In Gundlach's `No Normal' World, U.S. Treasuries Just Can't Lose
Blame the harsh winter for stifling economic growth or tensions in Ukraine for sparking demand for havens.
Jeffrey Gundlach, the star fixed-income manager whose mutual fund beat 97 percent of its rivals the past three years, has a simpler explanation for why investors have gotten the bond market so wrong this year: the aging of America.
More retirees mean a shrinking workforce, leading to less spending, slower inflation and greater demand for low-risk, income-producing investments. RBC Capital Markets, one of the 22 dealers obligated to bid at U.S. Treasury auctions, says annual growth in the working age population will slow to 0.2 percent in the coming decade from 1.2 percent in the 10 years before the financial crisis. This helps explain why the best and brightest erred in calling for a bear market in U.S. bonds -- and why benchmark Treasury yields may stay low for years to come, according to Gundlach.
“That’s one of the reasons why yields are not just going to explode on the upside,” Gundlach, who oversees $50 billion as the co-founder and chief executive officer of DoubleLine Capital LP, said in a May 7 interview with Tom Keene from Bloomberg’s headquarters in New York. “Part of this equation is the demand for income from the growing number of retirees.”
Demographics are part of Gundlach’s twist on Bill Gross’s “new normal,” a term that the founder of Pacific Investment Management Co. popularized in 2009 to describe an era of lower growth and reduced U.S. influence in the world following the credit crisis. Gundlach calls it the “no normal.”
Since 2008, the Federal Reserve has inundated the economy with more than $3 trillion in cheap cash to hold down borrowing costs and restore growth. While the deepest recession since the Great Depression ended five years ago, questions over the resilience of U.S. consumer demand have lingered in the bond market with the Fed paring its debt purchases this year.
Treasuries have rallied 2.5 percent, defying economists’ estimates for a second year of losses. Longer-term bonds led the advance with their biggest gains since 1995, pushing down yields on 10-year Treasuries to 2.62 percent at the end of last week. The yield was 2.65 percent as of 11:55 a.m. in New York.
At the start of 2014, forecasters anticipated yields would approach 3 percent by this time and 3.4 percent by year-end.
Gross domestic product grew at an annualized 0.1 percent rate in the first quarter, the Commerce Department said on April 30, less than all except one of the 83 estimates in a Bloomberg survey that predicted growth of 1.2 percent. Although U.S. employers added more jobs last month than at any time since 2011, average hourly earnings stagnated.
For Gundlach, there are few reasons to anticipate a sudden surge in Treasury yields because a rapidly aging population will constrain long-term demand in an economy that is already being hampered by a lack of wage growth.
“Household income is being challenged at the paycheck-level, but increasing at the demographic level because of a great bulge of baby boomers retiring,” the 54-year-old money manager said. “Those that are working have to work that much harder to have GDP stay at the same level.”
The number of Americans 65 years old or more will balloon by 14.5 million this decade, the biggest increase versus the total population going back to 1900, according to data compiled by the Census Bureau. The ranks of the elderly will double over the first three decades of this century to 72 million and equal almost 20 percent of the population.
Older Americans will also buy more Treasuries for steady, low-risk income, said Gundlach, who was named “Money Manager of the Year” by Institutional Investor magazine for 2013.
His $32.5 billion DoubleLine Total Return Bond Fund (DBLTX) has posted an annual 5.9 percent gain in the past three years, more than double the peer average, data compiled by Bloomberg show.
The majority of economists and forecasters are sticking with calls that yields will rise. Based on a Bloomberg survey on May 8, yields will end the year at 3.24 percent.
Priya Misra, head of U.S. rates strategy at Bank of America Corp. in New York, says yields have fallen because of short-term factors such as the effect of the weather and will rise as investors re-focus on an economy that’s strengthening over time.
While economists have pared this year’s growth forecasts, they have ratcheted up their estimates for 2015 to 3.1 percent, the first increase in more than a year.
The jobless rate has also fallen to 6.3 percent, the lowest since Lehman Brothers Holdings Inc. collapsed in 2008.
The market is “seemingly disconnected from fundamentals,” Misra said by telephone on May 9. Yields “should be higher from a pure economic perspective,” she said.
Misra, whose firm is also a primary dealer, predicts 10-year yields will rise to 3.5 percent by Dec. 31.
Still, the lack of inflation is turning into one of the most persistent signs that consumer demand, which accounts for 70 percent the U.S. economy, is diminishing.
The Fed’s preferred measure of inflation has now fallen short of its 2 percent target for two years. In the five years before the credit crisis, the gauge averaged 2.5 percent.
“The economy is going to gradually improve, but the pace of recovery is not enough to generate inflation pressure,” Yusuke Ito, a senior fund manager at Mizuho Asset Management Co., said in a May 7 telephone interview from Tokyo.
Ito predicts yields on 10-year Treasuries will decline to 2.25 percent within the coming year.
With America’s lackluster growth and the biggest explosion of its aging population on record, the U.S. bond market is starting to resemble another country dealing with a graying society: Japan, according to George Goncalves, head of interest-rate strategy at Nomura Holdings Inc., a primary dealer.
A generation of start-stop economic growth and deflation after Japan’s own asset bubble popped in the 1990s has pushed down yields on its 10-year government bonds, which averaged about 4 percent that decade, to just 0.605 percent today.
“Without wage growth and productivity you don’t get real GDP growth,” Goncalves said by telephone on May 7. “It’s going to cap rates, which is what happened to Japan.”