Jeff Gundlach - Why Own Bonds At All
In the continuing series of reports from the 10th annual Strategic Investment Conference, presented Altegris Investments and John Mauldin, the question of why you should own bonds was answered by Jeff Gundlach who is the CEO and CIO of Double Line.
Why own bonds?
I have been presented with the question twice in my career. The first time was in the 90’s when bonds and stocks were highly correlated. If stocks rose, bond prices fell, and vice versa. Therefore, investment managers decided that they should only own stocks as there was no advantage in being diversified. Unfortunately, we all know how well this turned out.
Today, investment managers are making the same decision but for a different reason. With the Fed’s artificial suppression of interest rates to historic lows; the return from owning bonds has become painful particularly for underfunded pension funds. That pain, combined with the inflation of asset prices via continuing QE programs, has forced managers into overweighting stocks.
The other reason that managers are jumping into stocks is due to the belief that interest rates are going to start rising on “Tuesday.”
“Let me be clear. This is absolutely wrong. Yields are NOT going to rise any time soon.”
There is one thing about being an asset manager. Timing is everything. The synonym for “early” in the investment business – is “wrong.” If you had bought the Nikkei two years ago you would now be right – after losing about 20%. Now is the right time.
Is there a bond bubble?
Flows into bond funds have been robust compared to equities. This has particularly been the case since 2009 as investors have scrambled for yield. Therefore, there must be a bubble – right?
The answer is no. The great rotation is NOT happening. First of all, for every buyer there is a seller. Therefore, in order for someone to sell their bonds and buy stocks means that someone has to be selling stocks. It is a zero sum game.
“There is no secret treasure trove of equities waiting to be bought.”
Furthermore, as opposed to most mainstream commentators, equities are not under allocated. The U.S. currently has more than 40% of household assets in stocks which is the highest of all other major countries. There is also no stash of cash waiting on the sidelines waiting to rush into the markets and, lastly, bonds are only a small percentage of most investor’s holdings.
“Quantitatve easing is NOT going away. Every major country is running a deficit. If they are all net borrowers then who is the lender? The central banks. For this reason – QE is not going away for a long time.”
QE programs will continue until such time that the Federal Reserve begins to see negative consequences. However, up to this point as Ben Bernanke has clearly reiterated, there has been NO evidence of any negative consequences.
Of course, Janet Yellen, who is a front runner for Bernanke’s replacement, also sees no negative impacts and says QE should be appropriate through at least 2025.
Should you own bonds? In such an environment as currently exists, and will likely continue to exist, bonds are absolutely appropriate in a portfolio. Yields will be lower in the future – not higher.
What About Stocks?
Most individuals believe that the Fed’s QE programs have propped up the stock market – they are right.
However, there is a misconception. While there is ample evidence that the Fed’s Q.E. programs have supported stock prices – QE is NOT a “put” on stocks. In reality, QE is a “put” on treasury and mortgage bonds as injections go directly into the bond market.
This is why you should own TLT in your portfolio as long as QE remains in play.
A Few Other Thoughts
Copper is clearly saying that there is no economic growth going on. As opposed to what is reported - China is most likely growing near zero in reality.
Understand that there is NO WORLD in which rates will rise with copper prices falling. Interest rates are currently telling the same story as copper – there is very little economic activity occurring.
“Volatility on bonds is at historic lows – bonds are acting like the bond market is manipulated…because it is.”
Another point here is the mistake that all investors are currently making. DO NOT buy stocks for the dividend yield simply because they yield more than stocks. There is no guarantee that dividend yielding stocks will perform better in the long term versus owning bonds. History says that is unlikely to be the case.
“Let me reiterate….bond yields are not going to rise. QE drives yields lower as it goes straight to the heart of the bond market.”
Rates will not rise with real HIGH unemployment. The unemployment (U-3) rates is a false measure of employment due to the high level of dropouts. All that really matters for the economy, and ultimately the bond market, is the labor force participation rate which is at the lowest level since the 80’s.
Rates will not rise with median household incomes at the lowest level in 19 years.
Rates will not rise as QE is all about funding the federal budget. if rates rise the budget will be blown and deficits will explode.
Rates will not rise as it will kill any economic growth. Housing, private investment and consumer borrowing all rely on low interest rates. If rates rise it is the end game for the economy.
Despite what you may have heard – the reality is that rates will not rise any time soon. This is the liquidity trap the Fed has gotten itself into.
Furthermore, Bond indexing makes no sense into today’s market. However, emerging market bonds, on a very selective basis, will likely be lucrative as the global economic malaise continues in their developed counterparts.
If the current financial experiment fails – the only place to be will be long US Treasuries. A decent hedge in the event of an economic disruption will be long US Treasuries and short French Bonds. As all European bonds converge toward 1% the reversion due to economic disruption could be hugely profitable.
Own bonds? You bet. With corporate profits in the U.S. at all-time highs as a percent of GDP the repayment probability for bond holders is extremely high. However, this is also bad for holders of corporate stocks because the reversion of profits to GDP will be brutal.
Financial Investment Thoughts
Bank debt is likely a good bet particularly since the Fed’s actions benefit them directly and they are unlikely to be allowed to default.
Real Estate will go higher because of lack of supply. However, IF YOU BELIEVE that rates are going to rise DO NOT BUY A HOUSE.
MLP’s are massively leveraged and will lose tremendous value if rates rise.
Talking heads on CNBC started talking about a new bull market in stocks. REALLY? That started 4 years ago folks. We are likely closer to the end of a bull market cycle than a beginning.
Lastly, why own bonds, because they are negatively correlated to stocks. You may not get rich - but you will survive the long term investment game.