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Gundlach On GDP, Oil, Bonds And More

It seems not all money managers out there have the warm-n-fuzzies for equities in 2015.  Especially considering the almost two year sell-off in commodities, finally joined by crude oil in dramatic, face ripping action.  In fact, one feels that the rise in interest rates in 2015 will do what is not expected; flatten the yield curve.

If the curve flattens gradually, most traders said it probably means investors believe the Fed will keep future inflation in check with gradual rate hikes. Bond traders hate inflation because it erodes the value of their fixed-income investment.

But if the curve-flattening trend speeds up?

"It's time to trade out of investments whose success depends on a strong economy... for both stocks and corporate bonds," said Anthony Crescenzi, chief bond market strategist at Miller, Tabak & Co., an institutional brokerage.

This means reducing exposure to sectors like retail, transportation and automobiles and moving into defensive picks like health care and consumer goods.

Jeffrey Gundlach @ DoubleLine says he’s constantly asked “how low oil prices can go,” and he responds that no one will know until they stop falling. “That answer isn’t meant to be cute,” he says. “When you have a market that showed extraordinary stability for five years -- trading consistently at $90 [a barrel] or above -- undergo a catastrophic crash like this one, prices usually go down a lot harder and stay down a lot longer than people think is possible.”

Likewise weighing on U.S. bond yields will be brisk foreign buying from investors in Japan and Europe, where long-term sovereign debt bond yields are mostly lower than U.S. rates and economic growth prospects are less bright. “Everybody worried about what would happen to the U.S. government [bond] market when the Fed ended [its third round of quantitative easing] last fall and stopped its heavy monthly government bond purchases,” he points out. “The answer, of course, is that foreign buying easily replaced declining government support of the market. And the strengthening dollar, which we think will continue, only makes U.S. bonds all the more attractive, for not only do foreign investors benefit from higher relative rates, but they also win on currency translation profits.”

GUNDLACH ISN’T PARTICULARLY sanguine about the prospects for U.S. stock markets. Early in the year, rebalancing of diversified institutional portfolios from stocks to bonds will create some price undertow for equities, he claims. Also, he worries that gross-domestic-product growth for next year and 2016 is unlikely to hit the 3%-plus annual targets that forecasters are assuming. That’s because the deflationary tide unleashed by a slowing world economy and excess capacity will begin to lap against U.S. shores by the middle of 2015. A strengthening dollar won’t help U.S. competitiveness.

Low oil prices will begin to wreak real havoc on employment, capital spending, loan collateral values, energy-company balance sheets, and the junk-bond market. “The boost to U.S. consumers from lower pump prices is the first shoe to drop, but the negative secondary effects from the crude-oil price collapse take longer to surface,” he says.

There’s plenty wrong globally that will eventually weigh on the stock market. He mentions the obvious. Emerging-market economies are sharply slowing. China, despite its current stock market boomlet, rests on shaky financial and economic foundations. Greece threatens to come apart again. Russia is a basket case. Sinking oil prices threaten to amp up geopolitical risks that Russia or Iran might do something dangerous out of economic desperation. Currency wars impend, led by Japan’s systematic yen-devaluation campaign.

But such factors constitute the wall of worry that bull markets typically climb. Bad news or weakening fundamentals can, as often as not, have scant impact on the course of the stock market.

For Gundlach, a mathematics whiz, some of the charts and technical indicators he religiously follows are what give him pause about stocks and the global economy. He sent us over 70 charts from a recent presentation to make various points about what is going on in the belly of the beast.

One shows U.S. CRB Index Futures -- weighted commodity prices going back five years. To the untrained eye, there’s not much to see beyond a vertiginous peak made between late 2009 and late 2010 with a series of smaller peaks saw-toothing down to present levels. But Gundlach draws another conclusion: “Look, commodity prices have fallen back to their lows of 2009, which of course was at the height of the financial crisis. Something is obviously very wrong these days in the global economy.”

Another chart, delineating the movement in yields of two-year government securities of various key euro-zone nations over the past 14 months, looks like a tangle of spaghetti. But Gundlach points to an interesting divergence that has shown up since September, when the rate on German debt sharply diverged from two-year rates on Italian and Spanish debt. The German yield turned negative, while the two Club Med countries’ yields headed the other way. This told Gundlach that trouble lies ahead for the euro zone beyond the headlines of European political unrest. “Folks in Europe are obviously losing confidence and scared if they are willing to pay Germany for the privilege of parking their funds there,” he says.

Considering his funds had a banner year, with his flagship DoubleLine Total Return Bond fund (ticker: DBLTX), with $40 billion in assets, and DoubleLine Core Fixed Income fund (DBLFX), with $3.4 billion, finishing in the top decile of their Morningstar groups. Likewise, the DoubleLine Emerging Markets Fixed Income fund (DBLEX) ended in the 96th percentile of its Morningstar class......I'd say he's called it better than most in 2014.  It would spell pain for those continually attempting to short bonds but then again, the market tends to do what we don't expect, doesn't it.

Happy New Year

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