Jeffrey Gundlach presents "Up, Up and Away"

In his webcast “Up, Up and Away,” titled in reference to the 375-basis point hike in the target federal funds rate (0:06), DoubleLine CEO and Chief Investment Officer Jeffrey Gundlach surveys a raft of data points, finding, among other signs, the U.S. economy within months of recession; headline inflation continuing to recede; peaking interest rates; and interesting risk-reward opportunities in fixed income, especially in mortgage-backed securities. The webcast was recorded Dec. 6, 2022.

Early in the webcast, Mr. Gundlach reviews (2:09) the four episodes of quantitative easing (QE), including the $4.7 trillion QE in 2020-2022 “financing the most outrageous budget deficit in U.S. history.” He notes that equities (4:03), as represented by the S&P 500 Index, which “seem to follow the shape of the Fed’s balance sheet,” have rolled over against a backdrop of balance-sheet shrinkage, albeit at a slow pace. While market prices imply a federal funds terminal rate of 5% (6:02), he doubts the Fed will make it to that level. “I think the data is weakening too rapidly.”

Inflation, Mr. Gundlach says (8:08), “has come down and will continue to do so,” with the May 2023 CPI, which will come out in June, likely below 4.5% year-over-year. Inflation expectations in market pricing and consensus forecasts (10:41) foresee inflation falling at the same rapid rate that it rose once it broke out above 3.5%, then coming to a dead stop at 2.5%-3% and going “dead sideways out through 2026.” Calling that outlook the “strangest, most implausible forecast,” he says that “if the Fed brings inflation down to about 2% or 3% a year from now, it will overshoot well below” that level, perhaps even going negative. Such a scenario, he says, would trigger a massive bond rally.

M-2 money supply growth (16:40), Mr. Gundlach notes, “is basically the lowest in my lifetime,” with the six-month annualized growth rate negative. “That’s not very supportive of the economy, and it’s certainly not supportive of an accelerating inflation narrative.” Other headwinds (17:30) for the economy include “many months in a row of accelerating declines in excessive savings,” growing business and consumer pessimism, a deep inversion (21:44) of the U.S. Treasury yield curve, weakening reading of the ISM Manufacturing Purchasing Managers Index (23:44) and an unemployment rate (25:02) threatening to cross above its 200-day moving average.

Foreshadowing investment opportunities (29:51), Mr. Gundlach says, “Versus history, the (mortgage-backed securities) market in terms of risk-reward is as favorable as at any time in 25 years, and the yield spreads are highly attractive.” Analyzing interest rate trends (31:13), he notes, “We’ve already had a 75-basis point decline in the 10-year Treasury (yield) just over the past few weeks. And as the Fed keeps talking tough, the 10-year is starting to taunt them by going lower.”

Given the magnitude of tax-loss selling (38:15), Mr. Gundlach sees the possibility for “at least temporary strength” for stocks in early 2023, but he sees headwinds further out for the equity market notably in the form of declining liquidity. The end of a number of megatrends predicted by Mr. Gundlach in his June 9, 2020, webcast has occurred, notably (40:00) the ends of growth’s outperformance of value and of the Nasdaq 100’s outperformance of the S&P 500. One megatrend that has yet to reverse (41:50) is the outperformance of U.S. equity prices versus the rest of the world (?44:46). The catalyst for that reversal will be a declining U.S. dollar.

In his “bloodless verdict of the markets” (42:58), Mr. Gundlach surveys the returns across different segments of equities, fixed income and commodities as well as major currencies. He points out a throwover (44:33) of the S&P 500 versus emerging markets (EM) equities and attractive spreads of EM bonds versus the dollar. After a survey of credit spreads in U.S. investment grade and high yield corporate bonds (46:44), he notes tightening business-lending standards (49:29) might presage a rise in default rates, particularly in bank loans, which are floating rate.

Where Mr. Gundlach finds attractive spreads is in areas of the securitized universe. These include AAA commercial mortgage-backed securities (51:35) relative to investment grade corporates and BB collateralized loan obligations (52:43) versus B high yield corporates.