- To Jeffrey Gundlach — the CEO and chief investment officer of DoubleLine Capital — today's stock market environment is being propelled solely by momentum.
- Gundlach notes the lack of breadth throughout the marketplace, and says that it reminds him of the 2000's tech bubble.
- On Monday, the exact scenario Gundlach had been warning about came to fruition as momentum stocks plummeted.
- Marko Kolanovic, the global head of quantitative and derivatives strategy at JPMorgan, aids in the discussion, pinpointing the swoon in momentum-based issues.
- In the next 18 months, Gundlach expects the stock market to "crack pretty hard."
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"But it is a 100% momentum-based market, the most dangerous type of market in the world."
That's what Jeffrey Gundlach, the CEO and chief investment officer of DoubleLine Capital, said in a recent Real Vision interview when asked about his current outlook for the stock market.
"I turned negative on the Nasdaq September 30th, of 1999. I was really negative," he said. "Of course, in the fourth quarter of 1999, it went up 80%. But one year later, it was down 50% from the September 30th level. I feel like we're in that type of an environment."
For context, in the midst of the tech bubble, investors bid up issues of early-stage companies to sky-high multiples using metrics like "eyeballs" and "clicks" to discern value. Soon, an overwhelming amount of those companies would file for bankruptcy while the Nasdaq composite lost over 80% of its value.
Gundlach is drawing parallels.
The reasoning behind his bearishness is simple: Only a handful of stocks have propelled the S&P 500 to new highs. In his view, there are six stocks in particular (which one has to assume are Facebook (FB), Apple (AAPL), Netflix (NFLX), Microsoft (MSFT), Amazon (AMZN), and Google parent Alphabet (GOOG).
The other 494 stocks within the index are simply along for the ride, not contributing much. And that is the essence of the momentum trade, which is self-reinforcing by nature because it involves betting on the market's past-year winners and betting against its losers.
In a recent client note, Bank of America helped to demonstrate this idea. Only five stocks make up over 20% of the S&P 500 index.
And here's a scatter plot depiction of the relationship.
Kolanovic continued: "Momentum stocks typically make gains in small incremental steps with confirmatory news flow (e.g. rising COVID cases favoring lockdown beneficiaries) and have big losses on days when unexpected contrarian information is revealed (e.g. effective vaccine allowing faster re-opening). In other words, Momentum factor returns have a fat left tail."
Put differently, a market underpinned by momentum is vulnerable to sharp, violent declines.
When news of a COVID-19 vaccine broke on Monday, investors seemingly couldn't jettison momentum-based issues from their portfolios quickly enough. It's the exact type of scenario Gundlach's been warning over.
"It's so strange how faddish the market has become," he said. "My thinking is we're in the late stage, very late stage of this momentum market."
For that reason, Gundlach doesn't recommend owning US stocks at this time. But if you're going to do so anyway, he says you have to own those six momentum names. Just be ready to get out at the drop of a hat.
"It can always continue longer than you think possible, but I do think that within 18 months, it's going to crack pretty hard," he said. "I think that you want to be avoiding it for the time being."
With all of that under consideration, Gundlach relays an adverse warning, conveying a day of reckoning on the horizon.
"I turned positive March of 2009 on equities because everybody was so bearish and the PE for about two days was actually below 10 on the S&P 500," he said. "I think that's coming again. It will be quite a pleasant experience to not be in the car on the first hill on the roller coaster that's coming. I just want to be very low-risk right now."
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