Bond Guru Jeffrey Gundlach of DoubleLine Capital appeared on CNBC on Dec. 11 for an interview. Gundlach is famously savvy when it comes to reading the economy and foreseeing potential problems, making his insights helpful even for hardcore equity investors. Here are some of the key takeaways from the interview.
According to Gundlach, the Federal Reserve wants inflation to be higher and is coming up with a story of strenthening the economy to legitimize that desire. Both the Fed and Central Banks worldwide want to have interest rates below inflation rates.
According to Gundlach, we are not really getting out of the post-crisis situation in terms of monetary policy. Fed Chair Powell came in saying he would be tightening monetary policy, but three weeks later it was exactly the opposite. Instead of raising rates, he has been cutting them. The only thing Gundlach likes about the Fed's stance is that Powell has said he doesn’t think negative interest rates are a good idea.
The Fed is meant to follow its own purpose regardless of what outside forces say. The Fed is now comfortably on hold, after Powell raised rates 4 times and then cut them 3 times. We’ve gone nowhere except for a wild media ride hyped far beyond the actual effects of the minor interest rate adjustments on the economy.
If left to market forces, long term interest rates would probably rise. There is not much chance with the Fed following through on its mid-cycle talk. Even if inflation goes up, they are not going to change policy. The Fed has turned into a body that follows the market.
Recession forecast
Gundlach does not see an imminent recession. Earlier this year, he put the chance at about 60%, but he has since brought that estimate down to 35%. He now sees a recession as being likely only near the end of 2020.
That doesn't mean he likes everything in the economy today. Job growth under Trump is 10% less than it was under Obama, though there are fewer approved claims of employees being layed off. The consumer view of the present economic situation is still pretty high, and Gundlach predicts that weekly unemployment claims will have to start rising for recession risk to increase.
Gundlach is extremely bearish on a trade deal with China, holding that there will be no trade deal until the 2020 election. There is no need for China to make a deal now, as they may get a deal with a more old school person after the election. The most thorny issue is the theft of intellectual property. China doesn’t want to change its views on the ownership of ideas, and this is the biggest sticking point for the U.S.
Gundlach says there is potential (if there is economic weakness) of an echo of the taper tantrum in the U.S. We had a 150bp rise in the 10 year because, as Bernanke said, “we are thinking about tapering.” However, this is not going to happen in the next 3 weeks.
How to invest?
- Play defense against interest rate risk
- Credit risk right now is very dangerous
- The time to exit the corporate debt market is now
- Gundlach likes TIPS
- Gundlach believes mortgage bonds are relatively undervalued
- The dollar will go down
Morgan Stanley research says that if you use only leverage ratios, 39% of the corporate bond markets should be rated junk. If that is the case, you would see horrific drawdowns in this space.
Spreads in corporate bonds are very narrow at the moment, as are nvestment and junk spreads. The percentage of the investment-grade bond market that is AA rated is historically low.
Foreigners are buying U.S. corporate bonds and not hedging. That’s why the dollar has held on to a relatively stable position. However, the dollar should be falling soon based on two things:
- The Fed is loosening monetary policy
- The trade and budget deficits are rising, which is historically correlated with dollar weakness
The dollar has held up thus far because of naked dollar buying by foreign buyers. If the dollar starts weakening, we will likely see waves of selling.
The question in Europe used to be, "how do we suffer through this low yield environment?" Now the question in the U.S. is, "will we be in this no yield environment forever?" Should we take away these negative-yielding bonds from our asset allocation altogether and just move up the risk spectrum?
In bonds, you make money quickly and you lose money quickly.Ă‚ This underwriting cycle is going to end so badly that you can risk being early in sidestepping it.
Gundlach called the Trump win in the 2016 election. He has some interesting views on the chances of various candidates.
In his view, the base case is for Trump to win the election. The democratic party is in disarray, and no single democratic candidate has captivated the audience. A potential front runner would have need to have shown more momentum by this point. Not even Biden seems to be gathering steam.
Bernie is Bernie. Nothing new there according to Gundlach.Ă‚ Warren has yet to recover from her drop in the lead.
Buttigieg is a great speaker, the best since Ronald Reagan, but he’s so young. It is a big step to go from 50,000 votes to enough to get the presidency.
Bloomberg has no chance. Right out of the gate he has major problems as an ex-major of New York. Bloomberg has a problem with his stop and frisk policy, and behavioral mitigation taxes are not going to fly.
The strongest candidate the democratic party has is Hillary Clinton. However, Gundlach says a Trump win has the distinct advantage of the market potentially holding up better in the face of fears of an upcoming recession.
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