Investors need to think about junk bonds in relation to municipal bonds, Jeffrey Gundlach, CEO of the fixed-income investment management firm DoubleLine Capital and former CIO of TCW Group, told CNBC on Wednesday.
"There's a tax benefit in municipal bonds. When you take that into account on a tax-adjusted basis, long-term munis yield 8.25 percent—about a percent and a quarter more than a basket of junk bonds," Gundlach said.
"One can say there are problems in municipal bonds, in terms of fiscal situations at the state level. But either those problems are going to blow up or they're not," he said.
"If the problems don't blow up, you're obviously going to have better results in munis and, if they do blow up, junk bonds are going to blow up too," Gundlach said.
"It's kind of three strikes and you're out when your looking at junk bonds," he said.
"The municipal bond market is going to have investors scared to an even greater degree than they are now, so the watch word is 'dry powder' for the municipal bond market," Gundlach said.
"The problem is that people only buy munis for one reason: the tax benefit. And people who do that are all in...they have all their fixed-income money in munis. Now all is a lot," he said.
"The way to successfully invest is to understand that a problem lies ahead, whether it's a moderate problem or a larger than moderate problem really doesn't matter," Gundlach said.
Since the low in March 2009, junk bonds are up 84 percent, he said.
"People look at the yield spread versus Treasurys and some people say it looks kind of cheap, because high-yield to no losses (on principal) yield 7 percent, while Treasuries yield 2 percent, so there's about a 5 percent spread—that's about historically average," Gundlach said.
"That's a failed analysis because high-yield bonds have a lot more volatility then a Treasury bond index," he said.
"You really need to compare high-yield bonds to long-term Treasurys, and since the yield curve in Treasurys is so steep—long treasurys yield about 4—so 7 percent to no losses from high-yield bonds is only a 3 point spread," Gundlach said.
"The spread really isn't all that great when you volatility adjust it," he said.
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