A collapse in the corporate bond market could rival the sub-prime debacle a decade ago, according to Jeffrey Gundlach.
Q1 hedge fund letters, conference, scoops etc
Corporate bonds are not as overvalued as sub-prime mortgage debt was prior to the financial crisis, according to Gundlach. But because the corporate market is so much larger than the sub-prime was, the overall exposure to investors could be of the same scale. Indeed, “We could easily see $400 billion in losses,” he said.
Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital. He spoke to investors via a conference call yesterday. Slides from that presentation are available here. The focus of his talk was DoubleLine’s asset-allocation mutual funds, DBLFX and DFLEX.
Gundlach’s fear is rooted in the excessive amount of corporate debt, particularly bonds that are rated BBB, the lowest investment-grade rating, just above high yield.
Corporate bonds have been rich by one standard deviation for most of the last three years, he said, and now are at an “outright sell” level. A massive amount of corporate debt is weighing on the corporate bond market, and a lot of bonds are “complacently owned.”
Gundlach cited a Morgan Stanley report that showed the oversupply and weak ratings standards that could lead to downgrades. Based on corporate leverage ratios, 38% of the corporate bond market should be rated junk, according to Gundlach. That’s actually an improvement over the last time he cited this data, when the corresponding metric was 45%.
“This could mirror what happened to the sub-prime market during the financial crisis, in terms of the mis-rating of bonds,” Gundlach said.
He added that the corporate bond market is five-times the size of the sub-prime market prior to the crisis, although it is neither as mis-rated nor as misunderstood.
The high-yield market is just as expensive as the investment grade market, Gundlach said, and spreads are totally inconsistent with corporate debt levels.
Elsewhere during the webcast, Gundlach warned of excessive fiscal indebtedness, uncertainty surrounding Fed policy, exposure to a weakened dollar and the risk of a recession. Let’s look at those comments.
The global economy
Quantitative tightening has stopped. Gundlach said investors are left with a confusing picture of Fed direction.
The S&P has outperformed the rest of the world by a factor of two since the financial crisis. The reason, he said, is that earnings in the U.S. have grown at an even greater rate than the doubling of the stock market performance. Since last summer, however, the markets have had similar performance.
World stock market performance has been pressured because the European banking system is a “basket case” due to negative interest rates, according to Gundlach. Deutsche Bank’s stock is at its all-time low and Credit Suisse is flirting with its low.
GDP growth is not as great as Trump claims, Gundlach said. Real GDP is in “okay shape” at 3.2% growth. Some of that is due to the deflator that adjusts nominal to real GDP growth being “kind of screwy,” he said, due to a time lag in reporting. Manufacturing PMI has fallen sharply, he said, but not to recession levels.
Read the full article here by Robert Huebscher, Advisor Perspectives
