JEFFREY GUNDLACH'S RULE OF INVESTMENT RISK
Jeff Gundlach, the legendary investment manager at DoubleLine Funds, hosted another one of his very popular public webcasts last night.
His presentation — titled "The Big Easy" — focused on the distortions that are created by central bank balance sheet expansion.
Gundlach is particularly concerned about what he called "circular financing schemes." This is when the government issues debt and the central bank buys it.
While these efforts may limit economic volatility in the near-term, it never eliminates the risk. Ultimately, you end up with much larger imbalances later.
Here's a rough transcription of the Gundlach's explanation from last night's call:
"This is what I call Gundlach's Rule of Investment Risk. If you run things and you try to get them very smooth, without ever any downside, you're trying essentially to eliminate the frequency of problems. I believe the frequency of problems times the severity of problems when they occur equals a constant. Frequency times severity equals a constant. That is Gundlach's Rule of Investment Risk. When you try unnaturally to push into the future problems, and quantitative easing is designed to do that, you end up increasing the severity of the problem."
In summary:
(Frequency of Problems) x (Severity of Problems) = A Constant
If you think of this in terms of economic recessions, then you can have two scenarios: 1) frequent, yet shallow recessions or 2) infrequent, yet deeper recessions.
For now, Gundlach believes the Federal Reserve "will keep [easy monetary policy] going for not months, but years."
However, he is worried about what will happen further down the road.
"It wont show up until something tails out, which the Fed doesn't think is going to happen," said Gundlach referring to the economic calamity that is being put off. "I find that to be very disturbing. I think that running a circular financing scheme cannot work over the long term. If it does, we've solved all the world's financial problems, but i just don't think that's the going to be the case."
Gundlach offered his "Rule of Investment Risk" while presenting the chart below.
