand the macro stuff and how it's changing. I enjoy it and I've developed a style, I think has been quite value-added. I enjoy it and I'm good at it. Everybody falls in behind because, it's funny, a lot of people it takes them a while working on the team to understand that we pretty much get the macro stuff right about seventy percent of the time, which is a very high batting average. If you can get it right 53 percent of the time, you're going to be successful. But most people get it right about forty-eight percent of the time, and that's the problem. But for some reason, I seem to have a good vision on that stuff and get it right about seventy percent of time, which means I'm wrong 30 percent of the time. When you've been in the business 35 years plus 30 percent of the time, I've been wrong for a decade. So if anybody wants to hate on me, that's fine. I hope you've got a long, long time period if you want a list of things that I've gotten wrong. >> So Jeffrey, the other interesting thing about that is I have a feeling that one of the reasons why the 70 percent number, which is high as you say, is because your time horizon is different to most participants. So most hedge funds are monthly marked market. But you're trading with longer-term views, you can accept different types of drawdowns in individual positions. You can pursue portfolio differently. So the time arbitrage because macro, as you know, we get one bloody piece of economic data a month, that mean nothing changes for six months. It does take time to play out. Do you think that's one of the secrets? >> Absolutely. In fact, one of the very first things that I did in the investment business I was working when I started in the bond department, there was a guy who needed some quote support and he gave me a task of just doing a historical study on what time horizon of investment would be most optimal. We started out with a study that we assumed that you had perfect foresight with a five-year horizon. So we just used historical data on every asset class and said, "Let's just say that on day one, you have perfect foresight and you invest in the asset class that ends up being the number one return for the next five years." You can do that because you just using historical data, so you're just analyzing return series and what we concluded is that even if you had perfect foresight with a five-year horizon, you would probably go out of business. Because so many of the actual data series displayed the characteristic that even though you knew with metaphysical certitude that you were in the right sector for the full five years, so often, it was bad for the first two and the return was very often back loaded in those five-year periods. We came to the conclusion that your clients would fire you if you were that bad for two years and refused to think. >> Just when your pay now was about to take off, you've got fired. >> Right. It's just like that value investor. Was it Julian Robertson to closed down and in 2000, a value manager right before value really did well. So we came to conclusion that five years is too long. It might be fine for your personal money because you don't have anybody badgering you about it. But when you have clients that want quarterly and monthly reporting, they're going to complain as they always do even if you have a bad quarter, let alone two years in a row. So I came to conclusion that five years was too long but I also perceived that what most people say they do, which they're lying actually, they say that they're analyzing markets continuously all the time, which of course is a lie. When they're asleep, they're not doing it, when they're eating lunch, they're not doing it. But most people, they do have a weekly meeting and some people make changes pretty frequently, talk about hedge funds have a short horizon. I just think that the longer your horizon is, the higher the probability of your success. If I wanted to invest for my great great great grandchildren, I'm positive that certain real estate investments and certain resource investments would be obvious winners. But who cares about your great great great grandchildren? So you'll have to balance the higher probability of a long horizon with the tolerance of your investors, your impatience of your investors. I came to the conclusion that 18 months was the best horizon. It's long enough that you bring your probability. In my case, that's about 70 percent. But it's short enough that you don't have the five-year problem. I've succeeded in this business by having about an 18 month horizon. Sometimes it ends up being two years and sometimes ends up happening in a year. But I found that to be the real sweet spot and it's served me very well. >> I was running a macro hedge fund, for Jail G back in London back in the day, and I eventually left the business for the reason that I just thought the time horizons were mismatched. Since then, I've written research service glow micron investor, of which I've gone at exactly the same time horizon and haven't quite hit 70 percent, but not far off from exactly the same structures. Nobody's doing it. The time arbitrage, it's good. If I went to short short-term trading, I'm just not that good. >> I'm sure my results would be substantially worse. I think my hit ratio would go down to 55 percent if I was really trying to do month by month. Odd people burn out in hedge funds. That's a very common thing because they're so short-term oriented. I've talked to many hedge fund managers who say that they wake up several times in the night and have to grab for their phone because they're panicking about the opening in Singapore or something. That's no way to live. So I'm not surprised that people that use that very short-term horizon don't have staying power. >> How do you think about before we go into your view going forward because now we've framed your time horizons, stuff like that, which is always really important because if you don't listen to somebody's time horizon, you don't understand what they're saying. So many safe people will be able do. Talk to me a little bit about risk management. So how do you think about sizing a trade? Because you talked about the 300 percent trades that you've had. Sometimes you get these opportunities, but they are rare, how do you think about trade sizing overall. >> Typically it depends on the asset class. Like if I'm running a corporate bond portfolio of risky stuff, I really don't want things to be more than about a percent under normal conditions. Any particular name or something like that in the mortgage market, when I used to invest in some really risky refinancing oriented securities, which is huge price changes. I wouldn't have a single position that was more than 1.5 of one percent. Because there's a lot of syncretic things that can happen. But I'm completely comfortable when you get to those rare moments where I'm pretty comfortable calling all in. But you have to be in those rare moments. It only happens probably once every dozen years or so and it takes all the patients in the world to wait, wait and wait for the prices to just drop. But once you get to that level where you can almost analytically prove that you're going to get more money back from a bonds here, particularly, that you might not get all your money back if it's a corporate bond situation or a default oriented commercial mortgage-back security. But you get to points where it's virtually impossible to not get more money back than where the market is actually willing to sell you these securities. At that point, I'm pretty willing to go all in. Now what I mean all in, I'll actually raise funds to do one trade. I did that in 1994, I did that in 2008. and I'm preparing to do it again, but the market opportunity isn't there yet. It was coming, but the Fed screwed it up with the bond support purchases, but I'd started fund to do basically one and it's almost a beta trade. I've two different styles. There's the normal course of business where everything's an alpha trade and that's where we are right now clearly. I mean, the opportunities, particularly in the fixed income market are pretty paltry. Everything's in alpha trade, there's no beta that's worth anything right now, so you have to find parts of the capital structure that are particularly cliffy and all that stuff. Right now everything's in alpha trade, but you do alpha trades waiting for the big beta trade. When the beta trade comes, I don't want risk management. Risk management is when you're in the alpha trades. You need risk management right now. When the market falls apart, you don't want risk management, you actually want to just put the pedal to the metal. >> You want to take as much risk as you can when you got to. >> Yeah, because it only happens what? Five times in a lifetime? >> Yeah, your entire career, you're going to get a few of those. >> Right, and so you have to really push it. Like I said earlier, my biggest mistake was I didn't push it the way I should have across the board in the corporate bond market in 2002. I vowed I would never miss that again, but you have to play defense, waiting for those things to come, and that means a lot of diversification, small position sizing, particularly when you're in a market that is I would say processed is priced for good outcomes, assuming that nothing bad will ever happen again, and we were there in February of this year. We were there and I think we're going to get there again, but this whole situation that we're in right now is wickedly unstable in my view. >> Let's talk about this a little bit. I mean, I have 30 years in this and I'm a bond market guy because that's been the greatest source of risk adjusted returns of almost anything, and here we are with the bond market it's like zero-vol and [inaudible] zero-vol as well because the Fed have stopped the credit market. So yes, I can see that more credit related equities is selling off or moving around a bit. It's a bloody hot market for macro right now. The dollar has not done anything much as you say, so we're stuck. What are you thinking? >> We were just having this discussion this week in one of my strategy meetings where some of the people were lamenting the state of affairs, and I said you just have to take reality for what it is. I mean, if you were only a treasury market investor, right now the situation is truly hopeless. Hopeless. I mean, the yield is 50 basis points and the vol as you correctly stated is zero, so you have virtually zero income and there's no volatility of trade that you could actually make something happen through price change. It's literally hopeless. In environments like this, you actually just have to not try very hard and just accept the fact that you're not going to be posting big numbers, because any attempt to post a big number is probably a very long shot in terms of potential success. >> Yeah, you can wait for the breakout in the end because if you push a position in a market like this as you say, you can lose money, so then you trade options, you just bleed, time decay, it's just not like a market. >> Yeah, I have been way less active in the past, I would say three months, then pretty much anytime in my career, I was quite active of course in March and April where we were just trying to stay alive, but in the last few months, there's just nothing going on but you always low volatility leads to high volatility. There's a reason why Death Valley is right next to Mount Whitney. Death Valley is the lowest spot in the lower 48 states, and Mount Whitney is the highest spot. There's a reason why they're right next to each other. That dirt got to go somewhere, and that's what happens, vol never stays low, and so you simply have to pay attention and wait for the opportunities because the vol will go up. I mean interest rates will not stay at 67 basis points on the 10-year forever. >> My view was always that suppressed volatility leads to hyper volatility. >> Absolutely. It's actually gone locks law of investment physics. I say the frequency of trouble times the magnitude of trouble equals a constant. >> Yes, that's right. >> The worst thing you can try to do is invest in one of these hedge funds that claims that got everything, all the risks are ironed out flat and they find a way to make 75 basis points every single month. At 75 basis points every single month, and I've seen a few of these come and go, and they can do it for a couple of three years. Then comes the bankruptcy filing, because when the vol comes, they lose 100 percent, so an attempt to make an earning stream or a return stream that's absolutely constant at some level above the risk-free rate is doomed to a bankruptcy failure, because usually those types of strategies also employ many turns of leverage and that's ultimately their down fall. On long-term capital management which should have been called the short-term capital management because they weren't even in business for five years, that was a bad construct right there. [inaudible] attempts never work. >> I remember I was running a [inaudible] fund in London back in the early 2000s and our competitor was this other fund that was well-known and he was doing two percent a month but consistently, and our partner was moving around and we were reasonably well performing, and as he was moving around, I'm like how is this possible? What are they doing? So there's two percent, two percent, two percent, and only investors were going while guys are idiots, these guys know what they're doing, it's just you guys are fools; two percent, two percent, two percent, down 47. >> Well, that's the way it works. >> [inaudible] options. >> One of the funniest things is a lot of large investment pools employ consulting firms to help them analyze risk-adjusted returns and the like, and unfortunately they don't really quite understand how things work. They use a lot of CFA manual types of techniques, and I saw one of the most entertaining speeches ever. I was speaking at a client seminar conference, and there was this fellow who got up. He was really entertaining. He went through some risk-adjusted return analysis and he got everybody all hyped up and he was just using actual return streams as an example, and he got everybody to agree that there's one investment they would absolutely positively do, and then he revealed that it was the historical record of Bernie Madoff. You got to be careful in these things that look like they somehow have solved the entire problem of eliminating volatility while keeping returns high, because I just wouldn't even want to go there. I wouldn't give a dime to somebody that has one of these two percent a month attempts because you're going to lose all your money within five years. >> Looking forward, acknowledging the markets are pretty frustrating right now, what do you think the good opportunities are over the 18 month time horizon? You've talked about the dollar a bit. >> I think 18 months is enough for the dollar to fall and that means, probably the most frustrating allocation that many investors in pools have made that has not paid off is recognition that the returns of the United States stock market, let's just say the S&P 500 have just been so incredibly dominant versus the rest of the world, and that those returns are really, for the last couple of years, only in the S&P 6. The S&P 494 have no return at all over that time period. So I've got this strange advice for people. I say, if you want to own US stocks, you should own those six knowing that you're going to take a blood bath if you overstay your welcome, but it is a 100 percent momentum based market, the most dangerous type of market in the world. I turned negative on the Nasdaq, September 30th of 1999. I was really negative. Of course, in the fourth quarter of 1999 it went up 80 percent. But one year later, it was down 50 percent from the September 30th level. I feel like we're in that type of an environment. If you're going to own US stocks, which I don't recommend, but if you want to own them, I think the only way it goes is those six and you just got to have your finger on the exit button pretty close by. But I think that's your only chance of making money and yet I don't want anything to do with it because this is the Nasdaq. >> Do you abide to the theory that people are thinking of these tech companies like the new zero coupon bonds? That these have infinite cashflow and with zero interest rates. These just go to the moon, there's no valuation. I mean, I can tell by the smoke on your face, you don't believe. >> They've already gone to the moon. It's so strange how fetish the market has become. The one that just blows my mind is actually not a tech company, it's actually a restaurant company, it's Chipotle. I just can't understand why the stock has tripled over the last six months. It just baffles me and yet people say, well, they're thriving on their delivery. Okay, but isn't the PE like a 150 or something? I mean, that's a lot of tacos. But yet the stock is invincible. I was actually short that stock in February, and as good luck would have it I covered it on the low because it's tripled since then so I would have gotten hammered. But my thinking is we're in the very late stage of this momentum market. It can always continue longer than you think possible. But I do think that within 18 months it's going to crack pretty hard, so I think that you want to be avoiding it for the time being. I think when the next big meltdown happens, I think the US is going to be the worst performing market actually and they'll have a lot to do with the dollar weakening. I know a lot of people have diversified out of the US on valuation reasons and on just relative performance differentials, which are really mind blowing how well the US has done versus, I mean, Japan hasn't done anything for forever, Europe's not doing anything. But I do think that you're going to be not well served in dollar based investments which should include the US. You don't have to do it today necessarily because it really needs a rollover to start getting going, but I do think that diversifying away makes a lot of sense. There is something that was very popular and it gained a lot of money, a lot of AUM. It was called the permanent portfolio. It was very simple concept, I think it had four things equal weighted I think. It was stocks, high quality bonds, cash, and gold. I think they were one-fourth each. It got very successful because there was a window there in the aftermath of the global financial crisis that it did really well, that mix of assets. Then it fell on hard times when stocks really got going and the AUM in that particular permanent portfolio mutual fund collapsed. But I think that's a good investment right now. I think we have such a potential tail risk of outcomes, such a disperse potential outcomes that you really need to have this kind of bar build asset allocation concept. I actually think owning 25 percent gold isn't crazy right now. Nor do I think owning 25 percent cash isn't crazy, the kind of the opposites. I also don't think 25 percent stocks is crazy. Because one thing about a potential inflationary environment is stocks can add a zero to their prices. You might not gain in real purchasing power, but you can keep going with the nominal value that has some inflation protection. The high quality bonds, maybe you're supposed to just have two doses of cash instead of that because the high quality bonds, the yield it's not much different than zero. >> There is a possibility, I'm more of a deflationary kind of guy. Even in your dollar scenario, it sounds like the dollar goes up, blah, blah, blah, that's deflationary for a period of time so the bond part of the portfolio works. Maybe rates go negative in the US, maybe they go to probably zero at 30 years, and then after that we get inflation. But that whole portfolio make sense. >> I agree with you on that. I am ultimately an inflation fearing person, but in the short term I do not think there's an inflation. I think what's happened this year is pretty clearly deflationary. Particularly, I think white collar wage deflation is going to be pretty intense. One thing about work from home is it gives you a different prism through which to analyze your business and the way businesses operate. I'm pretty sure just about every business owner and CEO has been made aware of ways of working more efficiently remotely or maybe they can cost cut by moving some operations to other places. Like my IT department has said to me, there's really no reason for us to ever go back in the office. Because they just live on the 16th floor on our building, in a corner, you never see them. They're just behind a closed door typing away. They can so easily do that at home, why do we need that office space? That's clearly deflationary. What about the traveling salesman that can't travel right now? I think most businesses are probably thinking, do I really need this many travelling salesman? No. So there's going to be a lot of deflation in the wages of traveling salesman and a lot of other middle managers I think are going to learn that people have figured out that all they're doing is watching people work that report to them and not really doing any work. Maybe you don't need so much middle management. I think all of this is deflationary. What if somebody moves? They're tired of all the needles on the sidewalk in San Francisco and they decide they want to go to Boise? Well, you don't have to pay him as much. I mean, the cost of living is lower, that's deflationary. If somebody felt at risk of losing their job in March and April, they're probably still fearful of an event of job insecurity. I think that they're going to take a pay cut rather than a pink slip. I do think that there's a lot of deflationary things and until, weirdly as Laci Hunt points out so academically correctly, one weird thing about the deficit is it really isn't inflationary. It's not inflationary until you start actually declaring the liabilities of the federal reserve to be legal tender and actually giving money to people, which we're starting to do. That's why I'm ultimately an inflationist. When I used to give speeches when there used to be gatherings of people, I used to routinely say I know how to get inflation by five o'clock this afternoon, literally. We have an announcement from the Treasury Department that every bank account in America is going to have a one billion dollar deposit at 4:59 this afternoon. That will cause inflation. Because if we don't have inflation, the lines at the Ferrari dealers would be something to behold if you gave everybody a billion dollars at 4:59 this afternoon. So you can do it. There just has to be the true desire, the true commitment to doing it. Obviously, we've been ramping up this procedure ever since the global financial crisis of giving money to people. Actually, it's comical how people talk about modern monetary theory or universal basic income is some wacky idea. We've been doing it since the '60s. I mean, not to the whole population. But what do you think welfare is? It's universal basic income, but it's not universal. It's just for a certain subset of the population. It hasn't exactly solved the problems. In fact, in my view, it's made them much worse. You can't get inflation, but you have to really, really want it. I think it takes more pain of disinflation. >> I want to talk about the pain. One of my thesis is we've got a massive insolvency about to happen. >> Of course. >> The market is not pricing this yet properly, but it feels that. Let's say, where's GDP year-on-year run, I put it down five percent year-on-year. This is still the biggest recession. >> Its negative nine in the United States, year-over-year, June 30th, 2020. >> This is still the biggest recession since the 1930s and we're just coming off the bottom of the massive quarter. But even if I look at the real-time economic data, maybe it's down to seven or six, whatever the number is. It's so huge and there's no cash flow. As you pointed out, all these deflationary things, every restaurant, small business is closed, everything. >> Well, I don't think people fully understand how many business closures there's going to be in the next few months. I don't travel out of my property here very often because we're working from home. I'm not going to go to a grocery store or something, I've got people for that. I venture out every now and then and I had to go to the bank, and I was shocked at the empty store fronts. How many empty storefronts there have started to develop in the last, say, six weeks? I mean, businesses, they have been in place forever, they are now just for lease, and it's going to be a lot more of that. I think it's going to really accelerate. We were talking this morning. What about the movie theater industry? I mean, what's going to happen there? How long can they hang on? I think there's going to be real problems in the wintertime here. >> It's concerning for the individuals, all of these small businesses. The bulk of the American capitalism is these small businesses. But when you look at this massive group of triple-B rated companies on the edge of a cliff and the Fed stopped it. They stopped what had to be the market clearing event, which is all this triple-B was going to go to junk. >> Well, the triple-B bond market in 2006 or 2007 or so, was the same size as the junk bond market. Today, its 300 percent the size of the junk bond market. If one third of the triple-B's get downgraded, the junk bond market will double in size. >> Or halve in price. >> Something like that. I mean, that's obviously some combination of the two. But that's almost certain to happen, I think, but the Fed stopped it by providing liquidity. But as so many people have correctly pointed out, there's a big difference between short-term liquidity and long-term solvency, and the Fed can't stop the insolvency. >> But they are buying corporate bonds. They're buying bloody Microsoft bonds and G-bonds and everything else in this black robe fund. >> They haven't bought very many. They didn't really need to. It was just doing any of it that made people decide that the prices were supported and that they had something of a put to the Fed. It hadn't ever occurred in the junk bond market before, and it's not supposed to happen. But they're that close to just buying equities. I mean, there are one slice of the capital stack away from doing the Bank of Japan and just buying the equities. I don't know if they're going to do it or not, but at this point, unfortunately, because they're in violation of the Federal Reserve Act of 1913 right now, almost anything can happen. Because why stop there? You've taken the guardrails off of the operations that are deemed legitimate. We'll see what happens. But the downgrades have already started to happen. It's really interesting to look at charts about lending standards, surveys of bank loan officers, and the like and just how much [inaudible] crazy. The junk bond market should probably be right now at a 15 percent default rate year to date, but it's not. The downgrades almost certainly have to come. Clearly, there's just a lot of overinvestment in the corporate bond market, thanks to the way it behaved this year. I think there are quite a few investors, unsophisticated investors that believe the corporate bonds have no risk. >> One of the things I've been looking at, I looked at this too and I'm like, it's so frustrating. Because as you said, there should have been a good opportunity here. You could sort out the wheat from the chaff. What I did is I've constructed a basket of triple-B rated equity. I just took the largest component of each part of that triple-B market by sector, that inequity. That's interesting because the equities are moving. I'm looking at the European bank stocks as well. I've been following those for a long time. I think the equity goes to zero, but the bond doesn't because they get nationalized. >> Yeah, that's possible.I mean, certainly one thing that we've learned is that negative interest rates are fatal to banking systems. I mean, that seems pretty crystal clear. Japan went negative a long time ago, and they're banking sector on the Tokyo Stock Exchange is down 85 percent from where it was in 2006 or even 1990 something. The Europeans once they went negative, it was hopeless. >> The UK's just gone negative. It's two-year gilt to negative. The UK banks are at all-time record lows. They've gone below 1986 prices. >> I know, it's because they can't possibly survive a negative interest rate. You mentioned that maybe the US rates go negative. I certainly hope not. J. Powell says he doesn't like the idea of negative interest rates. I applaud him for that. Because I think if the US wants negative interest rates, I think the global financial system would collapse. >> But don't forget, I mean, I went back and looked at it, and shunts went negative 18 months before the ECB finally gave up. Two-year gilts have been negative, and short sterling was negative six months before the Bank of England gave up. So I think, I don't know whether the Fed gets the choice. Powell can say whatever he wants. The bond market is always, I think, the truth and it will decide whether it's getting negative or not. I don't know, as you say, what the **** is it doing to the system? Who knows? >> Well, it's one thing for Japan to be negative and Europe to be negative, but the US is a massive capital market. At least capital can go the United States and survive capital destruction of negative interest rates. You don't get much of a reward, but you're not getting destruction. If you start to have destruction in a capital market, the largest in the world by far, I just don't think the system globally can survive. >> No, but I think you and I will agree that, okay, so here's a set of outcomes is deflationary potentially goes to negative rates, we don't know, but let's assume there's a tail risk of it. Let's assume there's another larger risk of massive fiscal stimulus financed by the central bank. There's also a risk that the central bank buys stocks or got more QE. We got back to the 25 percent allocation in gold, doesn't seem so stupid, does it? >> We're starting to get to this 40,000-foot overview type of thing, which is very important. But I've been talking about this. Neil Howe calls it The Fourth Turning. >> That's right. I'm speaking to Neil this week. >> I've been talking the same ideas for a long time then I met Neil Howe. It was just remarkable how we had exactly the same ideas, but he was actually much more deep into it. I realized that we really obviously are going through this and the institutions are not working. People know that something's wrong, and they know that the institutions are resisting change as they always do, because their elites don't want them to change, and yet they're not working. It really has to go. We do have to go through this massive Fourth Turning of changing the institutions, and obviously the wealth inequality problem has to be somehow addressed and all of this stuff. The ultimate magnitude of the change, I think, is much vast, much more severe, much larger than many people appreciate. It really is the frog getting boiled in the pot. If you could go back to 1995 or 2005, even, in a time machine and explain to people what the world looks like today, they simply would not believe it. >> No way. It would have sounded ridiculous. >> It just doesn't seem possible. But it's happening in such a rapid pace. The presidential election is just a microcosm of the whole thing. The world really is characterized by this fantastic computer thing where two people can listen to it, and one person hears Yanny and the other person hears Laurel. Davis, have you tried that? You should google Yanny, Laurel. >> Yes, it's amazing. >> It's mind-blowing. But it actually has something to do with physiology like sounds in your ear, because I've actually found a way to hear both of them. You have to move around and stuff, and you can hear like Yanny, Yanny, Yanny, Laurel, Laurel. Yanny, Yanny, and it goes back to Yanny. It really plays with your mind. But that's a perfect metaphor for how people process what's happening in our world today through current events. They just simply see something completely different and it has to get resolved. People have to start seeing things the same way again, and that's the first turning. >> Yes. . I 100 percent agree with all of this is. It is because it's so overwhelming that people actually just filter out some things, so they stick to one truth. There is no universal truth, we all know that. It's a blended thing, but people can't deal with the magnitude of this. It's very difficult for those of us slightly burdened with financial markets, because you go and speak to somebody else and you're, listen, this is really bad and there is a huge change coming. I don't really know how it plays out, but it's going to get ugly. >> I think people in financial markets are attuned to it because it's part of their professional life. If you go to Wyoming, go to Meeker, Colorado, or go to Wyoming, and you will go to these little towns, it's a different world. People, they're going through their regular life, they don't watch the news. It's amazing how different life is for those that are in major urban centers or in financial markets where you're forced to be hyperaware of all of this dissension, and you go to these quiet hamlets and it feels it's 1955 or something. They don't know the magnitude of the tension that exists in the more densely populated urban centers that are obviously going to have monumental changes in the next five years. >> Have you caught the Bitcoin bug yet? >> Bitcoin, I don't believe in Bitcoin. I actually have made good advice. I've never bought Bitcoin, but I actually recommended Bitcoin twice, and I recommended selling it once, and all three of those trades were really good. I just don't believe in it. I think that it's a lie. I think that it's very traceable. I don't think it's anonymous. >> It's not anonymous. >> It's big allure was it's supposed to be anonymous, and it's not. >> No, it is actually a beautifully constructed pristine asset. It is like gold. It's very divisible, it's transferable. Forget the anonymity of it. Forget that. Because of it's fixed money supply, it's the only asset with a purely defined money supply, that it's flow versus the stock of it is always diminishing. It becomes extremely interesting as a hard asset. >> I don't really have a strong opinion about Bitcoin. I think it's a fantastic trading vehicle. >> Yeah. Well, obviously, you've got the skill for it. >> It's got huge volatility, and I've actually been positive on Bitcoin pretty much all year. >> My guess is because of your larger big-picture construct, spend a bit of time with Bitcoin, I think you're going to like it. Because I looked at it and in the end, I couldn't find, it's not going to go to zero, but it could fall 50 percent and never rally, it's fine. >> Sure. >> But I can't find anything with the skew of risk-reward where I'm not paying option premium, there's no time decay. For me, even when I look at, you like charts too, I look at the chart versus gold, chart versus equities, chart versus almost any asset, and it's this is breaking out against every single thing on daily charts, weekly charts, monthly charts. I'm like, okay, this is really super interesting." >> I hear what you're saying. I'm not at all a Bitcoin hater. >> For you, that's just not something you'd do. >> I prefer things that I can put in the trunk of my car. I prefer gold or really precious stones, stuff like that. I believe in that. They're not terribly liquid, but I like that stuff. I've got quite the art collection, that stuff, and I just enjoy it. I don't really need wealth preservation anymore. I just want peace of mind and lifestyle quality. I prefer my Mondrian on the wall to a digital entry that has the same value. >> Yeah, I get it. Why would you not? >> Yeah. >> Let's say we're in the middle of the full turning, it should happen because we're at the election point, we've got the big crisis, we've got the debt thing. Almost everything should be in place that they all talked about that we've all been looking at. What's the big trade outside of gold? Forget gold, I think a lot of us agree with that. When it comes, and these things aren't setting up yet. I don't see it. >> I like that permanent portfolio concept. I'm going to stay there. I want massive diversification. I'm worried about deflation, and so cash sounds good. I'm worried about the inflationary response, so gold sounds good. I don't like the dollar in any case, and so at a pullback, with a big pull back, I would substantially buy stocks. But at this level, I think 25 percent is really basically all I can stomach in the stock market. It's just this four pillared highly diversified thing. The other thing is I feel, like we said earlier, the opportunities that are really good are very rare, and I want to have liquidity when the next one comes, because I think it's coming in a couple of years. Not 20 years, maybe five years at the very outside, but may be very well come in two years or 18 months. So the trade is to wait for that trade. >> Where do you think that trade's going to come? Is it going to be credit? Is going to be equity? What do you think the trade that's going to set up is? The one that makes you go, "I'm waiting for this." >> I think equity. But we're talking about a PE in the single digits when it happens. >> Yeah. >> I turned positive March of 2009 on equities because everybody was so bearish and the PE for about two days was actually below 10 on the S&P 500. Unfortunately, I sold out at about a 50 percent gain, because it was just too easy. But I think that's coming again, and it will be quite a pleasant experience to not be in the car on the first hill of the roller coaster that's coming. I just want to be very low risk right now. >> Yeah, and you might be able to make some money shorting it as well if it plays out that way. >> Yeah, I probably will short. I don't really want to press shorts right now, but I do think there is a trade on the short side. >> Jeffrey, listen, thank you very much for your time. A really great conversation, thoroughly enjoyed it. >> I did too. Thanks a lot, and good luck. >> Yeah, and you. Take care. >> Bye, now. >> Hey, there. Since you got to the end, I'm guessing you liked the video. That's probably because we don't just turn on a camera and film, we work really hard on getting the narrative flow just right. That's why many finance companies are actually now hiring Real Vision to make videos for them. 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