February 24, 2012 / 9:56 PM / 7 years ago

Exclusive: Gundlach warns U.S. stock market vulnerable

(Reuters) - Jeffrey Gundlach, one of the world’s leading bond fund managers, on Friday warned that the rallying U.S. stock and corporate debt markets are highly vulnerable to a major reversal.

The investor, who was crowned by Barron’s as the new “King of Bonds” a year ago, said in an interview that he thinks the recent rally in stocks, which this week drove the Dow Jones industrial average above 13,000 points for the first time since May 2008, has gone too far.

Gundlach, the chief executive officer and chief investment officer of the $28 billion DoubleLine Capital LP, said he is still concerned about the euro zone crisis and deepening tensions in the Middle East.

The United Nations’ nuclear agency said on Friday that Iran has sharply stepped up its uranium enrichment drive in a report that will further inflame Israeli and Western fears that Tehran is pushing ahead with an atomic weapons program.

“It’s an awfully easy decision right now to not be making further investments in risk assets,” Gundlach said.

“The pricing of the market has returned to the levels prior to the scales falling from investors’ eyes regarding the global financial crisis, and I really don’t think that’s appropriate,” he said.

The Dow has gained 8 percent since December and the broader S&P 500 index is up roughly 10 percent.

The size of the gain leaves no cushion of safety given all the dangers in the world economy and leaves the stock market as priced for disaster as it was when the financial crisis hit in 2008, Gundlach argued.

“When I look at the pricing in the market today, I see a good chance of downside movement of some significance,” he said.

Such predictions reinforce Gundlach’s status as a bit of an outlier given the optimism among many in the U.S. markets prompted by some stronger economic figures in recent months.

Gundlach, whose prescient call to buy U.S. Treasuries last year boosted his DoubleLine funds, said he was concerned about “schizophrenic” investor psychology that had flipped to over-confidence because of some stronger economic data and market gains when only five months ago people felt a new recession was imminent.

He said a decline in stock market volume was a worrying signal. Average daily volume on U.S. exchanges last year was 7.84 billion shares but so far in 2012, average daily trading has been 6.95 billion shares.

Gundlach’s investment track record has been very strong. Last year, for example, the DoubleLine Core Fixed-Income fund, Gundlach’s multi-sector bond fund which can invest in corporate bonds, mortgage-backed securities, Treasuries, and emerging-market debt, posted returns of 11.5 percent.

In comparison, the Barclays Capital U.S. Aggregate bond index - the fixed-income market’s equivalent of the S&P 500 index - posted returns of 7.8 percent.


Gundlach’s view clashes with that of many money managers, who cite low Treasury rates, strong corporate balance sheets, and worldwide liquidity programs as reasons to allocate money to riskier assets such as stocks.

When asked why few other money managers agreed with his views, Gundlach said: “I’d say that’s because the great majority of money managers never say, ‘take money out’.”

Like Wall Street analysts who “never have a sell signal on anything,” managers tend to only go public with buy or hold sentiments, he said.

Investors that concede that the market may not rally further but still expect to earn their high-yield coupon are the biggest red flag to flee the risk sector, Gundlach said.

“That’s usually about as negative as the consensus gets, and usually I warn my clients that when you start hearing a predominance of that method of thinking it’s about as close as you’re going to come to a sell signal.”

Coupons for BBB-rated companies hit a record low this week, according to IFR, a unit of Thomson Reuters. CSX Corp (Baa3/BBB) set a record for the lowest 30-year triple-B coupon with its $300 million 4.4 percent deal at just 133 basis points over Treasuries.

Rising oil prices, tensions in the Middle East, and deficit policies to be announced in the U.S. elections in November are just three possible catalysts to burst the rally, Gundlach said.

“When you see volume decline and you see insider selling at a high level, you’re already seeing the market showing cracks, and it’s already there,” he said. He added that positive economic surprises “can only, at some moment, disappoint.”

Gundlach also said that worsening government finances in the United States and much of the developed world were “completely unsustainable” but that once politicians tried to really deal with them, there were major risks of a recession.

“You might also at some point have a well-meaning attempt to address this absurd amount of government borrowing to fund the spending outlays. If you do that, you will go into a recession immediately,” he said.

Gundlach said a mix of Ginnie Mae and non-guaranteed mortgage-backed securities is “the best fixed-income strategy right now,” since the risks of both, when blended, can be positioned to offset each other. This blend can also yield about five percentage points above a generic Treasury portfolio, he said.

“I’ve been at this game for about 30 years, and what I’ve learned is that in the world of finance you tend to make money slowly and lose money quickly, and the idea is to not be there when you have potential for downside movement,” he said.

Reporting by Sam Forgione Editing by Jennifer Ablan, David Gaffen and Gary Crosse

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