Jeffrey Gundlach: DoubleLine Total Return Bond Fund – Summer Insects

On June 9, 2015, Chief Executive Officer and Chief Investment Officer Jeffrey Gundlach held a webcast discussing the DoubleLine Total Return Bond Fund (DBLTX/DLTNX) titled “Summer Insects.” Summary via DoubleLine.

Jeffrey Gundlach: The Bloodless Verdict of the Market

• Performance
  • Winners: High-yield bonds as represented by the BofA Merrill Lynch U.S. High Yield Cash Pay Index
  • Losers: Local currency Emerging Markets (EM) as represented by the Barclays Capital Emerging Markets Broad Local Currency Bond Index (DoubleLine remains U.S. Dollar (USD) denominated across all strategies), German Bunds, Italian and Japanese bonds
  • Credit quality: The best performer has been lower B and CCC-rated
• Global Bond Yields
  • Contrary to consensus opinion, interest rates have gone up when quantitative easing (QE) is announced. They tend to fall when QE is taken away. (ex. European Central Bank (ECB) rates are higher now than when QE was first announced).
  • Europe
    – As mentioned weeks ago, Jeffrey Gundlach believes the German 10-year will make it to 1%-1.25%
    – Reason for low ECB yields – Net issuance of total debt is negative (includes sovereign and corporate debt)
    – Most 3-year bonds in the ECB have negative rates

The Federal Reserve (“Fed”) Policy

• The Fed and USD
  • Fed Funds futures are pricing in a 60% probability of a rate hike later this year; Jeffrey Gundlach believes it is unlikely that the Fed raises rates this year
  • Factors to keep an eye on
    – Nominal GDP and Consumer Price Index (CPI) are well below historical norms for a rate hike
    – Hourly earnings growth has remained weak which has been highly correlated to the Fed Funds Rate
  • Jeffrey Gundlach believes the USD is on a multi-year bull market that started in 2008. Currency trends to average 10 years.
  • Inflation measures
    – The Treasury Inflation-Protected Securities (TIPS) market as measured by U.S. breakeven rates is projecting inflation between 1-2% for all future time windows up to 30 years
    – U.S. Core CPI, which does not include shelter, is as negative as Eurozone Core CPI; As such, Jeffrey Gundlach prefers Nominal GDP when measuring growth because it excludes inflation which can be squishy
  • Gross Domestic Product (GDP)
    – Nominal GDP is a great secular and short term indicator of interest rates
    – Global nominal GDP has declined for the last few decades

• Rising Interest Rates?
  • U.S. Treasury Rates
    – Market forecast for year-end 10-year UST yields are consistently incorrect and are again predicting a 1% increase
    – Jeffrey Gundlach believes the 10-year yields are near the highs for the year. If rates somehow make it above a technical level of 2.60%, all bets are off.
    – He also believes the yield curve will flatten if the Fed raises rates. The long end of the curve wants the Fed to raise rates under the assumption that the current environment is too fragile to do so.
  • Fund flows into Intermediate and long duration funds were very strong at the beginning of the year. The flows look similar to the same flows that left bond funds during the 2013 “taper tantrum.”

Summer Insects

“You cannot discuss ice with a summer insect, as they are bound by a single season” – Chuang Zhu” Most people in the investment business have NEVER experienced a rising rate environment, particularly high-yield noted Jeffrey Gundlach.

• High Yield
  • Jeffrey Gundlach is not concerned about the high-yield market over the short term; He remains cautious long term however due to:
    – The energy sector continued to become a larger percentage of the HY market (similar to autos in 2005 and banks in 2008)
    – The large maturity wall coming in 2019-2021, especially if we have a higher rate environment.
    – Worsening budget deficit
    – Energy companies are using a greater % of revolving credit facility
  • Historically, high-yield spreads have widened following a Fed tightening cycle. Jeffrey Gundlach believes that an investor may do well selling HY at first Fed rate hike
• Bank Loans
  • New issuance Covenant-lite percentage is near and all-time high; the number of covenants has declined

The DoubleLine Total Return Fund (DBLTX/DLTNX)

• Statistics
  • Portfolio is priced below par at $99.08
  • DBLTX duration 3.51 vs. 5.52 of Barclays Aggregate Bond Index
  • DoubleLine intends for the duration to be lower than the Index particularly as rates fall
• Portfolio Composition (as of 2/28/15)
  • 28.8% Agency Pass-Throughs, 23.0% Agency Collateralized Mortgage Obligations (CMO), 22.8% Non-Agency Residential MBS (RMBS), 7.8% Commercial MBS (CMBS), 4.9% CMO, 4.3% Treasury and 7.2% Cash
  • Only 1.8% of portfolio is in Inverse Only (IO) and Inverse Floaters

Question and Answer

• German Bund – Jeffrey Gundlach believes the German 10-year has a target of 1.25%
• Puerto Rico
  • General Obligation (GO) bonds should receive at least 3 more coupons, thus reducing the cost basis to 60. This represents an attractive investment if you believe you will get paid back or even close to fully paid back
  • Pension Obligation ( PO) bonds were pricing in default at 37.5 and are up 20% since Jeffrey Gundlach’s first recommended them over a month ago
• Long bond has recent sold off because of:
  • The Fed’s hesitancy to raise rates
  • Rising European yields which were an anchor for the U.S.

See full PDF below.