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Stormy markets ahead

By Barbara Whelehan ·
Friday, June 25, 2010
Posted: 10 am ET

I'm at the Morningstar conference, trying to get a sense of the outlook for the markets, the economy and where to put money. Hundreds of financial advisers from around the country attend the conference. The overcast skies in Chicago seem to affect the moods of several speakers, mainly money managers.

Jeff Gundlach of DoubleLine Capital delivered the opening keynote session that kicked off the conference Wednesday. I heard him speak three years ago at the 2007 Morningstar conference, when he presciently spoke of an impending subprime loan crisis -- "a total unmitigated disaster," he called it.

Note that he predicted the financial collapse of the system long before it occurred.

Views still negative

His opening line this year wasn't reassuring: "This is one of the most difficult time periods for the next several years that we'll probably face in our investing careers. I think the issues that we face are bigger and of greater consequence than even those issues in 2007."

Debt was the problem he foresaw in 2007, and it's still the problem he sees now. However, now he's focused less on consumer debt and more on the national debt, especially the unfunded promises of Social Security and Medicare. "Right now as of fiscal year 2009, we have $62.3 trillion of ... promises to pay, and this is against a $14 trillion economy," he says.

Gundlach says Social Security and Medicare will move into a deficit condition in 2016 or 2017, according to Office of Management and Budget estimates. At that point, "you have to start making payments or making decisions or defaulting," he says.

Gundlach is prepared for a default, but his definition of default is rather loose. A "polite default" would be raising the retirement age or taxing benefits. "We could even contemplate a maturity tax on government bonds to maybe foreign creditors somewhere down the line. That would be a way of engineering a default in a creative way."

And the government needs to move into austerity mode pronto, he adds.

Storm warning

Gundlach peppered his speech with statistics. A sampling:

  • Domestic U.S. credit represents 350 percent of GDP, not including debt at the state or municipal level.
  • Some 80.22 percent of all AAA securities have been downgraded, mostly to CCC status.
  • According to some calculations, the base case scenario for mortgages suggests 41.88 percent of home loans will ultimately default. "That's a depression. A monster depression."

After his talk, Gundlach spoke to journalists in the press room when a tornado warning was issued. The Chicago weather was bad, but the market outlook is worse.

"Bull markets are about cooperation; bear markets are about divisiveness," Gundlach says. "Whenever you see more and more data points of people not cooperating, it reinforces the idea of a bear market.

"When Germany can't get along with Greece, when Arizona can't get along with California, when the tribes in Hawaii want their land back, when people in Texas are talking, albeit at the fringes, about secession, that's bear market stuff."

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