The Bond King's Top Values for a "Fear and Loathing" Market

The Bond King's Top Values for a "Fear and Loathing" Market

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

In the run-up to a potential U.S.-led military strike against the Assad regime in Syria, U.S. stocks were little changed today, although they did manage to eke out a small gain, with the S&P 500 up 0.2%, while the narrower, price-weighted Dow Jones Industrial Average rose 0.1%.

That even small gains were achieved is not unimpressive, given that a new U.S. military action in a volatile region now looks imminent, and they probably owed much to some rather encouraging economic data. This morning, the Commerce Department raised its estimate of second-quarter GDP growth from 1.7% to a better-than-expected 2.5%.

For reference, prior to the Western military intervention in Libya beginning on March 19, 2011, the S&P 500 fell 6.4% peak to trough between February 18 and March 16.

Still, there was no papering over rising stock market uncertainty in the options market, as the CBOE Volatility Index, Wall Street's "fear index," rose 1.9% to close at 16.81. Barring Tuesday, this is the highest closing value since June 28, when the stock market was still struggling to digest the prospect of a ratcheting down in the Fed's monthly bond-purchase program. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

Volatility was also on the mind of DoubleLine CEO and Chief Investment Officer Jeff Gundlach, when he appeared on CNBC today. Gundlach was named the "king of bonds" by Barron's in 2011. (This is a case where the title isn't outrageously hyperbolic -- Gundlach has a superb long-term track record.) In the interview, here's how he characterized the current environment:

The sentiment is now "fear and loathing" -- people have gone from "I don't care about volatility, I want income" to "I don't care about income, I don't want volatility."

Which might be a problem, since he thinks volatility is on the way:

I think the Fed will taper... on the moment that happens, I think you actually get rallies in markets, but after that, we'll start to enter a period of a higher volatility, I think, because, the markets won't have a safety net and I mean equity markets also.

But if you're willing to accept a bit of volatility, Mr. Gundlach has a value pitch for you:

There is plenty of yield right now in the bond market. It's not in Treasuries, it's in areas that people who watch your program can participate, because it's very good for an individual investor: I'm talking about closed-end bond funds; I'm talking about mortgage REITs. These areas that are trading at 10% discounts to the value of their underlying bonds, or, in the case of the mortgage REITs, more that 10% discounts to their book values, so they have a cushion of safety... It's not hard to put together a portfolio that yields 8% using a bakset of these types of vehicles. That sounds pretty good, but nobody wants to buy them because of the sentiment and the fear and loathing... Investors are supposed to be accumulating these things.

I consider myself a value investor, but I don't like mortgage REITs such as Annaly Capital or American Capital Agency at all. Still, I thought it was worth highlighting Gundlach's idea. He is, after all, a successful investor -- and any asset can be bought intelligently at some price.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool has no position in any of the stocks mentioned, either. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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