March 24, 2009
Gundlach issued a warning to those who short the market, particularly through credit default swap (CDS) positions. Another market decline, he said, could be accompanied by a blowup in the CDS market and short investors – even if they are right about the market direction – will suffer because their CDS counterparty may not be there to pay them.Unemployment data for the current recession is “unremarkable,” according to Gundlach – completely normal in the context of previous recessions. The chart below shows job losses in the current recession on a path well within the bounds of other post-World War II recessions.
Gundlach forecast higher movement in the value of the dollar, primarily because “de-leveraging is a short position on the dollar.” Along these lines, he expects continued deflation as his “base case” and noted that both the dollar and commodities indices are at the same levels as five years ago.
Fixed income markets
Addressing the fixed income markets, Gundlach offered these comments:
- Investment grade corporate bonds remain at record spreads of 600 basis points and “will continue to widen this year,” he said. “Not much good will happen here, despite the consensus.”
- Investors should avoid floating-rate asset-backed securities, even though their spreads are also at record levels. “The cash flow from these securities is unacceptable,” he said.
- The commercial mortgage-backed securities (CMBS) market remains priced to “better-than-likely outcomes. Defaults will lead to writedowns and balloons will be extended,” he said. Fixed rate obligations are okay, but investors should avoid floating rate bonds.
- The high yield corporate market has rallied recently but remains exposed to defaults. “Look for wider spreads,” he said.
- Unlike the above sectors, the mortgage market is not priced at record spreads. Spreads are at a level equal to their average over the last two decades. Treasury purchases of mortgages, including the one announced the morning of the call, are the reason. “This is the democratic way to let everyone refinance their homes and to expand existing programs,” Gundlach said, adding that the Treasury actions were very good for the mortgage market. Prepayment rates are up in the agency and non-agency markets and the government will “keep the flame going for refinancing,” he said.
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