Gundlach: Bond Yields Could Hit 6% in Five Years
Trader Scott’s Market Blog
November 14, 2016
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Jeff Gundlach is one of the few big time money managers whom I respect (Stan Druckenmiller is another). Jeff did an interview with Barron’s (subscription)a few days ago in which he gave his bearish outlook (long term) on Government Bonds. I certainly generally agree – but on a much shorter term basis the yield explosion is getting way overdone and is nearing a resistance area (blue arrow). My belief is that most folks are vastly underestimating how much this multi-decade bear market in bonds will be like a wrecking ball thru numerous industries globally. For instance, the effects on junk bonds will ripple thru fracking, retailing, telecom, P2P lending, etc. There are other posts about this and more later, but we will be dealing with this for decades, so we might as well focus on this tenaciously. But it is the rallies in bond prices when you want to put on the longer term bearish bets. And lastly, Jeff talks about TIPS which will do much better under inflationary scenarios. An alternative to TIPS, and my preference, is I-Bonds.Although they were much more attractive in several ways many years ago. The Barron’s interview is below:
You heard it here first: Jeffrey Gundlach, CEO of DoubleLine Capital and one of the world’s most successful bond investors, predicted in January at the Barron’s Roundtablethat Donald J. Trump would be the country’s next president, noting, “The populist momentum is unstoppable.”
Now that the New York businessman has shocked much of the world by vanquishing rival Hillary Clinton, Gundlach sees something else unstoppable: a rise in bond yields that could lift the yield on the 10-year Treasury note to 6% in the next four or five years.
Trump’s pro-business agenda is inherently “unfriendly” to bonds, Gundlach says, as it could to lead to stronger economic growth and renewed inflation. Gundlach expects President-elect Trump to “amp up the deficit” to pay for infrastructure projects and other programs. That could produce an inflation rate of 3% and nominal growth of 4% to 6% in gross domestic product. “If nominal GDP pushes toward 4%, 5%, or even 6%, there is no way you are going to get bond yields to stay below 2%,” he says.
The yield on the benchmark 10-year Treasury bond rose 0.27 percentage point in the two trading days following the election, to end the week at 2.15%.
While the bond bull market ended in 2012, Gundlach says, he turned “maximum negative” on bonds on July 6, two days before the 10-year Treasury yield hit a multi-decade closing low of 1.366%. He predicted shortly thereafter that the 10-year yield would top 2% by year end.
After last week’s rapid run-up, Gundlach won’t rule out “a tradable rally in the bond marketbefore year end.” But the longer-term trend likely is higher. “The idea that inflation and interest rates can never go up is a very tired narrative, born of years of stability in both,” he says.
Gundlach, whose Los Angeles firm manages more than $100 billion, has been selling bonds and buying Treasury Inflation-Protected Securities, or TIPS, which he calls “my favorite investment as of two months ago.” The principal of a TIPS increases with inflation, as measured by the consumer-price index.
TIPS are still cheap relative to nominal bonds, despite a recent move up, he says. In August, Gundlach replaced the Treasuries held in the DoubleLine Flexible Income fund (ticker: DFLEX), which he manages, with TIPS, a swap affecting about 10% of the portfolio. He also sold Treasury bonds and bought TIPS in the DoubleLine Core Fixed Income fund (DBLFX). Both funds are beating their benchmarks this year.
IN THE AFTERMATH of Trump’s victory last week, Gundlach commended the long-shot Republican candidate for “playing the electoral game to win,” and cited three reasons for Clinton’s defeat: the WikiLeaks revelations that cast her in a highly unflattering light; votes cast for third-party Libertarian candidate Gary Johnson; and skyrocketing health-insurance premiums on the marketplaces created by the Affordable Care Act, aka Obamacare. Open enrollment in health-care plans began Nov. 1, just a week before voters headed to the polls.
Gundlach says he hasn’t formulated an opinion yet on what’s next for the stock market, partly because of the difficulty of reconciling opposing forces: on the one hand, pro-growth policies, and on the other, higher rates, which would pose competition for stocks. “If rates stay around these levels, it is probably a net positive for stocks,” he says. “But if they move sharply higher, I don’t see how stocks withstand it.”
Moreover, he says, “the structure of the U.S. economy and the pricing of the stock market are predicated on 1.5% Treasury yields and zero short-term interest rates.” Rising rates would hurt the U.S. housing market and possibly dent corporate stock-buyback programs. Buybacks helped boost share prices in recent years and were funded, in many cases, with borrowed money.
While Trump’s policies could stimulate the economy in the near term, the future could look darker, given a potentially “unacceptable” level of debt to GDP. “With rising interest rates and rising debt levels, we are going to have to make some tough decisions,” he says.“What are we going to do in terms of collecting taxes and distributing government revenue? What will we do about Social Security, Medicaid, Medicare? That is what the 2020 election will be about.”
Trader Scott has been involved with markets for over twenty years. Initially he was an individual floor trader and member of the Midwest Stock Exchange, which then led to a much better opportunity at the Chicago Board Options Exchange. By his early 30’s, he had become very successful in markets, but a health situation caused him to back away from the grind of being a full time floor trader. During this time away from markets, Scott was completely focused on educating himself about true overall health and natural healing which remains a passion to this day.Scott returned to markets over fifteen years ago where he continues as an independent trader.