In the next two years, companies that rely on junk bonds for capital should be fine. But as different interest rate conditions play out, DoubleLine CEO Jeffrey Gundlach warned that the junk bond market could suffer “the highest level of defaults of all time.”
Now is “an excellent time” for investors to get out of junk bonds, Gundlach said yesterday in a webcast. With high-yield indexes priced at about 387 basis points above Treasury bonds of similar maturities, he said investors would be “lucky to get out” before the day of reckoning arrives.
The problem extends beyond the junk bond market. Noting that actuaries have predicted the Social Security system will exhaust its funds in nine years, Gundlach also predicted that entitlements will become a dominant political issue in the 2028 election. “It’s no longer your grandchildren’s problem; it’s your problem,” he said.
The most challenging complication facing bond issuers of all stripes, from the U.S. Treasury to non-investment-grade companies, is the transition to the world of rising rates. For the last 40 years, companies and governments selling bonds have continuously enjoyed the benefit of refinancing their growing piles of debt at ever lower rates, Gundlach explained.
The low cost of debt has seduced everyone from home buyers to the Treasury to rack up debt nearly pain-free. This includes the U.S. government.
One reason is that governments keep ramping up their fiscal responses to recessions. In 1990 when Ross Perot was sounding the alarm about deficits, President George H.W. Bush was criticized for taking little action to address the recession. Later developments were much more stark and dramatic, including the 2008 financial crisis and the pandemic, when governments and central banks shelled out trillions in bailouts, stimulus programs and easy money.
“Government interest payments were below $1 trillion before the pandemic,” Gundlach said. “Now it’s going straight vertical.”
Gundlach was asked about the U.S. Treasury needing to refinance half its debt in the near term—52% of all Treasury debt matures in the next three years, according to some estimates. “I think the Treasury is in a hurry because they have to roll over all these Treasurys,” he said.
Most of the junk bond market benefits from slightly longer term debt. It is estimated that only 8% of all junk bonds mature in the next two years.
But in the second half of this decade, the market could hit a maturity wall, as a wave of high-yield bonds issued at favorable rates during the pandemic will need to be refinanced, Gundlach remarked. These bond issuers will find themselves competing against governments and investment-grade issuers likely to be offering far more attractive rates than they did during the last decade when bond investors were struggling to “survive in the fixed-income dungeon” of near-zero interest rates.
On the current economic front, Gundlach noted that indicators keep signaling a recession. For example, the U.S. Leading Economic Indicators remain “recessionary,” and when they are annualized on a six-month basis, the picture looks more “negative” than on a 12-month basis. That signals “momentum is building,” he maintained.
While the upbeat employment numbers for January stunned financial markets, the entire outlook might not be as bright. More than half the states in the U.S. are experiencing job losses, and Gundlach said those states represent 74% of the U.S. population.