Interest rates may be dropping now, but don't expect it to last. That's the message Jeffrey Gundlach, CEO of DoubleLine Capital, had for investors during his latest webcast on Tuesday, titled "Small Changes."
Gundlach went against the grain earlier this year when he called for the 10-year Treasury yield to fall from its highs even as other analysts were calling for continued increases in rates. The yield did fall― from a high of more than 2.6% in March to around 2.2% at the time of Gundlach's latest webcast.
Now Gundlach thinks that decline in the 10-year is likely done, and that he "wouldn't be buying bonds." On Wednesday, the yield on the 10-year fell to new lows for the year, reaching 2.1% briefly (bond prices and yields move inversely).
However, DoubleLine’s founder believes that ultimately the downside move in interest rates will exhaust itself, and that they will climb again starting in the summer and through the end of the year. Referring to the 10-year, he said, "I don't think we'll see 3% this year, but it's possible to go to a new high yield for 2017 before year-end."
Gundlach also added that he is standing by his prediction for the yield on the 10-year to hit 6% around the time of the next election.
Watch Yield Vs. Duration
Even though Gundlach expects U.S. rates to head higher (and bond prices to sell off), he doesn't recommend diversifying away from U.S. bond investments to other developed-market bonds "because the risk/reward on a yield versus duration perspective is so very bad."
He noted that the yield-to-duration measure―coined the “Sherman Ratio” by DoubleLine portfolio manager Jeffrey Sherman―was also poor for the Barclays Aggregate Index, Treasuries and investment-grade corporates.
The iShares Core U.S. Aggregate Bond ETF (AGG), the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the iShares 20+ Year Treasury Bond ETF (TLT) are a few of the ETFs that target those areas.
Gundlach didn't think very highly of junk bond investments such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) either: "High yield can grind along" with a little more "tightening of credit spreads that can happen, but you should be underweight the sector compared to your normal weighting because when this thing turns, there's a lot of room for spreads to widen."
The bond guru expects high yield to get hit hard when the next recession comes, though he isn't expecting an economic downturn in the foreseeable future.
Low-Volatility Days Numbered
Gundlach had a lot to say about stocks as well. He continued to recommend that "investors peel off a piece of their S&P 500 exposure and move it to Europe or even better, emerging markets." He explained that "based upon the policies in place in Japan and Europe juxtaposed to the policies of tightening in the U.S., there's still a lot of long-term legs to diversifying away from U.S. stock investments."
Another reason to be wary of U.S. stocks, in Gundlach's view, is because volatility is likely to rise. He expects that, sometime this summer, there will be a leg up in interest rates, which will be the catalyst for softer equity prices.
"Low volatility is almost necessarily followed by high volatility," he noted. Moreover, there is a massive amount of money that is betting against the CBOE Volatility Index (VIX), as evidenced by the exploding share count and huge short positions in the iPath S&P 500 VIX Short-Term Futures ETN (VXX).
"The trade is crowded," Gundlach warned. "The days of low volatility are numbered and you probably won't see it last until year-end."
He advises that if you're an investor, sit through the seasonally weak period that he expects; and if you're a speculator, you should be raising cash today.
Contact Sumit Roy at [email protected].