August 6, 2014 9:35 am

Gundlach reveals 2020 vision for bond market

It is not only hindsight that is 20/20. While other bond fund managers are explaining why they failed to see this year’s fall in interest rates, Jeffrey Gundlach, who did, is talking not about the past but about the future, and his next piece of foresight is focused onbelieve it or not 2020.

“A lot of things seem to be pointing to the year 2020 as an interesting timeframe,” he says, sipping cool lemonade in the Los Angeles heat. Mr Gundlach is the founder of DoubleLine, which went from a standing start in 2009 to $50bn in assets to become the fastest start-up ever in the fund management industry.

When a bond market maven says “interesting”, be scared. What is good for fixed income is rarely good for the economy as a whole, and Mr Gundlach has a whole list of interesting: a wall of high-yield debt that companies will need to refinance; soaring federal government deficits as baby-boomers drain social security and healthcare funds; ageing populations in China and other emerging markets; and the Federal Reserve’s Treasury holdings maturing, too.

His conclusion? By 2020, the Fed may well be resurrecting quantitative easing, its palliative for troubled markets.

“It seems like one of the consequences of this zero interest rate policy is you’ve pushed out the problem of refinancing, of rolling over, but you’ve really compounded the magnitude of it and it seems to be focused around the 2020s.”

Mr Gundlach has agreed to squeeze an interview in before a trip to New York state, where he is circling the auction of his hometown American football team, the Buffalo Bills, hoping to become a minority investor and ensure it stays in the down-at-heel city on the US side of Niagara Falls.

Quantitative easing has been kind to Jeffrey Gundlach the art collectorMondrian and Jasper Johns are among the personal holdings stolen and then returned after an art theft in 2012 – but it may not be so much for Jeffrey Gundlach the putative sports team owner. These are precisely the luxury assets, along with London and New York real estate and classic Ferraris, that have soared in value as money has been pumped into the system, he says.

Mr Gundlach’s star status, his supreme self-confidence and a strong track record stretching back to his earlier career inside TCW, made him an obvious heir to the “bond king”, Bill Gross, even before the Pimco founder hit a period of poor returns and negative headlines this year.
DoubleLine’s assets under management pale next to the $1.9tn at Pimco, and Mr Gundlach’s Total Return Fund and his smaller but more comparable DoubleLine Core Fixed Income fund add up to $36bn versus the $223bn in Mr Gross’s flagship fund. But where Pimco called the bond market all wrong at the start of the year, when the overwhelming consensus was for 10-year Treasury yields to march upwards from 3 per cent, Mr Gundlach reckoned on weak economic growth and weak housing and a slide in yields. Today, they are below 2.5 per cent.

If you GoogleInterest rates will fall in 2014what pops up is a whole bunch of articles that say bond prices will fall in 2014 because yields will rise. It picks up the search in a convoluted way

There’s only a couple that actually specifically answer that request and one of them is ‘Gundlach says interest rates will fall in the first half of 2014’. But I thought it was one of the easiest calls.”

Even after a 4 per cent print for second-quarter GDP (inflated, he says, by inventory stocking), he believes forecasters and equity market investors will eventually be disabused of the idea that the US economy is reachingescape velocity”.

They cling to the idea now, he says, “and then all of a sudden they won’t. It’s kind of like punching a pumpkin. It’s the same thing, the same thing, the same thing and then all of a sudden it all caves in. I would still be surprised to see full-year 2014 GDP exceed 2 per cent.”

That does not mean that DoubleLine is not positioning itself to capitalise on economic growth of sorts, at least in the area of mortgages, where the US government is trying to persuade private capital to fund loans without needing guarantees from federal agencies Fannie Mae and Freddie Mac. Mr Gundlach is close to signing a deal with a mortgage originator, who will offer loans that do not qualify for those guarantees and which can therefore be bundled into securities with a higher yield, which DoubleLine will place in its hedge fund.

“I think that people who are looking for the catalyst for the next mortgage meltdown are fighting the last war,” Mr Gundlach said, dismissing the notion that private-label mortgages would be subprime by another name. “I think the chance of that is really almost infinitesimal.”

No, the next crisis will be something else, he says. Something on that list. Something that requires 2020 vision.

Copyright The Financial Times Limited 2014.

August 6, 2014 5:54 pm

India’s Narendra Modi confounds devotees and detractors alike

India’s prime minister will fulfil neither the hopes of fans nor fears of foe, says Victor Mallet

Hindu nationalist Narendra Modi, prime ministerial candidate for India's main opposition Bharatiya Janata Party (BJP) and Gujarat's chief minister, walks during their national council meeting at Ramlila ground in New Delhi January 18, 2014. REUTERS/Ahmad Masood (INDIA - Tags: POLITICS) - RTX17JBK©Reuters
After the celebrations: Narendra Modi has to deliver on promises to revive a spluttering economy that will benefit all Indians, including Muslims

At first they thought he would do too much. Now they worry he will not do enough.

When Narendra Modi was swept to power in May by the election victory of his Bharatiya Janata party, Indians were divided between those who eagerly awaited wrenching economic reforms and those nervously anticipating the Hindu nationalist agenda of an authoritarian leader.

Almost three months on, it is clear that Mr Modi will quickly fulfil neither the fervent hopes of his fans nor the worst fears of his detractors.

Indeed, his first weeks in charge of the world’s largest democracy have been marked more by unexpected foreign policy initiatives than by revolutionary economic or political announcements at home.

Mr Modi has sought to improve ties with India’s smaller neighbours. He hosted regional leaders, including Nawaz Sharif of Pakistan and Lobsang Sangay, Tibet’s prime minister in exile, at his inauguration, and has visited the Himalayan states of Bhutan and Nepal.

Shashi Tharoor, the Congress member of parliament and former UN official, was so impressed by Mr Modi’s lack of post-election hubris and his foreign policy acumen that he was attacked by his colleagues in the opposition for writing an article in praise of the prime minister.

Some of Mr Modi’s supporters, on the other hand, are nonplussed. They are disappointed by his near-silence on domestic matters, his obsession with foreign affairs and the absence of “big-bangeconomic reforms after a decade of lacklustre Congress rule; “underwhelming” is the word used in New Delhi to describe the government’s first budget in July.

Here is a government that came in with a lot of hope, riding a tide of high expectations, promising change. Ennui has already set in,” writes Bibek Debroy, co-editor of Getting India Back on Track , a book telling the government what it should do.

Missing energy, the government increasingly looks aged and jaded and is riding one of the steepest anti-incumbency curves witnessed in recent times,” he says in a column in this week’s India Today magazine.

Pratap Bhanu Mehta, president of the Centre for Policy Research, is equally scathing – he says the nation grows restless while Mr Modi seems to be trappedin his own echo-chamber” – but he is less concerned by the domestic economic agenda than by the government’s clumsy handling of education and environmental protection, its renunciation of a previously agreed international deal on world trade and by Mr Modi’s failure to speak out against communal violence in the northern state of Uttar Pradesh.

“I think UP is in a real mess. It’s actually frightening,” he says.

Mr Modi’s supporters, however, insist there is more going on than meets the eyes of impatient business leaders who wanted spectacular moves on tax reform, privatisation of state companies and the repeal of old-fashioned labour regulations.

Mr Modi, his defenders say, can be blamed neither for the unrest in UP, which is largely the fault of the corrupt state government, nor for delays to economic reform: the defeated Congress party, for example, intends to use its support in the Rajya Sabha, the upper house of parliament, to block an increase in the foreign investment cap for insurance businesses from 26 to 49 per cent, despite having championed the same plan when it was in power.

According to Gurcharan Das – a businessman, author and cautious admirer of Mr Modi – the new government may have eschewed dramatic announcements but has quietly moved to improve the bureaucracy and make life easier for India’s 1.3bn inhabitants.

Self-attestationmeans citizens will no longer have to seek out and bribe an arrogant official to certify their documents. Senior civil servants, galvanised by the new prime minister, have apologetically returned calls to potential investors and reopened discussions on deals that had been stalled for months.

Quiet implementation is the mantra of this new government,” says Mr Das. “The deficit of this country is execution – we are a country of talkers not of doers.”

Arun Jaitley, finance minister and public face of the administration, endorsed this version of events in a television interview this week in which he defended the government’s record and explained why reforms were not proceeding as fast as some had hoped. “The art of reform in India is to persistently, doggedly move in one direction,” he said.

In India, as in other democracies, it is essential for a newly elected government to move quickly to enact reforms that are controversial or take time to bear fruit, before the commitment of the winning party fades and previously enthusiastic voters begin to have doubts.

Mr Modi will rightly be accused of having lost his political touch if he fails to make use of the mandate provided by the biggest Indian election victory for a generation. But he is a methodical manager who likes to hear a range of opinions before making his decisions. After 10 weeks of his new government it is too early convincingly to accuse him of hesitation, let alone failure.

Copyright The Financial Times Limited 2014.

Japan’s Self-Defense Defense

Joseph S. Nye

AUG 6, 2014
Prime Minister Shinzo Abe

CAMBRIDGESince the end of World War II, Japan has been ruled by an American-written peace constitution,” Article 9 of which prohibits war and limits Japanese forces to self-defense. Prime Minister Shinzo Abe is now seeking legislation to enable Japan to reinterpret the constitution to includecollective self-defense,” whereby the country would enhance its security cooperation with other countries, particularly its closest ally, the United States.

Critics view this as a radical departure from seven decades of pacifism. But Abe’s central objectivesimproving Japan’s ability to respond to threats that do not amount to armed attack; enabling Japan to participate more effectively in international peacekeeping activities; and redefining measures for self-defense permitted under Article 9 – are actually relatively modest.

Fears that the move would lead to Japanese involvement in distant US wars are similarly overblown. Indeed, the rules have been carefully crafted to prohibit such adventures, while allowing Japan to work more closely with the US on direct threats to Japanese security.

It is not difficult to see why Abe is pursuing broader rights to self-defense. Japan lies in a dangerous region, in which deep-rooted tensions threaten to erupt at any moment.

Given that East Asia, unlike Europe after 1945, never experienced full reconciliation among rivals, or established strong regional institutions, it has been forced to depend on the US-Japan Security Treaty to underpin regional stability. When US President Barack Obama’s administration announced its “rebalancing” toward Asia in 2011, it reaffirmed the 1996 Clinton-Hashimoto Declaration, which cited the US-Japan security alliance as the foundation for stability – a prerequisite for continued economic progress – in Asia.

That declaration served the larger goal of establishing a stable, albeit uneven, triangular relationship among the US, Japan, and China. Subsequent US administrations have upheld this approach, and opinion polls show that it retains broad acceptance in Japannot least owing to close cooperation on disaster relief following the Tōhoku earthquake and tsunami of 2011.

But Japan remains extremely vulnerable. The most immediate regional threat is North Korea, whose unpredictable dictatorship has invested its meager economic resources in nuclear and missile technology.

A longer-term concern is the rise of China – an economic and demographic powerhouse whose expanding military capacity has enabled it to take an increasingly assertive stance in territorial disputes, including with Japan in the East China Sea. China’s territorial ambitions are also fueling tensions in the South China Sea, where sea-lanes that are vital to Japanese trade are located.

Complicating matters further is the fact that China’s political evolution has failed to keep pace with its economic progress. If the Chinese Communist Party feels threatened by a public frustrated with insufficient political participation and enduring social repression, it could slip into competitive nationalism, upending the already-delicate regional status quo.

Of course, if China becomes aggressive, Asian countries like India and Australia – which are already disturbed by China’s assertiveness in the South China Sea – will join Japan in the effort to offset China’s power. But, as things stand, a strategy of containment would be a mistake. After all, the best way to engender enmity is to treat China as an enemy.

A more effective approach, spearheaded by the US and Japan, would focus on integration, with a hedge against uncertainty. American and Japanese leaders must shape the regional environment in such a way that China has incentives to act responsibly, including by maintaining strong defense capabilities.

Meanwhile, the US and Japan must rethink the structure of their alliance. While the expected revisions to Japan’s defense framework are a positive development, many Japanese still resent the lack of symmetry in the alliance obligations. Others chafe at the burden of US bases, particularly on the island of Okinawa.

A longer-term goal should thus be for the US gradually to transfer its bases to Japanese control, leaving American forces to rotate among them. In fact, some basesnotably, Misawa Air Base north of Tokyo already fly Japan’s flag, while hosting American units.

But the process must be handled carefully. As China invests in advanced ballistic missiles, the fixed bases on Okinawa become increasingly vulnerable. To avoid the perception that the US decided to turn the bases over to Japan just when their military benefits were diminishing, and to ensure that the move represented America’s recommitment to the alliance, a joint commission would have to be established to manage the transfer.

For Japan, becoming an equal partner in its alliance with the US is essential to securing its regional and global standing. To this end, Abe’s modest step toward collective self-defense is a step in the right direction.

Joseph S. Nye, a former US assistant secretary of defense and chairman of the US National Intelligence Council, is University Professor at Harvard University. He is the author, most recently, of Presidential Leadership and the Creation of the American Era.