DoubleLine CEO Jeffrey Gundlach thinks equities could grind 5 percent higher by mid-year, as economic data continues to surprise investors to the upside.
“This is the most synchronized global economic upturn in years,” he said, speaking on a webcast Tuesday that addressed asset allocation issues.
One reason Gundlach appears to favor equities is that “stocks generally outperform bonds until quite late” in the Fed interest-rate hiking cycle. The bond market would love to see the “Fed destroy the economy” but that’s unlikely.
Positive surprises are popping up in surprising places. Even persistent laggards like the eurozone are showing signs of life few expected. Moreover, the likelihood of worse political tensions in Europe have moderated as the odds of far-right French presidential candidate Marine Le Pen winning are declining.
The “soft data” in the U.S. has been remarkably strong, and “sustained optimism in animal spirits” is close to the highest ever. So high are business and consumer confidence that both need to weaken before trouble surfaces, Gundlach said.
Hard data, however, hasn’t caught up to soft data. It’s only “a little better,” Gundlach said. And the fact that he thinks in 5 percent increments also reveals that he is a bond investor first and a stock investor second.
Gundlach did not address specific problem areas of the economy. Retailing, a huge source of employment, appears to be in secular decline. This has serious implications for commerical real estate as well as employment. At the same time, autos and housing may have reached their cyclical peaks. Some have estimated that new breakthroughs like driverless cars could cost the economy millions more manufacturing jobs, even as some new employment opportunities will emerge in automation.
So why is Gundlach still modestly optimistic about U.S. equities? The “valuation of the S&P 500 is related” to the massive flow into passively managed index funds and ETFs. It shows no signs of abating. but for fundamental value investors, the inexorable power of passive investing sounds like a distant cousin of the greater fool theory.
However, don’t expect large-cap U.S. equities to advance more than 5 percent unless corporations start seeing significant revenue gains. Price-to-sales ratios of S&P 500 companies stand right at 2, or double their revenues. They only reach a higher level once before in, you guessed it, the late 1990s.
There is “a little bit of room for CAPE (Cyclically Adjusted Price-Earnings) ratios to move higher” if earnings come in higher, Gundlach observed.
Significantly, for the first year since 2013, analysts have not downgraded their outlook for S&P 500 earnings so far in 2017. In the previous four years, they typically retreated in January. It's still early in 2017 but so far they are holding up.
How this plays out remains to be seen. Sure as the sun will rise tomorrow, one can expect analysts to start calling for 12 percent earnings growth in 2018. Don’t take it “with a grain of salt,” Gundlach said. “Take it with a boulder of salt.”
But even international diversification is working. “Being in non-U.S. markets has been incrementally beneficial,” he told webcast viewers.
Regarding the last two interest rate increases, 10-year and 30-year Treasurys haven’t “behaved badly” following the hikes. He expects a rally on 10-year Treasurys to 2.25 percent and they could fall below 2 percent some time in 2017. “We won’t see 3 percent this year,” he said.
Investors are overallocated to corporate bonds, one reason why Gundlach doesn’t care for them. In fact, the corporate debt-to-GDP ratio stands near 45 percent. That’s about the only indicator out there signaling a recession. By itself, that's not a big deal, particularly since many companies have issued debt for no other reason than to exploit ultra-low interest rates in recent years. DoubleLine doesn’t expect a default cycle coming any time soon because they don’t see a recession on the horizon.
Widely respected for his macro perspective on financial markets, Gundlach gained currency as a political prognosticator in 2016 when he predicted the election of President Trump early in the year and stuck with it through the candidate’s many tough moments. At the end of the webcast, he told attendees that the Trump administration stood a much better chance of getting infrastructure reform through Congress than passing tax cuts.
Cutting taxes, in his view, would prove to be tremendously controversial because they inevitably would favor those who pay the most taxes—the very wealthy. Infrastructure, on the other hand, could garner bipartisan support.