- Jeffrey Gundlach, the CEO and chief investment officer of DoubleLine Capital, has a stark warning for investors with exposures to corporate credit.
- The so-called Bond King notes increasing size, leverage ratios, and unrealistic ratings of investment-grade debt as reasons to ditch the securities before an economic downturn.
- Gundlach thinks investors “should be playing defense right now.”
- His warnings match those put forth by other experts across Wall Street in 2019. They include Scott Mather of Pimco, Todd Jablonski of Principal Global Investors, and Raoul Pal of RealVision.
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There’s a reason why Jeffrey “Bond King” Gundlach’s opinions are highly sought after within the investment community. The self-made billionaire CEO and chief investment officer of DoubleLine Capital has quite the resume.
Not only is Gundlach known for his prescient market clairvoyance — the collapse of subprime housing bubble and the election of Donald Trump, to name a few of the more recents — he’s also responsible for turning $0 to more than $150 billion assets under management in less than 10 years.
It goes without saying that no one can accurately predict the future with consistency, but Gundlach seems to have a knack for nailing big calls.
“We are battling tooth and nail the next recession,” Gundlach said in a recent interview with Yahoo Finance. “The Fed has but done — and the central banks — everything they can to avert the next recession. But a recession will come.”
To Gundlach, it’s only a matter of time before the US inevitably succumbs to a period of contraction. Global central banks can cut interest rates all they want. But in his mind, if the byproduct of that stimulus isn’t tangible economic growth, then their efforts are for naught.
Still, periods of contraction create opportunities for those who are positioned correctly — and Gundlach thinks he’s spotted a corner of the market that he can take full advantage of when the next downturn sets in.
“The next opportunity is going to be in corporate credit,” he said. “We have zombie companies that are allowed to keep going because of these artificially low interest rates — and the corporate bond market is probably significantly over-rated, which sounds a lot like subprime in 2006.”
He continued: “Some of them were rated triple-A, and they fell to 20 cents on the dollar.”
It’s an argument Gundlach has made before. Back in May, at a media and client event in New York, he said the corporate-bond market would “really have problems” once negative GDP was realized.
Some of the world’s foremost financial minds have also expressed worry in recent months. The lowest rung of investment grade credit — or BBB — was a hot topic of discussion at the Milken Institute Global Conference, which also took place in May.
“When those tip into junk, it’ll be a mess,” Scott Mather, the chief investment officer of US core strategies at Pimco, told Business Insider about BBB-rated bonds. He lamented what he called the “riskiest corporate market we’ve ever had.”
Todd Jablonski, the chief investment officer at Principal Global Investors, agreed.
“You’ll eventually get some exogenous force that could disrupt the Fed and create additional pressure,” Jablonski he Business Insider in May. “That would lead to default coming out of the high-yield space. We’re underweight high-yield.”
Swollen corporate debt loads
Today, corporate debt levels tip the scales at more than twice the size they were in 2006.
The chart below depicts the explosive growth in corporate debt levels pre- and post-financial crisis.
Board of Governors of the Federal Reserve System (US)
Swelling corporate debt piles alone wouldn’t necessarily warrant cause for concern, but Gundlach thinks their ratings are way out of whack — and he named names.
“AT&T is one of them,” he said. “Right now, there are leverage ratios in the investment-grade corporate bond market that suggest that nearly a third of the investment corporate bond market probably should be rated junk.”
“When the recession comes, there won’t be any idea of addressing these leverage ratios,” he said. “You’re going to see en masse downgradings of the investment grade corporate bond market — and trust me, when a triple-B rated bond gets dropped down to a single-B rating the price doesn’t go up.”
If Gundlach and his colleagues are right, this will lead to a massive divestiture in corporate bonds. And for that reason, he thinks an investor’s exposure to the space should be at an absolute minimum.
“That’s why you should be playing defense right now,” he concluded. “The fact that 2019 has been really good is just a better reason to play defense.”