Gundlach Says U.S. Recession Could Hit This Summer

When this billionaire talks, it’s worth listening.

One of the investors I have come to really appreciate is the bond guru Jeffrey Gundlach of DoubleLine.

Gundlach was interviewed by Yahoo Finance on Feb. 13. He talked extensively about the firm's January report that is worth reading as well. Here are the three key takeaways from his appearance:

  • Fed has dramatically altered course.
  • Corporate leverage and national debt are the two most important risks.
  • A recession is at least four months out.

Fed changed course

The Fed is not going to do anything until they communicate it first. That’s a massive change from the previous stance when quantitative tightening or QT was on autopilot. The Fed is having conversations about quantitative tightening. They are considering quantitative easing as a regular policy tool. The market isn’t sure whether the Fed is going to do QT or QE. This isn’t necessarily bad. It is what Greenspan did as well.

Risks Gundlach is concerned about are:

  1. Corporate leverage.

  2. National debt.

The first risk is that there is considerable corporate leverage. If you look at leverage ratios alone, 45% of the investment grade bond market would be rated junk right now.

Because companies are saying they plan to pay down debt, rating agencies give them a pass. And rate the companies investment grade when they deserve a junk rating based on the quantity of debt.

If there is a recession, it will be obvious leverage ratios will not be addressed and rating agencies will issue massive amounts of downgrades.

Here I’m interjecting my own interpretation, but this will flood the junk bond market while scaring investment-grade investors out. Their supposed safe investment will turn out not to be safe. This means falling prices in both parts of the bond market.

The national debt is increasing by about 6% per year currently. In a recession it will probably increase by around 10% per year, assuming we go into a typical recession.

There are also $700 billion of government bonds that are maturing this year.

For these reasons, in the next recession we may only see Treasuries with short maturities act as a safe haven while long-term government bonds will be sold off.

The real key to thinking about these problems is, in light of the next recession, when they will come to the forefront.

When is this recession coming?

There are more signs compared to last year. The indicators Gundlach looks at for recessions are not even flashing full yellow yet:

1. The Conference Board leading economic indicators are weakening from a high level. They are still very high.

2. The stock market is currently moving up.

3. Sentiment indicators are coming down but from high levels.

4. Unemployment rate is going up a little bit. This is close to flashing yellow.

5. Junk bond spreads went out in December. But they completely rebounded. These are not signaling anything yet.

This leads Gundlach to the conclusion there is no recession on the foreseeable horizon. But the foreseeable horizon is usually about four to six months.

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