The day of reckoning for many overleveraged American companies is fast approaching, DoubleLine CEO Jeffrey Gundlach said Tuesday on a webcast. That’s a major reason why the talented fixed-income manager thinks the junk bond universe could expand dramatically during the next economic downturn.
If this happens, the fallout could spill over into many global bond and equity markets. As far back as 2012, Gundlach was warning of a debt trainwreck unfolding late in the decade, when all the 10-Treasury debt issued between 2008 and 2011, when the federal government was running trillion-dollar deficits, had to be refinanced. Then in 2013, many American companies embarked on debt-financed stock buyback programs.
For corporate America, strong balance sheets will be the key to survival over the next four years as there are many companies that didn’t borrow to repurchase shares. But as the bond market confronts wave after wave of corporate and Treasury debt refinancings the picture won’t be pretty for companies that leveraged themselves to repurchase their shares. Buybacks have turned many parts of the equity market into an “ever-thinner residual” that shares characteristics with collateralized debt obligations (CDOs), Gundlach said.
The rudest surprise could hit investors who buy the first serious decline in high-yield bonds when they suddenly look like a bargain. Gundlach predicted these investors could face the same fate as those who bought subprime bonds in the early stages of the financial crisis.
“People who buy the dip could turn into sellers,” he said, adding “that’s exactly what happened with subprime.”
There is about $1.8 trillion in triple B-rated corporate debt (one level above non-investment-grade) and much of it could be reclassified as junk, Gundlach said. After all, 62 percent of triple B debt would already be rated junk if traditional leverage measures were applied.
If prices for these bonds start slipping, Gundlach questioned “who is going to buy [them]?” He openly wondered what might happen if there were a buyers’ strike during a recession. It is worth noting that in November the booming junk bond market ground to a halt and not a single issue was sold during the month.
One major indicator of a recession is widening spreads between Treasurys and high-yield bonds. Gundlach noted they widened significantly in December and have tightened in recent days. And if there is a silver lining, it's that they resemble the period leading up to the 2001 recession more than the period before 2008 crisis. At present, the relationship still could be “a false positive,” he added.
Few triple B-rated bonds matured in 2018, but that is changing. In 2019, fully $619 billion of investment-grade debt needs to be refunded, followed by $714 billion in 2020, $707 billion in 2021, $606 billion in 2022 and $505 billion in 2023.
Credit downgrades could exacerbate any liquidity problems. This is happening at the same time the Fed is engaged in quantitative tightening, or deleveraging its balance sheet, while the supply of Treasurys “is exploding,” Gundlach noted.