Gundlach: Market has discounted tapering concept
Jeffrey Gundlach, DoubleLine Capital CEO, discusses corporate credit and default rates. Low rates prompted companies to refinance rather than default, Gunlach says.
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you’re right about the default rate. it’s basically nonexistent. we would probably have had about the right timing for a default cycle based upon the issuance patterns of 2009, 2010, but rates are so low, they’re at the all-time lows in yields, particularly for junk bonds. a lot of companies that under normal circumstances might have defaulted got to refinance instead. junk bonds or investment-grade corporate bonds. with corporate profitability as a percent of gdp record high, the fundamentals are pretty good. the problem, though, is valuation. when we’re at the end of 2013, the year end, long bond, 30-year treasury bond yielded about 4% and sort of unbelievably, in my opinion, double b corporate bonds using barclay’s data yield only 4.5%. that’s a really remarkably low incremental yield to go from a government guaranteed credit to something that has some default risk, although it might not be in the near term. in fact, we do evaluation analysis on my team that we’ve been doing for over 20 years that kind of compares historical patterns of return for corporate credit junk bonds and other sectors versus the treasury bond market. as of december 31st, 2013, the valuation of junk bonds as a category was at its all-time overvalued versus long-time treasury bonds using that analysis. interestingly, investment grade corporate bonds were also at their most over-valued level in history versus long-term treasury bonds. the problem is valuation. junk bonds yielding 4.5% for the double bger are so attractive, why do you simultaneously think that 4.0% is horrible, which most people think it is on 30-year treasury bonds? . quickly before we get to stocks, you do like corporate debt. you have a good amount of it in the close end fund, which had a rough 2013. why do you select this stuff? again, it’s valuation argument. the valuation of emerging market debt is about average versus treasury bonds, one of the only categories on a par value. most categories are over valued. securities are fairly valued and emerging market debt are fairly valued. those are kind of the two. the real risk in emerging market bonds seems to be the currency risk more than anything else. if you go dollar denominated obviously you don’t have that currency risk. last year corporate junk bonds in the u.s. had a 7% positive return and emerging market debt had a negative 5% return or so. and that kind of a divergence is historically very, very rare. there is something to mean reversion. we keep hearing taper for the rest of the year, given what happened in june and what happened in emerging markets, why would you want to own this stuff? there’s something called discounting in markets. the markets have acted exactly the opposite as everyone seems to think they’re supposed to. since tapering started, equities have been struggling. bonds have been doing well. emerging market debt is positive return in year to date. ta’s not struggling due to tapering. maybe we just talked the tapering so completely to death that the markets have discounted the concept of tapering. and this has been a pattern that has happened the last couple of times also the stimulus was removed or reduced in the economy. it actually led to bond rallies and performance of assets that are more he can with wit related. emerging markets have largely discounted the tapering. and we need some other variable to come into play to really start to get worried about a repeat of 2013 there.
Gundlach: Amazed at China’s massive growth
Discussing global economic growth and China’s shadow banking system, with Jeffrey Gundlach, DoubleLine Capital LP CEO.
well, the world hasn’t started out that great in 2014. i keep hearing about downgraded global economic growth from — you just did a segment on cnbc about russia growth being downgraded. chinese growth being downgraded. i have a feeling chinese growth is going to underperform the downgraded expectations. it’s sort of a miracle what’s happening in china when you think about it. i saw a news piece just yesterday that talked about how chinese growth is now estimated to be about 7.4% in 2014. and that would actually amazingly be their lowest growth since the year 1990. can you imagine that? that many years of growth at 7 1/2% or higher? it’s really amazing that the chinese authorities have managed to hold that amount of growth together. i mean, their gdp is up like 14 times in the past 20 years or so. and it kind of reminds me of like an investment firm that starts up. you know, it’s like two guys in a bloomberg in a garage somewhere imagining $100,000. and suddenly a year or two later they’re super successful and they’ve got $10 billion under management. you start to worry about managing that growth. is the compliance there. they really have their controls in place. and you wonder how the chinese manage to do this with this massive growth and keep it under control. you know, a lot of people say don’t worry about chinese growth. if it slows down to 7%, it’s an autocratic economy and they will get it back to 8% or higher. and they have had it at such a high level for so long it makes me wonder why all of us are so fond of free market capitalism. if you can put an autocrat in place and ramp up growth to 8% or higher — well, why don’t we — put an autocrat in place and get our economy humming at 8% rate. i think there’s a downside risk of fairly substantial proportion somewhere. maybe it’s not this year but there’s got to be a entrenchment at some point. that’s maybe a reason why we need to be worried. and, of course, there’s that shadow banking system problem that we all sort of loosely about for the last several of years. and up with of these days maybe it will be a problem.
Gundlach: QE will not end in 2014
Jeffrey Gundlach, DoubleLine Capital LP CEO, weighs in on Puerto Rico’s debt crisis and shares his thoughts on how the bond market will function under Janet Yellen.
give me your take on this. i know you’re not muni focused but none the less this is a huge credit. very important in general to the municipal markets and bond markets. 2 to 3 million geo deal, 9% coupon to yelled 10%. would you buy it? it’s not my cup of tea. i think it’s going to be fine though for investors that are not of the faint of heart. i think that at the end of the day, puerto rico will make it even if it’s only because of assistance from the federal government. so if you really want to make some money but aren’t afraid of losing a little sleep at night i uerto rico bonds are fine but they’re going to be volatile. my strategy and my kind of — the way i deal with investments, i don’t like that kind of volatility. the puerto rico bonds, i think, will make it to the goal line for investors that want to take that kind of risk. thanks for letting me get out a little bit of that news, of course, if they do come to the market they may not need to for quite some time. let’s get to the broader bond market now, jeffrey. we heard from yellen yesterday. continuity, if, in fact, that is the case, and the fed really does end qe, for example, in 2014, who is going to buy the bonds? well, first of all, they are on path as everyone knows who reduce qe by $10 billion every meeting as a base case. my suspicion, though, is that they will not end qe in 2014. there will be some reason probably because of market volatility to slow down the taper, even stop the taper, and maybe — maybe there’s a 50/50 chance to even have to go back the other way. but if — answering your question specifically, if interest rates rise because of tapering of the qe and if also stocks do better than they’ve started out 2014, we’ve got something of a mini repeat of 2014, the institutions will be the ones that buy the bonds because the funding position of corporate pensions in the united states really improved radically in 2013 because beyond yields rose which is why they value their liabilities at and stocks rose which is a lot of their assets are invested in. if that’s going to happen again as a hypothetical you would see corporate pensions in the united states with fully funded status in many cases which would be overwhelmingly tempting to lock in. think of the you’re a pension officer in the large corporation in 2008 and 2009, just how much indigestion and anxiety you had as you saw your funding status plummet and the markets have bailed out, particularly in 2013, and with asset gains in prior years as well in equities have bailed out the funding status of these corporate pensions. so there’s a huge bid for bonds at yields somewhat higher than they are now. so above, what, above 3%, you think? in other words, they would basically be able to immunize their forward liabilities. where is it though? 3, 3 1/2? probably 3 1/2 to 3 3/4 on the ten-year to make that happen. it would have to happen, also, simultaneous with equities doing better. it’s a possibility. i’m not sure it’s the base case but certainly a possibility. right.