The Federal Reserve’s premature decision to raise interest rates in December set the stage for what bond portfolio manager Jeffrey Gundlach, founder of DoubleLine, calls our current state of “malinvestment,” one that may be pushing the economy into a recession.
Gundlach, speaking at the Inside ETF conference Monday, pointed to the dissonance between the U.S. growth rate, with a real GDP of 2.2 percent and falling, and a European GDP of 1.6 percent and trending higher, and asked why the two regimes, not that far apart, have diametrically opposed interest rate policies, with the U.S. Fed tightening while European central bankers are on the cusp of more quantitative easing?
For the Fed, the justification for higher rates is only the rise of average hourly earnings, and takes that to mean inflation must be nigh - but of course it’s not, Gundlach said. Inflation, such as it is, is all in higher housing costs, and “what’s wrong with the middle class getting a little bit higher wages when wages are being pressured” by higher housing costs?
By all other measures - corporate earnings, profits, and especially commodities - the economy is beginning a tailspin. The nominal GDP, at 3.1 percent growth, is falling and the Fed is “whistling past the graveyard,” he said. “Never has the Fed raise rates when nominal GDP was this low.”
The ISM Manufacturing Index is below 50, which signals a recession, he said, and the collapse in commodity prices is demonstrating just how weak China’s economy is, he said, given that they account for well over half the global demand; “Low commodity prices are a symptom,” he said. In fact, he thinks China’s real growth is likely negative.
“it’s now consensus that the Shangai Composite Index (as of Monday at 2,800) is going to 2,500,” a collapse from 5,100 last June. Overlay China’s demographic woes (an aging population), and the scenario looks like Japan in 1990. “Grave,” Gundlach said.
Lower energy prices will also send more bonds into junk territory, and there will be more downgrades of high-yield issues than upgrades in the near future. Corporate leverage is at an all-time high, and even among non-energy issuers, EBITDA is falling. “Do not buy a junk bond index fund,” he warned. “You’ll sell it for a loss."
The one bright spot in Gundlach’s view? India. “If you have to buy one emerging market, buy India. It has massive labor force growth. China has none.”