Gundlach’s Forecast For 2019Advisor Perspectives
Jeffrey Gundlach said that 2019 will mark the start of a period when bond markets must recon with the rising federal deficit. In his most passionate comments ever on this topic, he said the exploding national debt and liabilities involving pension funds, state and local government governments and Social Security have reached a stage that is “totally unthinkable.”
Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, a leading provider of fixed-income mutual funds and ETFs. He spoke to investors via a conference call on January 8. Slides from that presentation are available here. This webinar was his annual forecast for the global markets and economies for 2019.
Before we look at his 2019 predictions, let’s review his forecasts from a year ago.
His top prediction was that emerging markets and commodities were the best opportunities for 2018. The MSCI emerging market index was down 14.58% last year. But, in fairness, when Gundlach has recommended emerging markets it has always been in the context of a long time horizon – seven years or more. Commodities also did not fare well in 2018. The two largest broad-based commodity ETNs, Shares S&P Commodity-Indexed Trust (GSG) and Dow Jones-AIG Commodity Index (DJP), were down 13.9% and 13.1% respectively.
Related to his commodities prediction, he said the dollar would go down in 2018. It did not; it was up approximately 4.7%.
Gundlach said to avoid the S&P 500, which he predicted would show a loss for the year. It did – the ETF SPY was down 4.45%. He also correctly predicted that stocks would go up in the first half of the year and retreat in the second half.
He predicted economic growth for virtually all countries in 2018. This was accurate; only 14 of the 193 countries tracked in this database had negative GDP growth. He correctly predicted that the U.S. would not enter a recession in 2018.
He said that by the middle of 2018, the Fed and ECB will be shrinking their balance sheets, and potentially Japan will as well. The Fed did contract its balance sheet last year, but those of the ECB and BOJ grew.
He correctly advised investors to short bitcoin. It was down 73.3% in 2018.
He said it was a “horrible time” to buy investment-grade bonds. Indeed, the ETF LQD was down 3.79% for the year.
On the fixed-income side, one of Gundlach’s most-cited prediction was that if the 30-year Treasury yield closed at or above 3.22% on two consecutive days – and, related to that, the 10-year closed above 3% – it would mark the end of the 30-plus-year bond bull market and would trigger a selloff in stocks. According to the official Treasury data, the 3.22% level was breached on October 3 and 4, precisely when the stock-market selloff began. The 10-year yield first hit 3% on April 24.
Let’s look at what he said will happen in 2019.
A recession is unlikely in 2019
Don’t expect a recession in 2019, Gundlach said, although a number of key economic variables are “flashing yellow,” warning that a recession is more likely than it has been in the recent past.
According to a Merrill Lynch survey done in December, over 80% of fund managers don’t expect a recession. Yet there is a lot of pessimism. Those same fund managers who expect real global growth was at its lowest level since 2008.
Gundlach also noted that 90% of asset classes had negative returns in 2018, the largest such percentage since 1901. Once the Fed started its quantitative tightening (QT) policy, he said the stock market responded with negative returns.
The Conference Board leading economic indicators (LEIs) have dropped sharply in last couple of months, he said, but are a “long way from going negative,” which has always happened prior to past recessions. The market has priced in the fact that the LEIs have dropped but are not at recession-predicting levels.
“Recessionary ideas are not priced in the market,” he said.
The manufacturing PMIs are “looking bad,” he said, and the most recent data had its biggest drop since 2008. This “bears watching,” he said, and the next observation will be extremely important.
Industrial production data looks similar to the PMI data, according to Gundlach, and both of those metrics can deteriorate rapidly. “The market will be on pins and needles looking for whether this data stabilizes,” he said.
Business and consumer sentiment data is “not bad,” he said, but worse that it had been in 2018.
Ominous signals are coming from the housing market. Gundlach said it was “really shocking” that mortgage applications are at their lowest level in 18 years. Construction layoffs are the highest since 2006 which, he said, shows how interest rates are affecting the economy and housing industry. Incomes have not kept pace with home prices, which are up a lot more than incomes.
The employment data released the prior Friday was “pretty good,” Gundlach said,, with 320,000 new jobs. But many of those gains were among old people, presumably reentering the workforce. This was not a sign of sustainable growth, he said. The 3.9% unemployment rate is above its 12-month moving average, which is an early warning sign of a recession, according to Gundlach.
Consumer expectations have been reasonably good predictors of recessions, according to Gundlach. This is one of those “flashing yellow” indicators, but he said the timing of its recession prediction is uncertain.
Junk-bond spreads “blew out” prior to the last couple of weeks, Gundlach said, nearing recession levels. They “kind of” look like spreads approximately six months prior to a recession, he said.
Another of the flashing yellow recession indications is whether Treasury bill yields exceed global bond-market yields. They just reached the same level, Gundlach said; Treasury bills had been lower since the end of the financial crisis.
Headline and core CPI are at 2.2%, slightly above the Fed’s 2% target. Headline CPI will fall as the crude oil price decline makes its way into the inflation data, according to Gundlach. Core inflation won’t come down, he said, based on the data from the N.Y. Fed UIG indicator, which has a very high correlation to core inflation 18 months hence.
Businesses are reporting problems getting quality labor, he said, which is predictive off higher wages. Average hourly earnings have been rising this year as well.
Global market predictions
Gundlach offered a few broad predictions for global markets.
The dollar will be stronger in 2019, he said, and this will lead to outperformance among emerging markets. Emerging markets are nearing a point that would suggest a “strong upswing,” he said. “This is a time to invest in emerging relativistically.”
Stay out of Europe, he said, which is a “value trap.” The euro may go higher, Gundlach said, which won’t help European equities.
Gundlach called this the “chart of the year”:
It shows that U.S. stocks and non-U.S. markets moved together starting on January 26 (when U.S. markets hit a peak) until May, when the S&P started doing much better. But since December, those markets have diverged with the S&P moving higher relative to global markets. The takeaway is that they are likely to converge again, and that the S&P will retreat and/or non-U.S. markets will rally.
Read the full article here by Robert Huebscher, Advisor Perspectives