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We are in a “fourth turning,” according to Jeffrey Gundlach, where institutions will be challenged, and profound structural changes will unfold.
The concept of the fourth turning was pioneered by Neil Howe. It is the final stage (or “turning”) of a societal cycle, when a crisis emerges. In this case, the fourth turning began with the global financial crisis. According to Howe, it will end when the boomer generation retires from public life and leadership. Millennials will become the new leaders, according to Howe, and the cycle will restart with a first turning.
But before that happens, more crises will unfold.
Gundlach said the fourth turning will force a default or restructuring of our unfunded liabilities “in the relatively short term.” By 2032, he said, we will be in the first turning.
Gundlach spoke to investors via a webcast, which he titled “Cave People,” and the focus was on his flagship total-return fund (DBLTX). Slides from that webcast are available here. Gundlach is the founder and chairman of Los Angeles-based DoubleLine Capital.
The idea for the title came from when Gundlach was told about people in Modesto, CA who were living in elaborately furnished caves. In Plato’s Republic, he said, there are references to people who were chained and forced to live in a cave. One of them escaped and was blinded by the sun. That person returned to the cave and told those there of the world outside. But the cave dwellers refused to believe him and would not leave.
Similarly, he said, many market participants refuse to accept reality. Although Gundlach did not say this, the implication is that most people are unprepared for the consequences of the fourth turning.
Gundlach covered debt and deficits, recession indicators, the inflation outlook, and the bond market.
Debt and deficits
The administration just forecast a 6.1% deficit (as a percentage of GDP) for 2025. With the deficit already at 6.3%, he said that forecast is “scary,” since we are supposed to be in an expansion, when deficits should be a lot lower.
“We are going to double-digit deficits,” he said, “which is a problem because of interest rates.”
From 1970 to 2015, unemployment was low when deficits were low and vice versa. But in 2015 that pattern broke; unemployment was low and deficits rose. Over the most recent three recessions, there has been a 9% increase in the deficit instead of the average of 5% since 1970. The next recession could see a 10% or greater increase in the deficit, Gundlach predicted.
He said, it looks like we are on track for interest payments as a percentage of federal revenue to reach a new high. This is why the Fed is eager to cut rates, he posited. The Fed is faced with a wall of maturing bonds, many with low coupons. Those bonds will need to be refinanced with now-higher coupons.
This is turning into “an absolutely critical problem,” Gundlach said.
The recession outlook
Gundlach cited many ominous signals of a recession, but stopped short of predicting that one was imminent.
Money supply growth, as measured by M2, turned negative at the end of 2022, but the recession that many expected did not ensue. The problem, according to Gundlach, was that the money supply was already at a high level, and there was ample liquidity to support economic growth.
The yield curve has been inverted since 2022 and has been de-inverting, which is a recessionary signal. But it needs to be flat or upward sloping to be a strong predictor of an imminent recession according to Gundlach. Based on the 2-10 spread, which is -41 basis points, he said it is likely the Fed will cut rates.
Employment has started to “flip,” Gundlach said. The rate of employment has risen above its 12-month moving average. “This has the look of a recession indicator,” he said, “and is the most important economic indicator to watch.”
The data for initial unemployment claims is puzzling, according to Gundlach. It has been very stable for at least the past two years and “looks contrived,” he said. It is based on surveys, and the percentage of responses has gone from 75% to 50% over the last decade. The smaller sample size makes the data more suspect, he said, as a result.
Among the 50 states and the District of Columbia, 88% have had rising unemployment over the last six to 12 months. But Gundlach questioned the math behind that data, which is also based on surveys. It runs contrary to the conventional wisdom of strong employment growth.
Similarly, the household survey shows that full-time employment has fallen for the last three months, and part-time has shrunk in the last two months. This suggests the rubric of a booming employment economy is not supported by data.
Hiring plans by small businesses and average hours worked are declining, reinforcing that thesis.
Consumers are showing signs of stress. Credit-card debt is up markedly, he said, and interest rates on that debt are up 600 basis points over the last year or so.
Inflation
Just-released data show that core CPI inflation is 3.8% and headline 3.2%. Core inflation is heading down, Gundlach said, but headline CPI has leveled off, and we are “nowhere near” the Fed’s 2% target. Part of the reason, he said, is this year’s 10% increase in oil prices.
“Inflation data has gotten to be a little sticker,” Gundlach said.
If shelter is excluded from the CPI data, the core inflation rate may hit 2%. The Zillow rent index has dropped significantly, but the OER has not and is likely to catch up and duplicate that decline. That gives the Fed hope of hitting its 2% target, Gundlach said.
The number of multi-family units under construction is at its all-time high. Single-family construction is strong, but not as high relative to its historical levels. “There might be hope for those looking for rent relief,” Gundlach said.
Core and headline inflation as measured by the PCE are 2.8% and 2.4%, respectively, but “super-core” (which excludes shelter and was adopted by Chairman Powell in 2022) has settled in at approximately 3.5%.
Import and export price growth have been negative for approximately 18 months, which is non-inflationary.
Commodity prices cannot get above their 200-day moving average, Gundlach said, and do not show an inflationary impulse, implying there is slow global economic growth.
Bonds
Bond-market volatility has been low, which has caused spreads to tighten. The new narrative, Gundlach said, is not to care about the spread and to focus on the increase in yield.
That is dangerous, he said, because the absolute yield is not a reliable indicator of performance, given defaults.
This is a bad environment for BBB corporate bonds based on historical spreads, but in high-yield (CCC) bonds have more attractive (higher) spreads.
Agency mortgage spreads are wider than their 25-year average, due in part to their lack of supply and low housing stock. But these are attractive because of low prepayment risk, Gundlach said.
Spreads on emerging market debt were at 500 basis points in 2022 and 2023, but now are 367 basis points. Gundlach said he is waiting for the dollar to weaken to take a more aggressive position in EM debt.
Overall, Gundlach expects the economy to weaken, and the Fed will cut rates. But there will be an “aha” moment when 10-year yield gets to 3.25% to 3.5%. Investors will then want more yield and drive rates higher. If we get a recession by 2028, he said, interest payments will go to 20% to 40% of the deficit.
“Everything could change under those circumstances,” he said, consistent with his fourth turning thesis. That could include a “radical restructuring of Treasury debt.”
Robert Huebscher is the founder of Advisor Perspectives and a vice chairman of VettaFi
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