CREFW-Winter2016

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Winter issue 2016 sponsored by CRE Finance World Winter 2016
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I’m not advocating that be done, but your question is what can be
done, and that’s something that could be done. Furthermore, if you
did it at a high enough rate in a high enough magnitude, you would
ignite inflation. To illustrate, let me use a facetious, hyperbolic
metaphor. What if the Federal Reserve sent everybody $1 billion
today? The United States would have enormous inflation. Imagine
the lines at the BMW dealers if the prices of the cars were left
unchanged. So we know how to get there. Now the problem with
fiscal policy — as with monetary policy — lies in execution — if
you believe in central planning, that is. When I was in elementary
school, we were lectured about the evils of central planning. Those
were the days of the Cold War, and the communists did central
planning. But for the sake of argument, let’s say you believe in
central planning. The problem is you must get it exactly right. Central
planning is a very blunt instrument, and yet you have to buy into the
idea that you have scalpel-like precision with it — and, of course,
you don’t.
I’m a bit surprised that we haven’t heard more of a call for fiscal
stimulus. You have started to hear it. For years, it was watch
out for the deficit. The deficit is bad, we’re harming our children,
grandchildren. But guess what, this year, I’ve heard loud and clear
a candidate with double digit support, even up to 30% support in
the Democratic base, calling for a radical increase in the deficit,
that’s Bernie Sanders. Rather than being booed out of the room or
laughed out of the room, he’s actually managed to capture about
a third of the party. So some support exists for fiscal stimulus.
However, the federal government has run deficits for so long that
the cumulative debt is pretty big. So much of the electorate is still
allergic to the idea of aggressive fiscal stimulus.
Stephen Renna: Shifting gears a little bit to the bond market.
We’re hearing, not necessarily in the CMBS sector, but in the
bond market more broadly, concerns about illiquidity. What is
your view on this? And if you do feel that the market is illiquid,
and if so, what might be driving that illiquidity?
Jeffrey Gundlach: Well, regulation is driving illiquidity. It’s the pullback
of participation from broker-dealers because they’re being heavily
regulated in terms of capital. They can’t play the same type of
role that they did 10 years ago. And when you see news stories
day-by-day, you know, such as Morgan Stanley cutting 20% of
fixed income trading, this firm exiting certain sectors of the market
entirely, it’s because of regulation. This topic has been very much
in the news for about 18 months now.
I actually think it’s kind of normal for bonds to be illiquid. What’s
unusual is the amazing amount of bond trading that went on 10
years ago. Bonds used to be a buy-and-hold investment class.
They were owned by annuity providers and insurance companies.
Fifty years ago, institutional holders didn’t even bother to mark
their bonds to market. There wasn’t any market. You just bought
bonds, and the beauty of it was that after whatever the maturity is,
this comes due and you reinvest it — a sleepy old way of traditional
investment. The onset of volatility of interest rates in the late ’70s
ushered in an era of tremendous amounts of bond trading all the
way up to probably 2009. That three-decade period of hyperactivity,
I think, was actually rather abnormal for bonds.
Bonds are about building a portfolio, earning it out, reinvesting at
maturities and, sure, when a credit is about to really turn sour or if
it gets really, really highly bid, maybe you want to hit that bid. But a
bid being high means you’ve got liquidity at least for that moment.
That’s the definition of liquidity; someone wants to buy from you. If
someone wants to buy your holdings for a very high price, you may
as well sell it to them.
Bond fund managers who fret about liquidity probably use strategies
that depend on high-frequency trading or at least run portfolios with
high turnover. At DoubleLine, we’ve never been very concerned
about bond liquidity, or lack thereof, because we run incredibly low
turnover bond portfolios. The DoubleLine Total Return Bond Fund,
our flagship fund, if you will, has a turnover of about 10% a year.
We’re kind of old school in that regard. I think it’s kind of weird that
bonds ever had liquidity.
I have a whole soapbox about liquidity. It’s really a false term. It’s
one and the same as volatility. Is Tesla stock liquid? If you say “yes,”
I would point out that that stock changes 10% in price on a daily
basis with some frequency.
Anything that changes 10% in price over the course of a day, by
definition, to me is illiquid because you have no ability to predict
what price you’re going to get. In the case of bonds trading, okay,
let’s say I thought I was going to get 98 but ended up getting a bid
of 97. That’s being termed as illiquidity. In the old days if I get 98
and you got 98, so getting 97 is less liquid, but bonds are about
the most liquid thing out there just because they’re among least
volatile things.
Now, true illiquidity in a bond market prevails in thinly traded
categories — for example, small names of second-tier energy
companies these days. Nobody knows where these bonds really
trade because there isn’t any observed activity. And if something
bad happens in the news to one of those credits, the bid is down
20 or 30 points the next day because nobody really knew what
the clearing level was; that mark-to-market was an illusion.
CREFC Exclusive Interview with Jeffrey Gundlach