Speaking to a full-house audience at the 2015 Inside Fixed Income conference, Jeffrey Gundlach's message was clear: The Fed should not raise rates. Slide after slide in Gundlach's keynote address illustrated why the founder of DoubleLine Capital believes economic and market conditions are much worse than many people―Fed officials included―appreciate.
Gundlach's speech contrasted with that of BlackRock's Rick Rieder, who offered a relatively rosy outlook for markets only hours before.
Things Are Worse Than In 2012
Gundlach talked at length about the Federal Reserve, and in his view, its foolhardy mission to hike interest rates. "The Fed should not raise rates in December," he said bluntly. "You shouldn't have to make a case for the Fed to hike; the case should already be made."
Yet that case is far from made, said Gundlach, who pointed to a chart of market expectations of a rate increase, which give only even odds of a move in December.
The founder of DoubleLine said that based on the Goldman Sachs Financial Conditions Index, market conditions have already tightened by the equivalent of 50 basis points, and it would be foolish for the Fed to move in the face of that.
Moreover, he was confounded by the fact that Fed officials are hung up on hiking rates now even though most financial conditions are worse than in September 2012, when the Fed eased monetary policy by embarking on a third round of quantitative easing.
Interestingly, Gundlach said that perhaps the single most important indicator for the Fed may be the S&P 500, which plunged in August and September, prompting the Fed to refrain from moving on rates. Now that the index has recovered, it "appears vulnerable to another pushback down because earnings are not there," he said. "The S&P 500's trailing 12-month P/E is 19; that's not cheap."
In addition to his bearish view of financial conditions, Gundlach wasn't too enamored with the economy either. He said net profit margins for companies are coming down, which historically has happened before recessions.
Moreover, sagging industrial production growth is "flat-out indicating danger," he said.
China's Lost Decade?
Aside from the U.S., Gundlach had a lot of bearish things to say about China. He said the commodity slump indicates China is not growing at 7 percent as official figures suggest, and demographic trends are extremely unfavorable for the economy. In fact, Gundlach went so far as to say that demographically, China may be where Japan was at the beginning of the "lost decade" in the 1990s and 2000s.
He also spoke ill of the demographic situation in Italy, which may lose 39 percent of its labor force in one generation; and Russia, which will have the "largest implosion of population in the history of the world absent war, famine or disease."
‘A Lot Of People Overexposed To Credit’
Gundlach saved his most bearish assessment for the corporate bond market. Using the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | A-77) as a proxy, he said investment-grade corporate bonds are trading near their lows for the year.
Junk bonds are doing even worse, with the SPDR Barclays High Yield Bond ETF (JNK | B-68) well below where it was in 2012.
Unless oil prices recover fast, things could get ugly, and there could be widespread defaults in the energy space, said Gundlach. Unfortunately, he doesn't see oil prices recovering, citing extremely high inventory levels.
In the bearish scenario Gundlach outlined, oil would stay low, and defaults in the high-yield bond market would rise. Moreover, downgrades in energy company debt from investment grade to junk could push the sector's weighting in the junk bond market to 30 percent.
"Junk bonds are a horrible long-term investment; you end up holding more and more of the worst quality bonds," Gundlach said. "They should be sold on strength."
It wasn't all doom and gloom from Gundlach, however. One rare bright spot in his presentation was his bullish outlook for India. "Demographics in India are great," he said. He recommended buying India on weakness for the long term.
Gundlach also recommended closed-end funds. They're trading at 85 cents on the dollar with yields three times what you'll find in the bond market. That gives them 2 percent downside and 10 percent upside, according to his calculations.
In terms of interest rates, Gundlach said he hadn't formulated his views for 2016 yet. He said that, historically, the 10-year bond yield was highly correlated with nominal GDP, and that using that as a guide, the yield could be pulled up to about 2.9 percent. Gundlach emphasized that that was an observation rather than a prediction.