Jeff Gundlach: A Survey of the US Capital Markets
January 27, 2009
January 27, 2009
- Municipal Bonds – Gundlach believes that yields on these bonds will increase, due to fundamental problems across the range of issues. Fiscal problems with state and local governments will lead to ratings downgrades, but not necessarily to defaults.
- Mortgage Backed Securities – Gundlach was the most bullish on this sector. Spreads on these bonds went to all-time record levels of nearly 300 basis points in November 2008, but they have since reversed and are now near their historical average. These spreads have been “engineered,” according to Gundlach, because the Fed has been buying these bonds to stabilize the housing market. He also cited the “incredibly important fact” that mortgage refinancing is not good for the holders of GNMA securities, since these are trading over par (and refinancing brings the value to par). By contrast, refinancing will be extremely good for non-agency bonds that are trading at steep discounts. Refinancing is problematic for non-agency bonds, since many are plagued by underwriting problems, declining housing prices, and appraisal issues. But Gundlach expects full-scale government action to accelerate refinancing, which will contribute to out-performance in this sector. Refinancing applications are up 7.5 times over the last couple of months, he noted. While government programs to restructure mortgages are possible, Gundlach said, he sees little chance that these would adversely affect this sector. Such programs are likely to be directed to sectors where borrowers were “tricked:” floating-rate securities (sub-prime, option-ARM, and Alt-A). These programs would be “overwhelmed by the global action of lower rates leading to refinancing,” which would in turn be positive for this sector.
Gundlach also provided data for the US equity market (see below) that showed one-year trailing price-to-earnings ratios for the last 150 years. “The market is not cheap,” he said — for it to be cheap, P/E ratios would need to be in the single digits. He noted, for example, that in 1982 P/E ratios declined to six, and he suggested that P/E ratios would need to decline to comparable levels for equity market valuations to be consistent with current valuations in the fixed income markets. “The equity markets do not make sense in a historical time frame,” he said.
In spite of these attractive opportunities, Gundlach said “Nothing says get out of cash.” “Do not pour into high-risk sectors until commodities and the dollar move differently.”Gundlach also said that he expects inflation will arise sooner than most people think. Although he said the common view among large asset managers has changed from inflation to deflation over the last six months, Gundlach is wary. “I am always skeptical of a 180-degree turn,” he said. “There is so much monetization going on. Inflation will happen in 2009 or 2010.”
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