Here is what Dan Sullivan had to say yesterday (July 27, 2011) after a volatile downdraft in the markets:
“The market averages have actually given an okay account of themselves. All of the averages are still in positive territory for the year. With our models in a positive mode, our advice for long term investors… is to stay fully invested.”
He went on to make the following comment in reference to what he calls the “debt ceiling debacle”:
“A credible case can be made that US budget deficits have been rising for over a decade and that investors have known this for quite some time. The financial crisis and recession have exacerbated the deficits in the past few years, but none of this is new to the marketplace. Even with the heightened awareness of the rising US debt burden, long-term interest rates have remained low. Therefore, it is quite possible that interest rates will remain low even if the U.S. credit rating is lowered.”
And finally, he reiterates his long-term view on investing, which accurately reflects my personal investment philosophy:
“Our experience over 42 years of investing validates our conviction that to be successful in the stock market you must have a disciplined plan and follow it. The investor without one will invariably make decisions that are self-defeating.”
The second expert is Jeffrey Gundlach, the founder and chief investment officer of DoubleLine Capital, a California-based fixed-income asset manager.
He has done exceedingly well throughout his investing career, and almost always goes against the consensus of the so-called “experts” in his field, with very favorable long-term results. Gundlach believes that Federal Reserve Chairman Ben Bernanke is “exactly wrong”—at least as far as the Treasury market is concerned—when he states that failing to raise the debt ceiling would be a “huge financial calamity.” This outcome—a huge financial calamity—is, of course, the general consensus view.
Gundlach disagrees and states that rates might actually go down, just as they did after the end of the last quantitative easing program orchestrated by the Fed (also known as “QE2”.)
“If there is no debt ceiling passed, it will force the government to essentially implement a ‘de facto’ austerity program,” Gundlach said. He believes that payments made to many government departments would stop, including those to some defense contractors. Coupon payments on the Treasury’s debt, however, would continue, he said.
Gundlach is far less optimistic, however, about the longer-term outlook.
“We are getting close to the end of the road” and must forestall a larger crisis caused by the government’s growing debt burden, he said.
Over the longer term, the government has four options left to deal with its debt problems, according to Gundlach.
- First, it can default on its Treasury bonds, which he said will not happen. It will, however, default on its entitlement obligations, in that future retirees will not enjoy the same Medicare and Social Security benefits as today’s retirees, he said.
- Second, revenue increases might be instated, possibly in the form of a value added tax, an income tax increase or an increase in corporate tax rates.
- Third, the government could continue to print money and risk higher inflation, he said, calling this a “print-and-pay” scenario.
- The fourth option is what Gundlach called “threading the needle.” The government could pursue some inflationary policies which might grow nominal GDP by as much as 6% annually, while freezing government spending and keeping short-term interest rates at zero and 10-year rates below 4%. But that is unlikely to succeed, he said.
The economy can’t grow at that rate while government spending is frozen, because GDP relies too heavily on government programs.
“More realistically,” he said, “we are left with a default on something, which is a form of cutting spending if it’s entitlement programs, taxing or print-and-pay.”
He expects cuts in defense spending and ultimately some reductions to entitlements. Either would be a “weakening factor” for the economy, he said.
Gundlach advised investors to construct their portfolios to defend against all of these potential outcomes by including inflation hedges, an income stream and protection against potential defaults.
*Past performance is no guarantee of future results*
*Nothing contained in this quarterly newsletter should be construed as investment advice*
