Deck + Notes from DoubleLine’s Jeff Gundlach

6-27-13 JEG Market Update by zerohedge

Last week, Jeffrey Gundlach of DoubleLine funds did a webcast, discussing his most recent slide deck. This followed a month of volatility and rising rates. My friend Laura sent me a full rundown of notes from someone a friend of hers who sat in on the webcast (Laura, please forward that name!).

This is a follow up to his last webcast a month ago (notes from that webcast follow these notes. The full presentation is attached.

Gundlach believes the liquidation and massive volatility is most likely over, and that creates some opportunity in specific sectors: EM stocks, closed end muni funds, long end UST and HY corporate bonds. Some of those sectors now have a good value proposition due to the rate rise and spread widening. He still likes the NKY up to 14,000 and is still short the yen.

1. Interest rose more than he expected.

2. Recent interest rate rise has nothing to do with inflation…CPI and PCE both well below Fed’s target. The PCE (Fed’s preferred target) is at half century low.

3. Gold is weak, partially as a loss of inflation hedge. Consensus is gold is going to $1000. Pivot point has been taken out. Chart is ugly.

4. CRB index is eerily stable at low level…feels it could fall below “shelf” and fall to 400. Partly because China is not growing as people think it is.

5. Incomes are stagnant, China is slowing, no global growth…this selloff has nothing to do with inflation

6. Dollar is strengthening…also deflationary for US

7. Global equity markets have been dropping led by Japan and Shanghai

8. NKY finding support at 12,500…thinks it will go back to 14,000

9. Enormous underperformance of EM equities…causing stress among investors

10. Liquidation has seemed to have ended. Expecting things like EM equities to correct…this is a good place for a contrarian play for next few weeks.

11. Brazil is a concern due to social unrest…but a basket of EM equities looks attractive.

12. Shanghai is ugly…brand new low…this along with commodity prices are saying there is no growth in China and the world.

13. Bank of China is shadow tightening…Shibor rates saying Chinese banks not comfortable lending to each other…a concern for Chinese banking system

14. Expecting stability in July to come back

15. Labor market still stressed…employment to population ratio is not recovering along with other job metrics…difficult to make case there is either economic growth or inflation in the pipeline.

16. Fed talking out of both sides of mouth…how does he reduce his GDP and inflation expectations…and talk about reducing QE? Said Fed is basically funding the budget deficit. So tapering is OK if deficit goes down, but Fed not communicating that properly.

17. Higher rates hurt leveraged markets…EM, HY, MBS, muni, etc…margin calls breed selling breeds more deleveraging breeds concern about credit which breeds more selling…this is what really happened past month. Some markets really gave investors big losses which caused concern (EM, MBS, etc), and not the generic rise in rates.

18. Housing market is facing major headwinds now due to major increase in mortgage rates, on top of higher prices. Change in affordability has been huge past month. This will hold back economy for near term.

19. The past 6 weeks, UST was best performer out of Lehman Agg index…in a relative sense, of course. Corporate bonds and MBS fell much more as spreads blew out due to deleveraging. So you can’t say UST are the problem…UST is the tail, not the dog.

20. Yield curve seems too steep now relative to Fed policy. He thinks the worse is over for UST.

21. HY was a big trouble point with leverage money getting stopped out. HY index dropped 7% over past 6 periods. The liquidation cycle seems to have run its course and market has come back. The worse seems to be over for HY for now.

22. HG also dramatically underperformed UST during past 6 weeks.

23. TIPS not protecting you from inflation based on market moves relative to time frame of inflation. Doesn’t like them. Not as against them now at these levels though. But he does not see inflation coming any time soon. The markets in June are telling you “deflation”.

24. Mortgage REITs…NLY as proxy…seeing some but not a lot of rebound.

25. Investors were lulled to sleep by Ben for two years…now he changes his tune to remove leverage…and investors found themselves over-invested. So people have sold to de-risk and get back to more comfortable risk levels.

26. He likes closed end muni funds here…negative price actions has caused massive discounts in the 6-8% range…oversold.

27. HY is now a good value proposition and value buying will stop the route

28. Thinks QE will continue until we see negative consequences. One was too much leverage in the system. If we are done with the liquidation cycle, then Ben did a decent job.

29. If you sell any bond funds here for fear of higher rates, you should keep cash…for if bonds go down again, everything will go down.

30. Thinks will see yields lower at end of year than what we see now…and by a substantial amount to capture decent profits

31. Gold has less than 20% downside from here, and up to 50% upside…but will probably go down first…but wouldn’t bother selling now if you have ridden it all the way down…starting to buy gold now if you have none makes sense.

32. He thinks people have foolishly redeemed bond funds. Thinks there is good value there now.

What is the World is Going on?
June 4, 2013

Policy changes are having an effect on volatility and thus equity markets. Still short yen and A$. Not long any European assets. Dislikes TIPS.

Likes bank loans, USD denominated EM corporate bonds and non-agency mortgages. Also starting to like long term UST at today’s levels.

I. Euro-zone
a. Bail-in of Cyprus where over $100K, 40% is taken is a disturbing development
b. Hot growth areas are centered in Asia and Africa. All global GDP growth coming out of BRICs
c. He believes China is fabricating numbers and is not growing near 7%.
d. The weakness of China economy is causing weakness in commodities…like copper, iron ore, etc…if CRB index breaks below 18 month “shelf”, the index could go down to 400.
e. Very concerned if global growth is supposed to be driven by China
f. North America has tepid growth at best
g. Australia growth likely to taper off due to exposure to China.
h. From 6 months ago, all growth expectations have been lowered, expect for Japan.
i. Global GDP growth on a declining path past 3 years…people increasingly playing a market share game…one great example is Japan, who is just trying to make their exports more competitive relative to other Asian countries. More countries will debase currencies to compete and even start to increase other actions such as tariff.
j. Yen will be weak for some time to come…next 5 years
k. Nikkei seems like it has seen its highs for time being…well deserved rest…but now is not a good time to exit the Nikkei
l. Around 12,500, that would be a good entry point…but won’t see new highs new years. In part of topping process.
m. EZ has no country that has strong economic growth…double recession due to austerity where the US kept growing
n. The Fed will reduce QE…tapering…the Fed is trying to match up size of purchases as compared to deficits…so right-size QE to match financing of budget deficit 1 to 1 and not more than that. The Fed wants to distort markets in a certain way…disturbing they are trying such fine tune manipulations. High probability of negative consequences.
o. EZ’s biggest problem is unemployment, especially among under 25 yo. QE has hollowed out the saver class (older workers), meaning they can’t retire, so young people can’t find jobs. Will cause disharmony among population.
p. But central banks have orchestrated very low yields for all countries, especially higher risk ones. But peripheral yields are starting to edge up again.
q. The ECB may be forced back later this summer to address bond market issues.

II. US
a. No inflation. Period. Expectations have turned down. Dislikes TIPS.
b. TIPS just not a great timing mechanism for protecting against inflation…market just doesn’t move at right time.
c. No inflation in commodity prices or wages either
d. Doesn’t really see deleveraging in balance sheets. Total US debt not going down…just a shift from households due to mortgage write-downs to government due to student loan and auto.
e. He doesn’t think yields will go much higher from here.
f. If 10 yr goes over 2.30%, the Fed has to rethink how it talks about policy…would have to talk about increasing QE as the economy would be too negatively shocked from those higher rates.
g. Higher rates will also blow out the Treasury’s budget as interest costs would balloon out of control very quickly…the increase in annual interest cost would dwarf the amount of money politicians are trying to cut due to sequestration.
h. That means there is a put on bonds…not on stocks…there is support on stocks, but there is a direct put on bonds
i. Corporate taxes: current structure not sustainable. Highest nominal rates, but low net receipts…while corporate profits at historical highs…taxes not keeping up with profits.
j. Corporate profits unlikely to keep going in the need for more tax revenue and focus on class warfare.
k. P/Es are at risk if future profit ratios are likely to go down. Could be a stressor for stocks. But this gives a cushion to corporate bond defaults.
l. In order to have inflation, you MUST have wage inflation…that is just not happening…median income not changed since 1994. Personal income on a real basis has not moved in 7 years
m. Wage inflation is nonexistent…1.75%…barely keeping up with inflation
n. No labor market traction as the % of population being employed is now at a multi-decade low. Some of that is demographic and retirements, but the lower employment ratios can’t support population and governmental needs.
o. Just like EZ, the low interest rates are hurting the saver group, so people can’t retire, thus the under 25 yo group is having hard time finding jobs
p. We need the retirement and eligibility ages to go up. The young people can’t support the older cohort needs
q. He thinks this is a horrible time to be exiting bonds and good time to enter

III. Housing
a. Refinancing index dropping with rise in rates
b. Mortgage rates exploded in May…so higher home prices due to supply shortage and higher rates is a dangerous combinations for housing…alters affordability for housing and makes people question whether they want to chase housing prices going forward.
c. Funds being raised to buy and rent houses are a big loser waiting to happen. Economic formula doesn’t work in the backdrop of higher prices, higher rates and strained consumers.
d. Doesn’t like homebuilders…prices of lumber is weak while homebuilders are strong…what is going wrong there?
e. Doesn’t like mortgage REITs. NLY ok for income, but prices won’t go up with dividends going down. But NLY is a buy at $12.
f. Buying longer term MBS in here