Discussing bond yields in a recent interview with Bloomberg’s Tom Keene, DoubleLine Capital CEO Jeffrey Gundlach explained that the bond market hasn’t entered a New Normal period, as Bill Gross and Mohamed El-Erian used to say, but a No Normal period where we can’t really asses what the driving paradigm is going to be.
No confidence in future policies makes bond markets difficult to analyze
“Economic growth was at a relatively high level because every time it was decelerating or it was headed towards a recession there was some new debt gimmick that came up, so that’s how we went from 1980 to 2006 – 2007 when we had this monstrous increase in public and private debt,” said Gundlach. “Now we have the situation where the funding of retirement benefits and health care benefits will start to worsen the deficit again, starting around 2017, and we don’t really know how we’re going to deal with that.”
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Gundlach makes it clear that he doesn’t assume bond yields will go up in the near term. The baby boomers are now retiring and approaching retirement at a rapid pace, and they are looking for conservative investments with little downside risk. This demographic demand for Treasury bonds will put pressure on yields even when other investors are starting to stay away.
The bigger question is what will happen in six to ten years when financing needs push rates up, but Gundlach doesn’t think anyone can say with confidence what sorts of policies will be put into place to deal with the situation.
High yield corporate bonds ‘most overvalued in history’: Gundlach
One reaction to low yields has been increased enthusiasm for high yield corporate debt, but Gundlach doesn’t think there is a strong value argument for high yield. First, he compares high yield to 30-year Treasury bonds (instead of 5 or 7 years) because it has a similar risk profile. At the beginning of 2014, 30-year Treasury bonds had a 4% yield compared to 4.4% for BB corporate bonds.
But corporate bonds face a number of risks that Treasury bonds don’t. If rates fall the bonds can get called in and refinanced, if yields rise you can lose out on interest rates, and if defaults pick up then the 4.4% won’t actually be achieved regardless.
The result is that Gundlach sees high yield corporate bonds as “the most overvalued in history,” relative to Treasuries.