Playing Gundlach's 2017 Market Calls With ETFs

We recap the DoubleLine founder's market calls for the year and suggest what ETFs investors can use to piggyback on his advice.

sumit
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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

A few weeks ago, bond guru Jeffrey Gundlach held his annual webcast, where he shared his outlook for financial markets in 2017. The presentation, titled "Just Markets," featured a number of bold calls by the outspoken founder of DoubleLine Capital.

Though known as a bond fund manager, Gundlach was not shy about making calls on other markets, or even areas outside of finance. From equities to commodities to currencies to politics, DoubleLine's founder let his opinions be known.

For investors looking for actionable ideas, Gundlach's webcast was a treasure trove. He wasn't shy about recommending areas of the market to buy and areas to avoid. In this article, we'll recap some of Gundlach's most prominent calls and suggest what ETFs investors can use to piggyback on the advice.

Diversify Equity Exposure Internationally

One theme Gundlach returned to throughout his presentation was that most Wall Street analysts were too bullish on U.S. equities. While Trump's policies will likely lead to an acceleration in economic growth from the "forever-2%-regime" the country has been in, offsetting that is the fact that price-earnings ratios are so high.

"I do not share the consensus view that you should be all-U.S. in your equity portfolio―far from it," said Gundlach. "This is one of the periods you should start diversifying."

Gundlach pointed out that the cyclically adjusted price-to-earnings ratio (CAPE ratio) is at 25 for U.S. stocks. For developed markets excluding the U.S., it's at 14; for emerging markets, it's at 10. With valuations so much lower elsewhere, "you should peel off a part of your U.S. stock exposure and move internationally," he explained.

Emerging Markets To Outperform S&P 500

In particular, Gundlach likes emerging markets. He said EM stocks could outperform the S&P 500 in 2017. If that happens, ETFs such as the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares Core MSCI Emerging Markets ETF (IEMG) are a better bet than the SPDR S&P 500 ETF (SPY).

Gundlach also mentioned two countries he's bullish on: India and Japan. The former is a country he's mentioned in the past; he likes it secularly because of favorable demographics and the prospect of economic reforms that will take place gradually in the years to come.

The iShares MSCI India ETF (INDA), the WisdomTree India Earnings Fund (EPI) and the iShares India 50 ETF (INDY) are the three largest exchange-traded funds targeting the country.

 

As for Japanese stocks, Gundlach said he's bullish on them because Abenomics is supportive, and there's "tremendous automatic buying from pension plans, the central bank and buybacks." He also said the yen will continue to weaken more. Thus, he recommends hedging currency exposure for investors buying Japanese stocks.

ETFs such as the WisdomTree Japan Hedged Equity Fund (DXJ), the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP) and the iShares Currency Hedged MSCI Japan ETF (HEWJ) offer exposure to Japanese equities while hedging currency risk.

Meanwhile, though he likes the charts for European stocks, Gundlach said he doesn't recommend them. "I don't like Europe because of the election risk in France and the Netherlands in the first half of 2017," he said. "I expected a year from now we'll be talking about increased trouble in the eurozone."

Rates Could Hit 6% In Five Years
As primarily a manager of bond funds, Gundlach had much to say about the asset class that's his bread and butter. From the start, he was clear in his expectation that bond yields would rise for a third year in a row. Part of that has to do with the Federal Reserve, which Gundlach expects to hike rates two or three times in 2017. Part of it also has to do with rising growth and inflation expectations.

"Rates are going to rise in 2017," proclaimed the bond guru. "I think almost for sure we are going to take a look at 3% on the 10-year Treasury [this year]. If we take out 3% on the 10-year, it's bye-bye bond bull market; rest in peace."

Longer term, Gundlach expects even higher rates. He reiterated his surprising call, originally made during the middle of last year, that the 10-year Treasury yield could be at 6% four or five years from now. According to Gundlach, the economy and inflation today are similar to how they were in 2006, when interest rates were last trading around 6%.

Shorten The Duration Of Bond Portfolios
Though a big jump on the surface, it's not necessarily bad for bond investors if rates went from 3% on the 10-year to 6% over several years, explained Gundlach: "You're getting higher bond yields at the start of every year."

"If you manage the portfolio properly, the return on a bond portfolio may not be that dissimilar to a scenario where rates stayed the same. You're reinvesting constantly at higher rates, and as long as you don't have a very long duration on your bond portfolio, you actually want rates to move higher over time; it will lead you to have higher returns," he added.
 

Gundlach emphasized that in the rising-rate environment he envisions, shorter-duration bonds and bond funds will be a better bet than longer-duration bonds and bond funds.

ETFs such as the iShares 1-3 Year Treasury Bond ETF (SHY), the PIMCO Enhanced Short Maturity Active ETF (MINT) and others offer low-duration bond exposure for investors. On the other hand, funds such as the ProShares Short 20+ Year Treasury ETF (TBF) and the Sit Rising Rate ETF (RISE) provide inverse Treasury bond exposure, something that may be compelling for investors looking to take more aggressive bets on rising rates.

Then there's always the SPDR DoubleLine Total Return Tactical ETF (TOTL), managed by Gundlach, which is an obvious option for investors looking to mimic the guru's moves in the fixed-income space. The PIMCO Total Return Active ETF (BOND) and the Fidelity Total Bond ETF (FBND) are two other popular actively managed bond ETFs on the market.

Emerging Market Debt Attractive

Gundlach touched on a few other areas of the fixed-income market. He said that TIPS and nominal bonds were at parity in terms of their attractiveness. He brought up the iShares TIPS Bond ETF (TIP) by name and predicted that it would continue to see strong investor inflows.

He also said he likes emerging market debt, and brought up another fund by name, the iShares JP Morgan USD Emerging Markets Bond ETF (EMB), which targets the space.

Meanwhile, DoubleLine's founder had much to say about corporate bonds. He pointed out that investment-grade corporate bonds "have a massive duration on them," so "flows into those categories are going to be challenged."

He also spoke at great length about junk bonds, which he says are more of an interest rate story in 2017, compared to a credit story in 2016.

"One of the great misconceptions out there that needs to be pointed out is that many investors seem to think that because junk bonds ended up with a high return in 2016, they're not vulnerable to further interest rate hikes―nothing could be further from the truth," he remarked.

"The junk bond market has decent interest rate risk on it; it's just that it was depressed with commodities so low in the early part of 2016. Now that commodities are more normalized, the junk bond market is every bit as much a bond market as the Treasury bond market. There will be a little bit of shock if interest rates move up in 2017 [because] junk bonds will not be going up in price. The spread has tightened to the point where the cushion of safety has been virtually, if not entirely, eliminated," said Gundlach.

 

Buy Commodity Funds
One asset that Gundlach doesn't have a strong conviction on in 2017 is oil: "I expect oil will vacillate between the mid $40s and high $50s. We’re not looking for big moves in oil prices this year."

Likewise, he wasn't a raging bull on gold, but he continues to be supportive of the metal as a long-term holding."I've advocated a permanent position in gold since the 1990s," Gundlach said. "I do have in my personal portfolio, a permanent position in gold. I'm not wildly bullish on gold―I became less bullish on gold with the Trump victory―but I see no reason to stop holding it as a diversifier in a portfolio."

ETFs such as the SPDR Gold Trust (GLD) and the cheaper iShares Gold Trust (IAU) offer direct exposure to physical gold for investors.

Though he was seemingly neutral on oil and gold this year, Gundlach had positive things to say about commodities as a whole. "Commodities have put in a massive multidecade double bottom. They bottomed at the end of 2015. If you're all financial assets and no real assets, you might want to peel off a piece and put it in a commodity fund," Gundlach advised.

Solid ETF options in the commodity space include the PowerShares DB Commodity Index Tracking Fund (DBC), the iShares S&P GSCI Commodity-Indexed Trust ETF (GSG), the iPath Bloomberg Commodity Index Total Return ETN (DJP), the United States Commodity Index Fund (USCI) and the PowerShares DB Optimum Yield Diversified Commodity Strategy Portfolio ETF (PDBC). Each fund holds a broad basket of commodities, and has more than $600 million in assets under management.

At the time of writing, the author did not own any of the securities mentioned. Contact Sumit Roy at [email protected].

 

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.