In a career spanning more than three decades, Jeffrey Gundlach had never seen the conditions the bond market faced last week. Indeed, he said the “setup for the 10-year Treasury was the worst in his career.”
Gundlach spoke to investors on July 12 to provide updates on two mutual funds, the DoubleLine Core Fixed Income Fund (DBLFX) and the DoubleLine Flexible Income Fund (DFLEX). He is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, known for its fixed-income mutual funds, closed-end funds and ETFs. Copies of his slides are available to download here.
Two elements created the ominous market conditions, according to Gundlach. Yields had moved to new lows, and investor sentiment became exceedingly bullish on bond prices.
His concerns were justified. Since July 5, the yield on the 10-year Treasury has risen 16 basis points, from 1.37% to 1.53%. The previous low yield for the 10-year was 1.39% in July 2012.
The bullish sentiment in the bond market, Gundlach said, was from pundits who were calling for a 1% yield on the 10-year. But the return from that move would be too small to compensate for the risk of an adverse move in yields.
The misguided bond-market sentiment can be found in statements like, “Bond yields simply cannot go up,” and, “Nothing can make them go up.” Gundlach said that sentiment is similar to early this year, when gold was at $1,075 and may claimed it could not go up. But gold went up 30% to its current price of nearly $1,400.
“I don’t like investments where, if you are right,” he said, “you don’t make any money.”
“If you are going to speculate on something, do it where you’ll make some real money,” Gundlach said. Wheat is “down massively,” he said. It may not go up, but if it does you’ll make 10% or 15%, according to Gundlach, which is a better deal than the 10-year Treasury.
Gundlach added that to make money on the 10-year, it would need be sold to “some greater fool at its lowest all-time yield.”
Let’s look at Gundlach’s comments on the economy and the broader bond market.
Banking troubles, the economy and a possible recession
One of the reasons the set up for bonds was so negative, he said, is because of troubles in the banking system. Below is what Gundlach called the “chart of the quarter”:
It compares the price movement of Bank of America’s stock from 2005-2009 to that of Deutsche Bank since 2013. In both cases, there was a slight appreciation followed by a “total collapse,” he said.
Deutsche Bank’s stock closed at $14.10 on the day Gundlach spoke. He predicted that when its price goes to single digits you will see calls for bailouts, and pointed out that this is already happening in Italy and Germany.
The next response to those bank problems will be “bond unfriendly” – deflationary – and will take everyone by surprise, he said. Those responses could include bailouts, “helicopter money” or a large fiscal stimulus, according to Gundlach.
Ironically, Gundlach said that the U.K. – the country that is leaving the EU – has actually been the strongest of the big European equity markets. That is based on the FTSE 100, which is an index of large firms. Those companies have been aided by the collapse of the pound, Gundlach said, and that currency weakness has started to reverse....MUCH MORE