One year ago at the Ira Sohn investor conference, DoubleLine CEO Jeffrey Gundlach caused a stir when he predicted that Donald Trump would win the presidential election, something virtually no other asset manager or pundit agreed with. Gundlach was right.
This year, Gundlach's Sohn presentation was more whimsical and eclectic even if he focused on more mundane financial topics, touching on the recent scramble into passive investing via ETFs and indexes, then turning to markets and observing that US equity valuations have become stretched on numerous metrics, one of which is the value of the S&P 500 relative to US GDP which has risen to historic highs that have even exceeded the dot-com bubble...
... while cyclically adjusted valuations as per the Shiller CAPE are also in nosebleed territory, and that while U.S. stocks could continue to grind higher, it's time to look abroad.
He managed to interweave his financial narrative amid a discussion of Friedrich Nietzsche as well as early 20th century art, focusing on a painting by Max Beckmann called "Night" which he dubbed alternatively as "a portrait of US long-only equity managers" while contrasting them to passive investing which has been on a tremendous run in recent years.
"The Night," Max Beckmann
Going back to the distinction between active and passive investing, Gundlach said passive investing, which he called a "bubble" is ultimately a "myth" without rigid rules, and that managers ultimately decide which stocks are included in indexes. He encouraged investors to take index funds and "throw them out the window" according to CNBC.
In a subsequent interview with CNBC (see below), Gundlach elaborated that one of the reasons for the US market's dramatic overvaluation is the indescriminate inflows going into all stocks via passive investing vehicles, which has pushed every sector of the market above its fair value.
In terms of his recommendation this year, Gundlach suggested that emerging markets will likely outperform the overvalued US stock market, and that he would short the SPY, or the S&P 500 ETF while going long Emerging Markets, which are looking like a better deal, via the MSCI Emerging Markets ETF EEM. Gundlach said that investors fret that when the Federal Reserve raises it will likely be bullish for the dollar, which hurts EMs returns, but he does not buy that thesis, noting that it often does not come to fruition: “Don’t worry about strong dollar" he said.
"Europe is more popular, I just think EM has more potential upside than ever Europe."
Should EMs outperform the US, it would have other investing implications he added: "When emerging markets outperform the S&P 500, active is outperforming the S&P 500." If this were to pan out, it would reverse years of underperformance of active managers versus the broader market. He also argued the outperformance of passive investors in the S&P 500 and the underperformance of Emerging Markets are both cyclical, and both of those cycles are about to change.
He gave a more detailed breakdown of his thinking in the following interview with CNBC shortly after his presentation:
As the FT notes, the pair trade recommended by Gundlach has already started generating returns, with the EEM generating year-to-date price returns of 14.7%, double the return of the S&P.
How did Gundlach's trade recommendation from last year's Sohn conference fare? In 2016, Gundlach recommended shorting the Utilities Sector ETF (XLU) while buying the Mortgage Real Estate Capped ETF (REM). While the utilities ETF returned 8.8% during the past 12 months, this is nearly 10% less than the S&P 500's 18.5% return, while the long end of his trade, the Mortgage ETF, returned 28%, for a generous ~20% return.