“Expect a recession by the middle of next year,” Jeffrey Gundlach warned investors. The Fed’s monetary tightening will not be as aggressive as expected, he said, but high rates will dampen housing, consumer spending and other sectors, and will force the economy to contract.
Gundlach spoke to investors via a webcast, which he titled “Up, Up and Away,” and the focus was on his flagship total-return fund (DBLTX). Slides from that webcast are available here. Gundlach is the founder and chairman of Los Angeles-based DoubleLine Capital.
The title was a reprise of the summer of 2020 when fiscal policies that made payments to consumers led to a bubble economy, he said, which was running on “easy money.”
Now the Fed funds rate has risen to nearly 4%. The Fed wants to raise rates and stop inflation, he said.
In 2020, Fed Chair Jay Powell embarked on the fourth round of quantitative easing (QE4), the most ambitious of the Fed’s liquidity programs. It ended in April 2022, after injecting nearly $5 billion of liquidity into the U.S. capital markets.
The S&P 500 has followed the shape of the Fed’s balance sheet, driving equity prices higher until late last year. But both have contracted this year, Gundlach said, and Fed policy is a headwind to stock prices.
The market expects the Fed to raise its funds rate 50 basis points next week, to peak at 5% in May 2023, and stay there for just one meeting. It then expects the funds rate to revert to its current level over the remainder of 2023.
“But the data is weakening rapidly,” Gundlach said, and he doesn’t expect the funds rate to get to 5%.
Lower inflation and more recessions signals
Inflation is and will come down from its 7.7% level. He predicted that by May the headline CPI will be less than 4%. Import and export prices both shot up rapidly at the beginning of this year, but declined substantially over the last few months, indicating less inflation.
Other metrics indicate lower inflation.
Money supply growth, as measured by M2, is the lowest in Gundlach’s lifetime. M2 growth has been zero for the last 12 months. “That is not supportive of economic growth or of inflation,” he said.
The savings rate spiked during the pandemic but has collapsed since October 2021 at an accelerating rate. This suggests a weak consumer, according to Gundlach. “Consumers are desperate if they are borrowing to buy food or gas,” he said.
But Gundlach warned about inflation getting too low.
“If the Fed succeeds in getting to 3%,” he said, “it will not stop there.” Inflation will go well below that level and overshoot on the downside, perhaps going negative and creating a deflationary environment.
That would mean a massive bond rally, he said.
The good news for bond investors is that when the Fed does its last hike, it eases within five months.
But the harmonizing message among economic indicators is of an impending recession.
The leading economic indicators (LEIs) are in recessionary territory – what Gundlach called “full-on recession watch.” That is also the case with measures of consumer, CEO, small-business and home-builder confidence.
Measures of present and future consumer confidence have converged, he said, which is “strongly indicative of a recession.”
The yield curve is inverted, based on the two-year to 10-year spread, which historically has meant that the economy is six months away from a recession. “But it could be as soon as three months,” Gundlach said.
The ISM PMI is declining, as it did with prior recessions, and that historically means a recession could start in two months. ISM supplier delivery delays have disappeared, Gundlach said, which implies less consumer demand and some supply chain normalization.
Credit card debt has grown similarly to what it did leading up to the 2000 dot-com recession.
Housing
Housing affordability went from very good pre-pandemic to its worst level in 40 years. That is because mortgage rates and home prices are up. Most 30-year mortgages carried a monthly payment of 17% of disposable income before the pandemic, versus 33% now. The baseline mortgage rate is nearly 7% and was between 2% and 3% a year and a half ago.
“There will be a lot of people not wanting to move,” Gundlach said, “because they don’t want a new mortgage.”
Nobody is refinancing their mortgage. “It is a zero,” he said, “which has never happened.”
Among agency mortgage-backed securities, 92% could not be refinanced even if rates went down by 200 basis points.
Mortgages bond prices are down so much that there is no chance of refinancing, he said, which creates a good risk-return profile. It has created a situation where those bonds have positive convexity, essentially meaning that prices could rise regardless of the direction of interest rates.
A year and a half ago, there was the lowest home supply in 50+ years. Now supply is robust, according to Gundlach.
Other market observations
The copper-gold ratio, which Gundlach regularly follows, suggests that the 10-year Treasury yield is too high and should be approximately 100 basis points lower than it is now (3.57%).
Real yields, as measured by TIPS, are up, which was very bad for “risk assets” (equities). That increase stopped a couple of weeks ago.
The S&P 500 was hurt by tax-loss selling, Gundlach said. But he expects there to be “redeployment of capital” in first couple of months of 2023.
Since the summer of 2020, many of the “mega trends’ that took hold after the global financial crisis have reversed. One of those was the outperformance of growth over value. Growth has significantly underperforming value and that will continue, he said.
The “FAANG” acronym has been replaced by “MANAMA” (Meta, Alphabet, Netflix, Amazon, Microsoft and Apple). Since 2008, the performance of the S&P 500 has been flat except for those six stocks.
“But those six are now sick,” Gundlach said.
One trend that did not reverse is the superiority of the U.S. markets versus the rest of the world. But the dollar has topped, which may trigger a reversal. Europe has held its own, he said, but emerging markets have done well since the dollar crested. Emerging markets are at half CAPE ratio of the S&P 500 and look “very good,” he said.
Crypto is for losers
Crypto is the ultimate asset for speculation, Gundlach said. The price of bitcoin went up when there was government money. Its price hit $60,000 to $70,000 during the pandemic liquidity programs, but now languishes at $17,000.
“Crypto goes on faith and speculation,” he said. “When there is speculation, there is fraud, and there is bankruptcy.”
“There is never one cockroach,” he warned.
Scammers get envious of other scammers and emulate their tactics.
“I never owned bitcoin,” Gundlach said.
Robert Huebscher is the founder of Advisor Perspectives.
Read more articles by Robert Huebscher
“Expect a recession by the middle of next year,” Jeffrey Gundlach warned investors. The Fed’s monetary tightening will not be as aggressive as expected, he said, but high rates will dampen housing, consumer spending and other sectors, and will force the economy to contract.
