Unlike some investment strategists, DoubleLine CEO and Chief Investment Officer Jeffrey Gundlach is not optimistic about stocks.
In fact, the Standard & Poor’s 500 Index has about 2% upside and 20% downside, he told investors on a conference call late Tuesday.
This is “a lousy risk-reward trade-off,” Gundlach says, adding that equities are a “big losing proposition.”
During the webcast, he also remarked that he views the current rebound as a “bear market rally.”
Others disagree. In fact, they see it as an indicator that we are on a continuing bull run.
Speaking about equities ahead of the bull market’s seven-year anniversary on Bloomberg Radio, Liz Ann Sonders said: “This pervasive pessimism, skepticism and unwillingness to invest in equities anywhere near the degree we’ve seen in past bull markets has been a very unique characteristic.”
In fact, such bullish views represent “the wall of worry that stocks like to climb,” she said.
Read on to see the 10 reasons that Gundlach disagrees.
1 . Connect the Dots
That’s what the DoubleLine chief likes to do on his quarterly investor calls.
While he echoed several themes from earlier presentations, the bond specialist zoomed in on several conclusions about where the stock and bond markets are in headed March.
Core inflation is rising, but it excludes food, energy and rents. And certainly, he points out, commodity prices are not trending significantly higher – and some continue to decline.
“If various measures of inflation are going up but commodity prices remain in the basement, how is that supposed to be good for companies” in the materials and energy complex?
This is an important reason to fear talk of continuing bull run.
Plus, the current political cycle is impacting volatility, as well.
2. Low Commodity Prices
While some market analysts see the current rally as part of a bullish trend, Gundlach is more concerned with where commodities are priced.
“It’s clear that stock markets fear deflation,” Gundlach said. He adds that oil has rallied recently, but it “is still too low.”
In fact, as he said at several points during his talk Tuesday, “Time is on your side.”
In other words, there is still plenty of time to wait for commodities to cheapen further before buying them.
The Bloomberg Commodity Index, for instance, is now at about 78, below where it was in 2000 (when it hovered near 100), and way off of its level of roughly 240 in 2008.
Meanwhile, the Dow Jones UBS Commodity Index is down about 25% from where it was in early March 2015.
3. Weak Corporate Profits
“How can earnings rise when wages are going up and the topline [growth] is no going anywhere?” Gundlach asked, emphatically.
According to DoubleLine’s analysis of both corporate profits and recessions since 1973, 1985 “was the only period when a 60 basis-point decline did not coincide with or predict a recession.”
A chart shared by Gundlach during Tuesday’s talk shows a drop in corporate profits staring at least 12 months ago.
Other profit declines took place in the mid-’70s, late-’70s, early-’80s, late-’80s and early-’90s, early 2000s and during the financial crisis.
“Profit margins peaked [earlier] and have fallen” recently, Gundlach said. “They will fall further with wages growing.”
U.S. GDP growth is currently at 2.2%, he adds.
4. A Weak Global Economy
World Bank estimates for global growth this year are now at 2.9% vs. the earlier 3.3% estimate.
“But I want to point out … specifically China’s baked-in rate of 7% [growth] in the forecasts,” Gundlach explained.
That is a very generous figure, he says: “You can look at the data from there … [complicated by] debt issues, low commodity prices worldwide … and it’s extremely clear that Chinese growth is not at 7 %.”
In fact, Gundlach stated, “It may be contracting. The data is a bit non-credible.”
China represents about 16% of the global economy.
“If we say China is at zero percent growth – with them representing 16% of the global economy – that means a takedown of growth by 1% or so for global GDP. And we could be at 2% or lower with China underperforming,” he explained.
Gundlach shared a chart that looks at the five-day moving average of China’s exports and imports, which are down 6% and 15%, respectively, vs. March 2015.
5. A Weak Chinese Stock Market
The Shanghai Composite is trading below 2,900.
This is way off of its highs of 2015, when it topped 5,000. (In 2007, it hit 6,000.)
“The Shanghai Composite could easily to go [down] to 2,500 or even 2,000,” said Gundlach. “The trend is that it is going lower.”
This trend, he explains, reflects the country’s current economic weakness. During his talk, DoubleLine shared a slide that showed quarterly business activity in China – as reflected in a profits index – weakening 4.7% in the most recent period.
“The yuan needs to be devalued to [help get] the economy to a better place,” the DoubleLine CEO said.
On Tuesday, Bloomberg reported that the Shanghai Composite is the worst-performing global index in 2016 so far, with losses of 20%.
There are concerns that corporate earnings in the country are set to further deteriorate, which, along with a weakening currency, will lead to more capital outflows.
6. Huge Supplies of Oil
The level of petroleum inventory is simply too high, according to Gundlach, as well as the U.S Energy Information Agency.
The EIA reported recently that as of March 4, “at 521.9 million barrels, U.S. crude oil inventories are at historically high levels for this time of year.”
Overall, the world’s developing countries have a glut of 3 billion barrels, Gundlach says.
This represents a huge problem for the U.S energy sector, as well as countries like Russia that depend on strong oil exports and prices, of course.
Oil inventories are still “through the roof,” the DoubleLine executive stresses.
7. Continuing Weak Demand for Oil, Commodities
“Stock markets fear deflation,” Gundlach repeated to investors on the call Tuesday. “And oil is the poster child. We need commodity prices to rally significantly further.”
While oil prices have moved up recently, “oil is at an incredibly low level. Recall that we used to say at $40 [per barrel] we were at the death level,” he explained. “We are below $37” as of Tuesday.
(The commodity rose to about $38 on Wednesday.)
Overall, Gundlach says, global demand is just too weak to spur a recovery in the energy markets and in other commodities, which has a negative impact on these sectors.
8. Growing Bankruptcy Rates
With problems in the energy field, lenders are impacted, too, Gundlach explains.
Bankruptcies are likely to increase in the sector.
The DoubleLine CEO points to Bloomberg data that show there have already been six Chapter 11 cases that involved $1 billion or more of debt in just the first few months of 2016.
The most recent case involved Abengoa Bioenergy, the U.S. unit of Abengoa.
(There were 10 such cases in 2009.)
Several European banks that are heavily exposed to the energy sector are having a hard time paying back energy-related debt.
Deutsche Bank, for example, had large losses last year and cited this situation as a factor in its poor performance.
9. Growing Number of Downgraded Bonds/Poor Credit Ratings
More corporate debt is being downgraded, Gundlach says.
As defaults occur, “Recovery rates are going to be highly disappointing,” he added, with borrowers now heavily levered.
Citing research from Citigroup and Moody’s, the fixed income guru pointed to a chart showing that downgrades took over upgrades in the first half of 2015.
“Downgrades now exceed upgrades by a pretty large amount,” he said.
“We’re looking at a bad fundamental background here,” explained Gundlach. “Time is not on your side.”
10. Recession Not Likely – But Stocks ‘Not Going Anywhere’
“I think we are near the end of a bear market rally,” said Gundlach, who referred a quote from another investment specialist, the late Richard Russell: “Bear market rallies look better than the real thing.”
Current conditions make for “a poor risk-reward setup,” he explains.
Driving his sanguine assessment is the fact that “We do not have enough GDP globally” to support equities and economic expansion.
“Something is going on … and that probably has to do with negative interest rates,” he added. “Maybe they – negative rates – are really bad. The [global] markets have not gone up – because [they're] bad for the banking system.”
If the Federal Reserve were to move the U.S. into the world of negative rates, that step would “backfire like an old Model T,” Gundlach stated.
The bright side, he says, is that even with a high likelihood of losses in U.S. equities, the chances of a U.S. recession in the near term are low.
“It’s premature to talk about a recession,” the DoubleLine executive stated, warning that the credit markets are nonethless being “hit” by multiple issues.
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