High-yield bonds may be selling at their most overvalued prices in history, particularly in relation to emerging markets debt. The extended bull market in equities could trigger major pension funds to reset their asset allocation levels in the next year. Those were two takeaways from DoubleLine CEO Jeffrey Gundlach’s webcast with clients yesterday.
Specifically, Gundlach said that if equity prices and bond yields keep climbing in 2014 like they did in 2013, pension funds might move some assets out of equities into bonds to lock in their funding positions. The net effect would be to provide "some sort of ceiling on bond yields,' he confirmed in an e-mail to Financial Advisor.
Implicit in Gundlach’s remarks was that the roaring bull market of the last five years has left pension funds in a much better position regarding their funding status. And if their risk tolerance is anything like other investors, they may be viewing the run-up in equity prices as reason for caution.
Gundlach also noted that the yield of double B-rated was 4.6 percent while the yield of single B-rated bonds was 5.2 percent. When compared to Treasurys on a historical basis, the spreads are as narrow as they’ve ever been.
He added that while double B-rated “don’t have a lot of defaults,” investors might want to consider whether they are being compensated for the risk they are taking. In 2013, junk bonds have appreciated on average almost 7 percent in a rising interest rate environment.
The spreads between U.S. junk bonds and emerging market bonds, which fell out of favor in 2013 after attracting lots of assets in 2013, appear to be at historical peaks. Gundlach was constructive about emerging market bonds in 2014.
Another area that has attracted yield-hungry investors is the bank loan market. The supply-demand imbalance has permitted borrowers to negotiate increasingly favorable terms with lenders.
“Covenant-lite loans will come back to haunt the bank loan market,” Gundlach predicted. These remarks have been echoed by Loomis Sayles Vice Chairman Dan Fuss, who said earlier this year his firm passes on about five out of six bank loans that people try to sell his funds.
On the inflation front, Gundlach implied that those who believe that real inflation rates are much higher than the statistics the government is reporting may be kidding themselves. Certainly, that is what the market is saying about the potential for long-term inflation.
Prices of 10-year TIPS are down 16 percent year-to-date. They might just be “the worst possible place to be,” he said. Indeed, Pimco’s Total Return Fund suffered big losses earlier this year in TIPS.
“If you think inflation is running at 4 percent [annually], I have some bad news for you,” Gundlach said. It would mean the economy isn’t growing at all.
When pressed by a listener, Gundlach suggested “hopefully” that individual’s circumstances had improved somewhat in the last four years and that this had prompted the questioner to upgrade their lifestyle.