Jeffrey Gundlach correctly predicted that oil and junk bonds would suffer in 2015.
But some are hoping his call on the U.S. election – that Donald Trump will become president – won’t come true.
A few folks exchanged worried glances when Gundlach, CEO of DoubleLine Capital, told a Renaissance Investments seminar in Toronto last week, “I think he’s going to win.”
Why? The electorate is dissatisfied with the anemic economy. “There’s not enough global growth to go around,” Gundlach points out. “When you have 2% global growth, the good [countries] are up at 5% and the bad [countries] are at -1%. When you have negative [growth], people are unhappy, and they want you to do something.”
And Trump says he’ll do something. He promises to end what he considers bad trade deals and bring jobs back to America. “He’s going to build a wall. […] He also says he’s going to build up the U.S. military. There’s going to be a lot of deficit spending.”
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Gundlach opined on several other topics and gave investment tips for a low-rate environment.
Gundlach’s not worried about a recession. He says we’ve never had a recession when unemployment is below its 12-month moving average, as it is right now. “The good news is we’re not flashing a warning signal. The bad news is, in three months, [we] might. The unemployment rate has stopped falling in the U.S.” If unemployment goes to 5.2%, that could be a harbinger of recession.
He adds that as long as the quarterly unemployment rate is below the three-year moving average, there shouldn’t be a recession. “And we’re not even close to a crossover,” he says.
We’re in a capital preservation environment, and we should expect lower returns, he says. He’s long gold and gold miners, and he likes bond portfolios that earn 3% to 4% without a lot of interest-rate risk.
“The worst place to be [is in] investments that are perceived to be safe, but aren’t,” he says. He points to low-volatility stock funds, calling the moniker “an oxymoron.”
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Instead, if you’re going to own risk, have a low allocation but “buy things that people think are scary as hell, which means high beta – emerging markets. I wouldn’t have large percentages, but at least [the risks are] priced in.”
For instance, he owns 8% Puerto Rican municipal bonds. “I bought them at 65 [cents on the dollar]; [they’re] triple tax-free for U.S. taxpayers. People think I’m crazy. I say, ‘It’s at 65. So what if they restructure? I’m earning 8% fully tax-free.’” By contrast, he says, folks are comfortable owning Illinois munis. If Puerto Rico restructures, he thinks Illinois will too, “and they’re not priced at 65. That’s risky, and people think it’s safe.”
Gundlach adds he’s a careful investor all around. “In bonds, you make money slowly, and you lose money quickly. It’s okay to sell early, and it’s okay to miss something because you thought it was too risky. We’re proud of being cowards, because it saves us.”
“Negative rates are an incredibly bad idea,” Gundlach says. “I believe the U.S. will never go there, because the evidence that it doesn’t work is piling up.”
In Europe, for instance, the euro has actually strengthened against the U.S. dollar after the ECB went negative. Further, “stimulus isn’t doing anything for the [European] stock market.”
And in Japan, “they went negative this year, and their currency has taken off like a scalded dog – it’s strengthened by about 10%.” And the Nikkei is now way below its peak.
What will happen now? “They’re going to give up on negative rates, but first, they’ll try even more negative rates in a bizarre act of insanity.” When that doesn’t work, Gundlach expects we’ll see “fiscal stimulus in the form of helicopter money.” He points out that it’s already happened: “George W. Bush gave everybody $500 twice. In Sweden, they’re giving everyone $600 a year — even billionaires.”
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Interest rates and junk bonds
He senses complacency about U.S. interest rate risk among investors. “I’m quite defensive,” he says. “[Rates] will gradually rise over the next three years.”
He expects a sharper increase near the 2020 U.S. election, when large tranches of corporate and Treasury bonds will come due. “We’ll have trillions of dollars in bond supply. What if we’re already under a secularly rising interest rate environment? [That] would mean higher interest rates and a very difficult high-yield bond market.”
He points out the modern junk market has only ever seen falling rates. “What if a company has a maturity that can’t be re-borrowed at a lower interest rate?” For instance, what if a high-yield bond issued at 5% in 2014 has to be rolled at 12%? “I think the default rate is going to be much higher than we’re used to.”
As for the current market, junk bonds are far off their highs of June 2014. “Typically the junk bond market is a better indicator than the U.S. stock market,” he says. “This is an excellent sell point for junk bonds, because the default cycle is heating up.” We’re also seeing more ratings downgrades than upgrades in the broader credit market, he adds, which usually signals future defaults. “Fifty percent of all energy high-yield bonds could default.”
To save the energy sector, Gundlach says we need months of $60 oil. But, with inventories still quite high, “I don’t see $60 oil even a day in 2016. I have a hard time believing we’ll push much higher than $45 to $50.”
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