Gundlach ? Where to Expect the Next Crisis
But with the “taper talk,” the Fed has chosen a “seat-of the-pants” way of handling its QE policies, he said. Gundlach said the Fed is using QE to fund the budget deficit. In that context, he noted, the tapering of QE should be predictable, because the budget deficit has been declining.
Gundlach said he doesn’t know what to expect from the Fed now. Fed officials have been quiet on this topic for the longest time since 1996.
Gundlach likened the current interest rate environment to May of 1994, when yields rose sharply. At that time, the ultimate peak in rates came six months after the initial rise, in November of that year. He said the total-return loss on the 30-year Treasury bond has been virtually identical to the loss in the 1993-1994 period.
For several decades starting in the 1970s, Gundlach said, returns on the bond market were positively correlated to those of the stock market. Fears of inflation characterized that period. Since 2001, fears of deflation have been more dominant, and the correlation turned negative — that is, until the “taper talk” in May, when the correlation turned positive again.
Indiaand other emerging markets
“If there is going to be a good candidate for what might blow-up with problems caused by policy changes,” Gundlach said, “India would be the leading candidate.”
Investors may be tuned in to those fears. Gundlach said that flows into emerging-market ETFs have decreased significantly since the “taper talk” in May.
Price movement in the rupee is signaling trouble. Gundlach said the rupee was up early this year but has lost about 20% of its value since February. Most of that downward movement has been since early May.
Another sign of trouble is the short-term debt-reserve coverage ratio on the INR ETF, which tracks the rupee. Gundlach said has decreased from 600% to only 200%.
“There is something of a foreign capital flight crisis – or mini crisis at least,” he said. “This has already taken place and it may get worse.”
Gundlach said he would not own Indian stocks, because the market looks “very scary.”
China, on the other hand, looks attractive, he said. It does not need foreign capital and has not engaged in QE, because it runs a substantial trade surplus. China also benefits from its 50% domestic savings rate, he said.
“If you are going to have a problem in emerging markets you probably will not make a fortune anywhere,” he said, “but at least you would be insulated from the currency run problem that you have in countries like India if you invest in China.”
He advised investors to go long China and short India.
Russia is also insulated from foreign capital needs, Gundlach said. But investors must consider problems such as corruption and illiquidity, which are making Russian stocks look relatively cheap now.
He suggested that investors go long in “risk markets” that are insulated from QE volatility and get out of those, like India, that are vulnerable to QE.
Where to seek safety
Investors fearing a crisis need to assess what will be the best safe-haven asset class.
Gold’s “monster run” from $600 to $1,800 an ounce between March 2007 and November 2011 coincided with the precipitous fall in housing prices, Gundlach said.
That was not a coincidence. When confidence in real estate eroded, he said, investors chose gold to protect their wealth.
“The minute that the real estate market found a bottom in the second half of 2011,” he said, “was exactly when gold peaked.”
Expect gold and real estate to be negatively correlated, he said.
At its current price of $1,350, Gundlach said gold is “something of a safe haven.”
Gundlach has been bearish on mortgage real-estate investment trusts (REITs) in the past, but he said they now “look cheap” – as do closed-end bond funds, broadly speaking. In both case, he said, assets are trading at about a 10% discount to their book value.
“I think they represent value, but I do not think they are going to go any higher anytime soon,” he said. “It seems that the dividends are going to be cut on mortgage REITs.”
Gundlach recommended that investors focus on agency REITs, like Annaly, and others that have suffered recent price declines.
The broad question is whether the U.S. economy can sustain the rapid rise in interest rates that has taken place this year.
Gundlach said higher rates are already causing problems. “The rate rise really does matter, and we are going to start seeing its effect in consumer behavior,” he said.
Home sales are declining, he said, and job growth in the last three months was slower than the average of the last 12 months. Strong auto sales will come at the expense of other discretionary consumer activity.
He said he is negative on the upper-middle-class discretionary consumer spending due to rising rates.
Gundlach warned that economic data will worsen in the months ahead.
“I do not think interest rates are can spike any higher, because the economic growth factor does not support it,” he said.
“A further rise in interest rates could cause a crisis — maybe in India,” he said.