Is this the end of the bull bond market?
Renowned DoubleLine Capital CEO Jeffrey Gundlach, fund manager of the $2.5bn Nordea 1 - US Total Return Bond Fund and the $36m Nordea 1 - US Bond Opportunities Fund, reveals his view of the bond market in 2017.
As a part of its multi-boutique model, Nordea Asset Management (NAM) acquired bond guru Jeffrey Gundlach, CEO of DoubleLine, to manage its Nordea 1 - US Total Return Bond Fund and Nordea 1 - US Bond Opportunities Fund, which was launched in 2016. Gundlach is recognised as one of the world’s foremost authorities on bonds and other debt-related investments. His reputation is built on a willingness to make forthright calls on the market – however contrarian they may be. He accurately predicted US treasuries and US government mortgage backed securities would rally in 2011, and correctly anticipated yields would fall in 2014 and the dollar would rally substantially.
In light of the Fed’s recent rate hike and indications it will hike again, Gundlach’s insights on how rising interest rates could impact the global market are apropos. Asked what the implications of US rate hikes will be for other bond markets, Gundlach points to signs of inflation in the Eurozone, UK and even Japan. “Germany’s CPI in December 2016 was at 1.7%, the highest level in sixteen years,” he says. “There is no way yields are staying at the current extremely low levels if inflation is at 2% or higher. Seems Bunds are quite vulnerable.”
Gundlach correctly called the election victory for Donald Trump, despite a chorus of voices to the contrary. Now, he says, the Trump presidency has given investors a sense of confidence – evident by the renewed interest for equities, particularly financials and industrials, which performed well post-election. “The dollar rose to the highest level in years as uncertainty over trade policy loomed,” he says. “But Trump’s success may be highly dependent on measures like higher average hourly earnings and greater opportunities for employment. What we know is that Trump will likely expand the deficit to build out infrastructure and the military, which can promote GDP growth in the short‐term if done right, but will likely add to the deficit in the long term. We may well be looking at a trillion plus dollar deficit by the next Presidential election. It also remains to be seen what shape the tax and trade policies will take and the effects they will have. Trade remains a mystery until the policies are made clear. Consumers could be greatly impacted if tariffs are imposed on China and Mexico as a value‐added tax.”
So what will Trump’s aggressive spending (which will add to the deficit) combined with rising rates (which will increase the interest on the debt) mean for bond yields? “As rates rise this year, we should take a look at 3% on the 10-year US treasury in 2017,” says Gundlach. “If yields accelerate to the upside above 3%, it is truly the end of the bull bond market, but not just for bonds. Times are a-changing and most markets would be impacted.”
What does this mean for high-yield corporate bonds? “If the 10‐year accelerates above 3%, junk bonds will fall into a black hole of illiquidity.” And for equity markets? “Stocks are trading at a very high level relative to earnings. The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, is nearing 1929 levels. Expect earnings to expand this year and P/Es to fall,” says Gundlach, who recommends peeling back on US stocks and diversifying globally. In particular, he favours emerging markets, India and the Nikkei.
Asked to elaborate his optimism about commodities, Gundlach points to the end of the multi-decade bottom in 2015. “I recommend adding commodities or real assets to a portfolio,” he says. “I expect oil to move sideways this year and stay in a range between 40’s and higher 50’s. Inventories are still high. Gold appears to have bottomed as well in 2015. I like a permanent position in gold. It is rising again, but I am not enthusiastic about it. However, I would stick with my positioning as a diversifier. Copper being down since December is supportive of the bond market rally. If it starts outperforming gold the economy is revving up.” Gundlach is not so positive about the dollar though. “We are eight years into the rally since 2009,” he says. “I am not bullish.”