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Double Line Capital founder and CEO Jeffrey Gunlock on this incredibly important day in the markets. Jeffrey, it is only fitting that you are here with us yet again. Welcome back. Thanks, Scott. Thanks for having me back again. I think this is our 38th time after Fed Day or 39th. I'm starting to lose count.
All right. Well, I'm glad we have continu continued the the tradition. I really hit on that uh at the top. December is not a foregone conclusion. Far from it. Um, Chair Pal went out of his way. Yeah, that was to to say that. Yeah, you're right. Yeah, you're right. In fact, that was going to be my phrase of the of the press conference.
So, you you've got you're on the same page that I am, not a foregone conclusion. And then he he reinforced that with far from it. And then he went back to that theme a little bit later on in the Q&A when he said, "What do you do if you're driving through a fog? You slow down." which is kind of uh sounds to me like if we don't have any more data I think that we need to price out to a certain extent the what was an assumption by the market that there was going to be almost with 90 90 plus% certainty a cut in December and I would say that that has been a reversed or should be reversed it's begun to be reversed but I think it should be reversed fairly substantially I might even put it at 50/50 when he says that there's a you know far from a foregone In conclusion, I saw in the in the pregame before uh the Fed announcements, I saw Rick Santelli talk about how the uh 2-year Treasury and the 10-year Treasury haven't changed since the last meeting.
And he's right about that. I'd take that I'd amplify that point, though, that the two-year Treasury is down since the before the Fed started cutting or the day after the Fed's first rate cut back in September of last year. The two-year Treasury rate is down all of five basis points. That's it. And the Fed has cut rates 150 basis points.
Meanwhile, the 10-year Treasury rate and the long-term bond rate are up uh since the first rate cuts, you know, steepening out the yield curve. And I think that one thing I've been contextualizing all through these Fed cycles is that the Fed tends to gravitate towards the 2-year Treasury yield with the Fed funds rate.
So, back in September of last year, there was about 150 basis point spread between the Fed funds rate and the two-year Treasury, with the two-year Treasury being much lower. But now that the Fed's brought the rates down, they're very much in the context of the two-year Treasury now, uh, with only about a quarter point difference between the two.
So, I I think what's really happened here, of course, is that we've seen tremendous rallies in, uh, financial assets this year. I mean, everyone's focusing on the stock market uh in the United States, but Europe's done well as well. Emerging markets have done even better. And bonds have done uh surprisingly well versus most people's expectations.
This is actually for the investment grade bond index that is most commonly followed. The last 49 years, this is the 11th best year uh following some pretty terrible years, particularly in 2022. So I I I think that we're looking at the possibility for a steeper yield curve. I think it's interesting that they're saying that they're going to let the maturing mortgage back securities.
They're going to reinvest them in T bills. And he mentioned in his comments, Jay Powell, that they want to reduce the duration of their balance sheet, which means that they're going to continue to emphasize shorter term securities, which is curious because that's the interest rate that they can control, that the Fed can control.
So, if they're really interested in thinking about reducing interest expense on the now 38 plus trillion dollar national debt, it's a kind of a clever way to do it to continue to manipulate balance sheet holdings into shorterdated securities. And then you can do QE again if you need to. And I think I think that they may ultimately uh manipulate mortgage rates lower by possibly doing quantitative easing when the uh environment uh calls for it to get mortgage rates down.
One of the biggest problems we tal Jay Powell correctly talked about in the inflation level has come down but the price level is still very very high versus 5 years ago. That also bleeds over into housing affordability, which is really bad compared to where it was 5 years ago. Home prices have gone way up and and mortgage rates are also higher than they were.
And so it's just possible that they might want to buy mortgage back securities and get them to an even lower yield versus treasuries. Uh I suspect that might be in the offing, not in the near term, but the intermediate term. And so we're quite positive on the agency guaranteed mortgage back securities market in spite of the fact that it's done very well in recent months now having more excess return versus treasuries than investment grade corporate bonds which has have also done well.
So it's been a great year for financial assets. A lot of that had to do with the Fed assumption of more Fed cuts. I would say that assumption is getting a little weaker after today's press conference. I like your willingness to give us act and our viewers of course actionable um ideas. It's interesting when when you say that maybe you're taking your own expectations for December down to 5050.
It obviously leads towards the road of the dissents in which we got two today. Expected of course from Myron who wanted 50 basis points but Kansas City Schmid wanted none at all. I also thought it was newsworthy that the the chair really underscored the idea of in his words decidedly differing views in the committee on what to do next.
They got a battle in the room at this point. That's what it sounds like. And uh it's it's understandable, you know, given the the the shortness of on data and the fact that Jay Powell uh admits repeatedly that they've got a problem with their dual mandate. They're both going in the wrong direction or at least inflation's not going towards 2% right now.
It's over three and we think it's going to stay above three year-over-year throughout uh you know things can change but throughout 2026. So the mandate uh it's difficult to figure out what to do when you know as he said we only have the Fed funds rate uh at the at the Fed meetings and you know one one mandate says cut it and one says don't cut it or even potentially raise it at the inflation rate.
So yeah, there's there's a battle in the room and I think that's that's going to continue going forward. You know, Myin is going to want 50 basis points every single meeting. I mean, that's that's where you're headed. And I suspect that's a taste of where we're going to be in uh say the middle of next year when we have a new Fred Fed chairman, which will probably be uh incrementally more dovish and maybe more than incrementally more dovish than Jay Powell has been.
So, it be interesting to see what's going on. I I just I just really believe that uh there's chances for uh lower interest rates with the new Fed chairman that could be below the inflation rate. uh if if possible and we've certainly heard Donald Trump and to a certain extent echoed by Scott Bessant that they want rates lower and not not lower doesn't mean three and 78 and the middle point of the Fed funds rate where we are now.
So we'll we'll see what happens but uh right right now we're just enjoying a really great year in financial assets. I think one thing that's um I I'd like the viewers to think about you know everyone knows that credit spreads are very tight just like the stock market valuation is very high those things naturally go go go together but the thing is while corporate bond spreads the investment grade corporate bond market are tight they're only about 75 some days 80 basis points more than treasuries that's a very tight level versus history it's really never been significantly less incremental year yield for corporate bonds and the same is largely true of below investment grade corporate bonds uh excluding the triple C category which is is has some stress in it.
You've have the tightest spreads in the high yield bond market. But both the investment grade corporate bond market and the high yield bond market are better off in terms of their credit quality and uh their their dynamics than they were back before the global financial crisis was which was the last time we had spreads this tight.
um people who think that that the history echoes, they might be worried about corporate bond spreads, but there hasn't been much change in them. And the fact is that the junk bond market is actually smaller uh than it was in recent years because a lot of the really bad credit is going not into the public corporate bond market.
It's going into the private credit market. And that's actually a good thing for the public uh investment grade and junk bond markets because it means that the junkier stuff that would be a a tell on what the default rate you might expect in the public bond market, it might be overstated this time because the defaults are showing up in uh more private categories.
So we're not really negative. In fact, we we added to investment grade corporate bonds at our most recent strategy meeting uh for the first time this year simply because we think the fundamentals are are quite good and also uh we we don't like treasury debt at the longer end and the corporate bond market tends to uh issue in the investment grade side in the 10-year category.
So, to the extent you want 10-year uh maturities, I I think you might be uh just as safe in corporates as you are in long-term treasuries because as the Fed eases interest rates and as the deficit grows, we've seen that in this easing cycle that started 13 months ago, long-term interest rates on treasuries have defied history.
They have not gone down. Yes, they've gone down uh in the middle part of this year, but they're still higher uh and significantly higher than they were back before the first rate cut last September. So, we're avoiding the long end of the of the Treasury market. We rather have uh corporate bonds in the 10-year category.
And we we still like uh the best performing category more recently, which has been local currency emerging market debt, which is one of the best categories. Emerging markets broadly have done well and if you're a dollar-based investor you've done double well because you had done better on the index price changes but you also have the currency translation which is which is translates to a profit for dollar-based investors.
That's also true in the invest in the uh in the local currency emerging market bond uh market which is the top performing sector in recent months. So we continue to be in that category. I have uh reduced my interest in gold once we got above 4,000. And you you'll remember all year I've been talking about kind of a a radical prediction that gold would go over $4,000 you did including including
Yeah. And it's gone up it went up to almost $4,400 which is really nosebleleed levels. I mean there's a there are sentiment indicators called market vein a service that uh polls investors on what whether they're bullish or bearish on various categories and you almost never get a bullish reading that's above the low 90s but the gold reading a couple weeks ago was at 95 which is just unheard of.
So, last time we spoke, I talked about having 25% of a portfolio in gold or or other types of hard asset things, which sounds high uh versus most people's uh uh recommendations, but it worked out pretty well. But I don't I I don't hold that any longer. I you know, there was somebody on the pregame that said what I think is now very timely investment advice, and that is with all these market moves, you really want to think about rebalancing.
uh rebalancing is a very powerful tool. So you want to take things that are at nosebleleed levels like gold was a couple weeks ago and uh you know if you had 25% gold it probably turned into 35% of your portfolio. It it was time to rebalance back down. Right now I think gold has to correct further. Uh we we we've seen about a 50% correction, maybe 40% of its big up move, but I would I would put gold now in my portfolio down to 10% and I would have 5% in other commodities, just a commodity index.
So you'd end up with a little bit more than 10% gold and about 5% commodities. I still like 45% in in stocks. I uh you'd probably be higher than that now. You have to rebalance that uh because stocks have outperformed bonds. But I still like uh having some uh local, you know, dollar a dollar investor in in emerging market equities.
I still like that. And I like non non- US equities from a valuation perspective quite a lot. I like 25% in uh in bonds in bonds. And it's the same it's the same game plan that we've been talking about. It's been working pretty much through the course of this year. and and that's uh intermediate term bonds maybe two years out to 10 years with uh more in the 5 years than the 10 years but also you know not not a lot of long trem treasury bonds we own very very little of long-term treasury bonds we think the curve is going to steepen and then we like these uh these asset back securities and and uh some commercial mortgage back securities which I believe the market is starting to accept even office commercial mortgage back securities we're seeing interest New York there's always interest in Manhattan office, but we're starting to see uh better performance and better acceptance of of Chicago office and surprisingly even some rumblings for San Francisco office.
So, this is a category that remains reasonably cheap. There's nothing super cheap in the entire financial markets right now, but we like and then I would have about 15% in cash right now because I I really think things are at a very aggressive level, not just gold, but which is certainly was at 4,400, but I I certainly think that uh you know the a stock market which is very narrow in breath.
I know it's better than it was before, but when I started following the stock market, it was in the early 70s. I was, you know, 12 years old. But, you know, they called it the Nifty50 and that was that preceded a pretty big correction down, a pretty big drop in 1974, but now we have the Nifty7. Uh, so I know it's a little bit broader than that now, but we, you know, there's a huge difference.
You know, I'm not a momentum investor. I know it doesn't feel it sometimes because we and we do have those huge earnings coming up. So, it's going to be front and center. Hang on with me with just a second. We're back with Jeffrey Gunlock. And the thing I wanted to talk to you about now is something else that the chair said towards the end there.
Um I don't see a broader credit issue is how he answered a question regarding private credit. Um you've had some of the issues around subprime auto obviously that we've all been focused on wondering because of what Jamie Diamond said there's never just one cockroach. You told me like 13 months ago that you were concerned and this was out at Future Proof out in Huntington Beach if you recall the conversation we had then where I asked you as everybody was talking about the prospects of a private credit bubble.
Um you you said you saw one. I'm wondering whether you now see the first cracks in it. Well, there sometimes is one cockroach. I mean with s that that Silicon Valley bank that was sort of a one cockroach situation. A lot of people thought that was the beginning of something and I was I was suspicious that that I thought it might be contained and turned out that was the case.
But there there we are starting to see weaker weaker activity in parts of the lower tiers of the credit market. And there's been more than one sort of write down or or default scenario that's already occurring. And they seem to be occurring kind of in a cluster. It's not like there's one and then six months goes by and then you get another another write down somewhere.
They seem to be happening in a cluster. Kind of like the layoffs are starting to happen in a cluster. So I I just I I I I think that uh private markets broadly have stopped outperforming public markets. That's certainly been the case in in recent times with the public markets doing so well. I I just think that there's going to be a uh liquidation that will occur in the next significant uh economic weakness period that is going to be surprising to people how uh much selling and uh unwinding there's going to be of what I think is an overinvestment in these private markets, both private equity and private credit.
We're already seeing signs of some major asset pools that have got themselves into illlquid positioning because of significant investment in private markets and they don't have any money. Uh you know that was famously Harvard University back when they were getting uh re you know their donors were pulling back because it was going out on on c on campus.
Uh, I think Yale's been talking about liquidating some of their private equity interests and the like and that's usually the sign of overinvestment and the the liquidity will dry up and it will turn into sort of a liquidation cycle. That's that's my map. I don't think it has to happen this week, you know, but it's it's been a process that's been developing over the course of this year, but I think that's going to be at the foundations of the next kind of financial problem that we have in the United States.
and perhaps beyond the United States borders, but certainly there's a lot of investment in that category. So, I I I caution investors. I think if you have liquidity options in uh some some funds, they allow a liquidity option, they'll give you a mark periodically on their private credit book. And if they allow a partial redemption and you don't see any degradation in the marks on the private uh on the private pools, I would I would take advantage of that liquidity function because I think you're going to be getting out at a better level than you'll be uh able to get out at in in future quarters.
So I'm very I'm very uh focused on private credit being an issue. Okay. And we'll follow that. Um you know, there's certainly a lot of focus on it. Uh you've given our viewers a lot to think about today and plenty of actionable ideas. For that I thank you and I look forward to our next conversation which will be after the next Fed meeting which now who knows now what seemed to be a foregone conclusion Jeffrey is going to be anybody's guess. I look forward to being with you then. Thank you. Heat. Hey, Heat.
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