Ok, so I didn't spend 40 minutes listening to Jeff Gundlach's latest webcast to validate my own take on markets. I promise.
That said, thanks to some cherry-picked quotes trumpeted by various news outlets on Tuesday, I knew ahead of time that the "bond king's" take bore an uncanny resemblance to my own views as expressed in a number of different pieces over the past several months. He even cites a Goldman chart I highlighted weeks ago.
If you want to know the truth, I actually tuned in to hear Gundlach call Bill Gross a "second-tier bond manager," which is obviously amusing, even as it seems a bit gratuitous to kick a legend in his twilight years.
By now, you've probably listened to the webcast and/or downloaded the slides. If you haven't, you've likely at least read a summary (or two) of the presentation.
Still, I wanted to highlight several very simple points Gundlach made about high yield bonds (NYSEARCA:HYG) and equities (NYSEARCA:SPY). Put simply, he confirms precisely what I've said about those two markets: all it takes to see that they're grossly rich is a cursory look at some basic charts.
Let's start with HY. I've talked a lot about the space lately (you can start here or maybe here). The main points are: 1) defaults are high, 2) the rally is entirely predicated upon rising oil prices but it seems overdone given that the last time spreads were this tight, oil was at $80, 3) HY bonds actually outperformed their equity counterparts in 2016, and 4) the share of distressed opportunities in the space has plummeted since last January.
First of all, Gundlach warns that investors shouldn't get complacent when it comes to junk bonds because, as I've said, they're priced to perfection. Here's the actual quote from the webcast (my highlights):
Many people seem to think that because junk bonds had a great 2016 that they're somehow not vulnerable to interest rate hikes. Nothing could be further from the truth. The junk bond market has decent interest rate risk on it, it's just that they were depressed with commodities so low. I think they'll be a little bit of a shock. If interest rates do move higher from here in 2017, junk bonds will not be going up in price. The spread has tightened to the point where the cushion of safety is virtually, if not entirely eliminated.
Gundlach goes on to point out the fact that HY credit actually outperformed the equity last year. Clearly (and if you read the pieces linked above, you can see that I was skeptical of this as it unfolded), that's unsustainable (my highlights):
Junk bonds had the same return as equities. The pattern is exactly the same. This is not going to happen again. The junk bond market is not going to mirror the stock market as it's no longer as much of a credit story as it was entering 2016. It's now more of an interest rates story with that spread cushion gone.
As for stocks, well, they're simply overvalued on almost every metric.
The easiest way to conceptualize this is simply to look at earnings and, perhaps more importantly, earnings expectations. Gundlach starts with another chart I pointed out around a month ago:
That should speak for itself, but in case it doesn't, the implication there is that earnings growth isn't driving returns. Next, have a look at the Shiller P/E ratio (a guaranteed crowd pleaser):
That, perhaps more than any other visual, should tell just how stretched we are. We're back to 1929 levels (assuming we exclude the dot-com bubble).
Finally, here's a look at the historical trajectory of analyst EPS estimates:
That's reminiscent of a few points I made over at the Heisenberg Report last week in "How Expensive Is The S&P 500?" Here's an excerpt:
Forward P/Es in the US and Europe are somewhere in the neighborhood of 1 standard deviation expensive. And that may be conservative as it assumes S&P 500 2017 EPS of something like $130. When you think about that number, consider that in order to get there, we'll likely need to rely on a combination of buybacks funded by repatriated cash, lower taxes and some pro forma magic.
When it comes to that $130 figure, perhaps Gundlach puts it best: "I'll take the under."
In the end the message (at least when it comes to HY and stocks) is simple: they're overbought and the outlook is questionable at best; especially if rates rise above 3%. I'll leave you with Gundlach's conclusions on US equities:
Clearly there's been a concerning divergence between earnings and stocks. Stocks are looking mighty, but they're at a high level relative to earnings. Investors may want to peel off some S&P 500 exposure.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.