By Lisa Ditkowsky, CFP®
DoubleLine Capital’s Jeffrey Gundlach hosted a webinar in advance of the March 16, 2016 Fed meeting. It was aptly titled “Connect the Dots”, as the DoubleLine Capital founder is so adept at doing. Likewise, “Connect the Dots” is a play on the Fed’s interest rate forecasting chart called the “dot plot”. Once again, thousands of Financial Professionals listened in as DoubleLine Capital impressed with economic data and markets’ insights galore.
As a successful CERTIFIED FINANCIAL PLANNER®, I must be selective about the money manager webinars that I listen to. One thing that stands out about DoubleLine Capital’s calls is that they are “after market close” because the firm’s speakers are actual money managers and traders that are working during trading hours. Likewise, the market is closed for trading for Wealth Managers like me. Fifteen minutes post-market close, I am relaxed enough to allow visons of Bloomberg terminals, S&P Capital IQ Slides and sugar plum fairies to dance in my head.
“The market is saying there is virtually no chance the Fed is going to raise interest rates in March,” Jeffrey Gundlach (correctly, it turned out) opined. Gundlach described the Fed as “still scared” and said, “The markets indeed collapsed after the Fed raised rates in December.”
Gundlach proceeded, “The market would be ill-prepared for a rate raise this month.” Yet, the billionaire fixed-income savant finds it confounding that “The Fed thinks it needs to plan on raising interest rates 300 bps (basis points) over the next three years,” when the Fed admits that there is “no traction at all in real or nominal GDP.”
Since June/July 2014, the Fed has been hiking, and the yield curve has been flattening. DoubleLine Capital’s Gundlach cited the 4.9 percent unemployment rate and 6.27 percent (“and falling”) moving average of the unemployment rate as evidence “it’s premature to talk about a broad-based recession in the U.S.”
DoubleLine Capital’s Jeffrey Gundlach on the Global Economy
Few money managers or economists can take one on an enlightening trip around the world as fast as DoubleLine Capital’s Jeffrey Gundlach. Other money managers opt to show their global prowess with colorful brochures of a developing China or eye-popping stock photos of all the countries they are invested in. DoubleLine Capital slices and dices the hard data from around the world and puts cold, hard proof on my computer screen via charts and graphs from Bloomberg, S&P Capital IQ and other financial information providers.
The World GDP in 2015 was 3.2 percent, pointed out Gundlach. “Maybe China’s even contracting; the data’s kind of unreliable,” he said.
Gundlach provided the hypothetical: “If China’s at zero and not 7 percent…global GDP growth would need to be adjusted lower.” A quick search of TradingEconomics.com reveals that China accounts for a whopping 16.70 percent of World GDP. Hence if China were at zero, as in the DoubleLine Capital Founder’s hypothetical, World GDP would become 2.67 percent.
Per Gundlach, China’s business activity is negative 4.7 percent through the period starting 10/31/11 to 03/01/16, and it has not been positive in a year. “So explain to me how China’s GDP is positive?” Gundlach rhetorically asked. If there is any credence to Gundlach’s doubt that China’s GDP is truly above zero, this drastically alters the global landscape more than half a percent lower in World Gross Domestic Product. That should be a hard pill to swallow for most Financial Advisors because suddenly, it becomes painfully obvious that “Global” and “International” are not easy diversification strategies. It becomes all the more important to look at exactly what countries and currencies money managers are exposed to within their portfolios.
Not surprising, 16 days after the DoubleLine call, Chinese Premier Li Keqiang came out and lowered GDP expectations to 6.5 percent, though couched in optimistic phrasing. TradingEconomics.com projects China’s 2020 GDP to be lowered to 5.5 percent.
“The Yuan needs to be revalued,” said Gundlach. “China’s move to a basket peg is apparent – the devaluation so far is specific to the U.S. Dollar,” he added. A move of a currency to a “basket peg” would value the currency according to various weightings of a basket of several different currencies.
“Global stocks have been moving with the Yuan,” said Gundlach. “The correlation is incredibly high with the global stock market moving down with the devaluing of the Yuan.”
“Japan has had six recessions in a row without an inverted yield curve,” pointed out Gundlach. This means that a country’s economy and stock market could theoretically be in horrible shape without short term interest rates ever rising above long term interest rates. Gundlach also points out that despite the quantitative easing in Japan, Japan’s Nikkei stock market index has performed terribly.
Gundlach turned to the European Central Bank and its continuing quantitative easing relative to the U.S. Fed’s turn to tightening. “The Flintstone tuba: It just didn’t happen. The ECB announces QE, and the U.S. dollar does not rally this time,” said Gundlach referencing the ongoing loose monetary policy in Europe, overlaid with a Hanna-Barbera Flintstone cartoon sound effect indicating a failure or let down.
“The markets are not even acting well with the extension of QE and other forms of monetary stimulus,” said Gundlach. Referencing Europe (and the European Alliance), he said, “The banks are bleeding money. You see incredible carnage in the banking sector.”
Gundlach said that a lot of countries are tapping into their reserves. “Banks have negative interest rates, and they are still paying their depositors,” explained Gundlach. The slides from DoubleLine Capital’s “Connect the Dots” webinar revealed that all major Central Banks around the world, except for the U.S. Fed, are projecting staying negative with interest rates. This includes Europe, England, Canada, Australia, New Zealand, Switzerland, Norway, Sweden and Japan. “I certainly hope the U.S. does not get negative interest rates,” said the DoubleLine founder.
Gundlach went on to talk about inflation, the Fed and markets – topics better summarized in the end of this write-up along with other DoubleLine commentary about the economic outlook in the United States. “South Korea exports are at negative double digits (negative 12.2 percent),” Gundlach added for emphasis of the global problems.
A recent DoubleLine Capital briefing on the Global Economy is like that 2.5-minute scene from CHARLIE AND THE CHOCOLATE FACTORY where Willy Wonka (Gene Wilder) takes everyone on a psychedelic boat ride through a chocolate river tunnel. It is fast and furious and leaves one just a little bit on edge. DoubleLine Capital gives me many proven digestible economic nuggets that I can pass along to Financial Planning clients in a way that makes sense. I thank DoubleLine for that.
DoubleLine Capital’s Jeffrey Gundlach - Bloodless Verdict of the Market
First, Jeffrey Gundlach ran through bond yields as of March 8, 2016: Treasuries at 2.2 percent, Corporates at 1.2 percent, Munis at 0.9 percent, High-yield at 1.8 percent, Ginnie Maes at 1.4 percent, U.S. Dollar-denominated emerging debt at 2.6 percent, TIPS (Treasury Inflation Protected Securities) at 2.2 percent, bank loans down 0.20 percent year-to-date. He declared that G7 Bonds, up 5 percent, are “one of the big winners” (G7 Bonds include the bonds of seven nations – Canada, France, Germany, Italy, Japan, the UK and the U.S.). He referenced the 10 percent return on Japanese bonds and then mentioned that DoubleLine Capital added a non-dollar denominated bond offering to the company’s investments lineup.
“It is simply not true that the dollar strengthens when the Fed is raising interest rates. In fact, the opposite has been happening,” Gundlach repeated a line from his January 2016 “Just Markets” webinar. “The dollar remains in a long term bull market, but in the short term, there’s no progress that’s happening,” he lectured.
Speaking of the Shanghai Composite, Gundlach said that it is supported at 2500, and “it does not seem that interested in going above 3000.” He said the Shanghai Composite “continues to be under pressure.”
Gundlach said that from April 2015 through February 2016, “Junk bonds were down approximately 20 percent” and that “DoubleLine called it.”
Gundlach explained, “Junk bonds remain under pressure because of commodities.” He said that junk bonds “need oil to be above $45 (a barrel) preferably, certainly above $35 (a barrel).”
“Time is not on your side,” Gundlach warned those waiting for the freefall in oil and global commodities to quickly reverse the damage. “Every day that goes by is one day closer to the day of reckoning,” the bond guru ominously added. “As long as commodity prices stay this low, time is not your friend,” he warned, saying it is not a good time to get into commodities. “Low commodity prices are bad for the economic industry,” Gundlach stressed.
“Gold is the only sector that’s up,” the DoubleLine founder advised. However, “I am a little bit nervous in terms of having made 40 percent in Gold Miners. It’s a lot of money to have made in a short time.” Nonetheless, “I still look for $1400.00 in gold,” Gundlach forecasted. On an interesting note, the broad-based Gold Miners were up nearly 60 percent for the previous 52 weeks ending March 27th, but the broad-based investment was down 9.15 percent off its March 17th high. Jeffrey Gundlach talks; investors listen.
Gundlach showed a slide of bond yields in 2015 and YTD in 2016 by investment quality. The more speculative, the harder the yields got hit in 2015, with AAA ratings through B ratings all above one percent so far in 2016. The junkiest (CCC ratings) were down 15.01 percent in 2015 and still down 1.54 percent YTD. Gundlach made clear regarding most of these bonds, “I don’t think that people buying them today are problems.”
However, for longer term holders of debt, “People are getting whipsawed,” Gundlach explained. For example, “When you had the negative interest rate talk, the two-year (Treasury) was smokin’,” he said in his Gundlach-brand slang.
Gundlach pointed to the 5-year Treasury at 1.341 percent, the 10-year Treasury at 1.821 percent and the 30-year Treasury. He said that the 10-year Treasury has moved to the 1.63-1.65 percent level three times in the past few years and that the market has rejected this level.
DoubleLine Capital’s Jeffrey Gundlach on Credit and Energy
The DoubleLine Capital Founder opened his fourth and final tab, “Credit and Energy” with a Connect the Dots picture of an animal. This was the cutesy play on the webinar title “Connect the Dots”. “I used to love these when I was a kid,” Gundlach pontificated. “I don’t know why. It seems kind of trivial,” he added. For a minute, the billionaire economic machine became very human.
“Leverage (borrowed money) in the high-yield market is at all-time highs,” said Gundlach. “Your protections are de minimis by historical standards; so, when defaults come, the recovery is going to be terrible.” The amount of borrowed money in a portfolio or the leverage ratio is important to look at because companies are often forced to refinance debt at much higher rates, or rates simply float higher if floating rate loans are employed. This can be costly or cost prohibitive for companies, and it makes them more likely to default on their debt.
“Year-over-year EBIDTA (Earnings Before Interest, Taxes, Depreciation and Amortization) growth is anemic,” he said, adding that “It’s actually negative if you remove energy from the equation.” Gundlach is fond of removing overwhelming negatives from the “A+B=C” equation and imagining the new outcome.
“We have the biggest caseload of defaults in years,” Gundlach said. “We are starting to see billion dollar bankruptcies.” He also pointed out that the “upgrade / downgrade ratio for all rated bonds is negative.”
“In March, there’s been some CLO (Collateralized Loan Obligation / bank loans) issuance, and that’s helped the bank loans market recover,” said Gundlach regarding lending.
“Oil inventories in developed nations are at a record of three billion,” Gundlach said, turning to the global energy industry. “The gap between supply and demand is widening again.” Reflecting on the recent $95 to $36 Dollar per barrel drop in the price of oil we have had, Gundlach said, “It is odd, the great magnitude that has occurred.” [It is as if the precipitous plunge in energy prices is impossible for the bond manager to explain in slides. In hindsight, I would attribute the fast and furious drop to the domino effect of deleveraging. There must be some point in time when enough borrowers realized that were being hoodwinked by tight money lenders in a loose money world, and the borrowers began to deleverage en masse. Those who could not wipe the debt off the balance sheets suffered skyrocketing costs of capital and doing business. Hence panic set in, and it was Code Red for selling oil].
“It’s not much of a Dollar per barrel rally (oil) in terms of how big a decline we’ve had,” Gundlach responded to a listener question.
Responding to another question, Gundlach said that DoubleLine is keeping the duration toward the shorter end of the yield curve across its portfolios. He also noted the extremely low percentage of CLOs (Collaterized Loan Obligations) in their portfolios.
Then, an Advisor asked about another money manager’s Mortgage Backed Securities fund that Gundlach mentioned in Barron’s in January. “(It) probably went up because I mentioned it in Barron’s,” said Gundlach, showing a hyper awareness of the effect his sound bites and success have come to have. Regarding closed end funds in general, Gundlach said it is “obviously” best to sell them at a premium and buy them at a discount.
“In the U.S., I don’t even think we are going to do QE (quantitative easing) again,” Gundlach said, fielding another Advisor question.
Gundlach also answered that U.S. government bonds would be the type of bonds to own if U.S. interest rates go negative. DoubleLine Capital’s long duration bond portfolio is all U.S. government bonds, the founder said.
“Yes, I do agree that emerging markets’ currencies need to bottom for oil to bottom,” he answered one more question.
“Watch out for buying into the idea that now is the time to be buying risk,” Gundlach cautioned everyone on the webinar and wished us all a good year. He channeled his best Alfred Hitchcock sign off. The whole tone of the “Connect the Dots” DoubleLine Capital presentation reminded me of “Fog Closing In”, a 1956 episode of Alfred Hitchcock Presents (Television) –
This concludes our play for tonight. Unhappily for Mary Summers, however, there is more to her story, for she subsequently found herself in one of those institutions she had come to fear. Next time we shall be back with another story. Until then, good night.
Is there reason for fear? Certainly. Should the fear become pandemic. I don’t think so. The systemic fears are already so baked into the markets. Every major global hub, ex-U.S., is drowning in negative interest-rate seas. The U.S. Fed knows how to keep its country’s head above water, even though the Fed may be doing the doggie paddle in water wings (I say “its” because Janet Yellen alone does not the Fed make).
DoubleLine Capital Jeffrey Gundlach’s Interwoven and Alarmist Comments About the U.S. Stock Market
I want to preface my summary of the DoubleLine Capital bond manager’s analysis of the U.S. stock market by saying that I found it lacking in substantiation and alarmist in tone. Indeed, on March 9th, 2016, leading news sources, including CNBC, lead with Jeffrey Gundlach’s highly debatable quotes about market downside risk potential, assessments that go against the grain of most respected economists.
“We now have Quantitative Tightening (in the U.S.),” said Gundlach. Regarding the U.S. stock market, he suggested, “Bear market rallies look better than this.”
“The S&P has maybe two percent of upside and 20 percent of downside,” Gundlach shocked. Indeed, major financial networks picked up this scary sound bite about the stock market, and the bond guru’s “Ten-to-one ratio” of downside potential in the market comment. Let’s see: Logically, it follows that if there were really only a one-in-ten chance of making money right now in the stock market, everyone would flock to bonds. And, like his fellow billionaire, Trump, branding “Lyin’ Ted” or “Little Marco”, Gundlach seemed to brand the world’s most liquid, stable stock market (the U.S. stock market) in a mere statement. What could be better for a bond manager than all the “smart money” flocking to bonds?
“The set up for risk assets and risk reward is very poor,” Gundlach said. “The markets seem intent on humiliating the Fed if they want to stay with their plan of raising interest rates 300 bps (three percent).” This has certainly held true lately, with higher yielding fixed income and a combination of too-long durations and too-low investment qualities burning investors.
However, consumer discretionary stocks in areas such as retailers, food and restaurants, non-speculative technology and telecom, certain healthcare, shelter and building, utilities and good dividend payers with solid fundamentals are indeed providing a good risk-reward ratio for moderate-risk investors. I also believe market behavior depends on how quickly the Fed raises interest rates. For example, the Fed exercised good judgment in March and did not raise rates. The market behaved.
Still, Gundlach’s precise quote was, “I think we are near the end of a bear market rally with a ten-to-one risk-reward ratio, which is incredibly unfavorable.” He was talking about there being 20 percent downside now in 2016, which is why the news media went crazy the next day. Of course they would! Who can forget an almost 40 percent stock market drop in 2008 or the double-digit compounding drops in 2000 - 2002. The S&P 500 moves in cycles just like every asset class, and at some point in future years, Jeffrey Gundlach will be able to proclaim that DoubleLine “called it” on March 8, 2016. But, Gundlach gave no time frame for his prognosis, leading all the financial media to think he meant that a 20 percent market drop was imminent. News is often about shooting first and figuring out what you shot later.
“High yield and the S&P 500 will converge, and we suggest it will be in the basement,” Gundlach said in his third alarmist statement. As high yield (aka “junk”) bond yields rise, bond prices will drop. Gundlach is suggesting that both the high yield bond market and stock market have a long way to drop. “I think profit margins are going to fall further,” Gundlach said.
Many of Gundlach’s 2015 comments are imprinted in my mind because I wrote an exhaustive article about a financial event in Chicago that DoubleLine hosted for local industry folks. Memorable and useful now is Gundlach’s explanation of high yield debt as a carry trade --
“Gundlach's "Wall Street Week" quoted data unearths that only $50 billion of junk bonds is maturing in 2015 and 2016. His same data reveals that come 2018-2019, $350 billion of Fed debt rolls off the balance sheets, $300 billion more of junk bonds, and another $300 billion of bank loans. So, it is documented that Gundlach told Scaramucci and guests that "investors should be investing down in high-yield bonds" while acknowledging their usefulness as a "carry trade" as long as the stability lasts. However, he said that the historical corporate borrowing default rate of 4 percent that investors have seen over the past 30 years could balloon upward. He also warned that if interest rates are rising in a few years and investors do not have the current desperation in their searches for yield, bond prices will inevitably fall.” – “Reading Between the Lines of DoubleLine”, Financial Advisor Magazine online, June 22, 2015.
DoubleLine is largely avoiding junk in its retail portfolios. Thus, the company can safely make an abysmal comparison between junk bonds and the stock market and not worry about its own inflows. The problem with Gundlach’s comparison is that high yield is one small fragment of the massive fixed income market, and the U.S. stock market is the biggest, most liquid, diverse market in the world. A more appropriate comparison would have been that he believes that high yield bonds and only energy stocks, for example, will meet in the basement. One cannot accurately compare a tiny sector of the fixed income markets with the entire U.S. stock market. It makes no sense, but makes great TV sound bites for looping all day and night. Sure enough, the newswires spread the foreboding sound bite like a National Enquirer hot political retweet.
DoubleLine offered its S&P 500 Stock Market projections as little more than a hunch, and he is a star fixed income manager, not a star equities manager. In fact, Reuters reported on March 4. 2016 that DoubleLine Capital would be shutting down its growth-oriented equities portfolio for poor performance and for lagging most of its peers.
It bears mentioning that CNBC’s Jim Cramer politely railed against Gundlach on his March 9th, 2016 Mad Money show for inciting his Mad Money, retail investor viewers. Jim Cramer translated the alarmist language and made it clear to his stock market investor viewers that Gundlach was not talking to them, is not an equities manager, and that “Booyah!” – There are still lots of good equity buys out there!
CNBC Digital Producer Abigail Stevenson wrote and produced a March 9th, 2016 article entitled, “Cramer: Jeffrey Gundlach wasn’t talking to you.” It is worth referencing because it includes the 4-minute and 20-second clip of Cramer translating Gundlach’s comments and explaining that there still exists plenty of good buys in the U.S. Stock Market –
In his “Connect the Dots” webinar, Gundlach went on to explain why he feels the market seemed to be rallying as of early March. “When you get a little rally in oil, commodities and stocks do better, and people feel better because they don’t think it’s such a deflationary world,” he said. “It is clear that the stock markets fear deflation. The stock markets want inflation.”
Gundlach pointed out that between 03/09/15 and 03/07/16, the correlation between global stocks and inflation has been incredibly high.
However, “People are victims of extrapolating the recent past,” Gundlach said. “It’s a poor idea to extrapolate inflation and to just say it is going to continue moving at this velocity. That just isn’t right,” Gundlach said regarding the anticipating move from an inflation rate of zero to 2 percent headline inflation.
DoubleLine Capital’s Jeffrey Gundlach does float in or near the top 1 percent of bond managers year after year. He has made numerous prescient calls as to the Fed, banking, debt, lending, housing, market sectors, the fixed income markets, commodities, etc. This is why when DoubleLine talks, the financial world listens.
Lisa Ditkowsky, CFP®
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.