I’ve just read Jeffrey Gundlach's quarterly "Letter from the Chief Investment Officer," dated May 12, 2008.  As some posters on this forum know, Gundlach is Chief Investment Officer of the TCW [once known as Trust Company of the West] Group.

One of the savviest bond-fund managers and manager of TCW Total Return Bond fund TGLMX/TGMNX, Gundlach was Morningstar's fixed-income manager of the year in 2006. Therefore I consider whatever Gundlach writes to be worth reading and considering thoughtfully.

Considering the future prices of credit mortgage-backed bonds, Gundlach posits three scenarios: first, a 20% probability that prices do not fall significantly, and second, a 40% chance that the market retests the March lows, but the floor holds. 

But Gundlach's third scenario--the terrifying one--is a 40% chance that "March will turn out to be yet another false floor. Such an outcome...would be a catastrophe for the U.S. financial system and ultimately for our economy...A piercing of the March lows...could create several "Bear Stearns,"...key institutions marked down as insolvent and collapsed under margin calls by their creditors."

Gundlach stresses that "this is a scenario, not a forecast," and continues "Price levels in mortgage credit may have seen the worst. Given the stakes, we must hope so. However...never confuse hope with investment strategy."

Read the entire report  <A HREF="http://www.tcw.com/cmRoot/Funds/CIO051208_Institutional.pdf">here</A> [six pages, PDF format].

Jagor 

I think his analysis is incomplete.  e.g. he doesn't address the scenario where the market goes lower but it isn't a "terrifying outcome."  At the point, the Fed is basically standing behind major investment banks.  You're very unlikely to see another Bear Stern even if markets test new lows. 

Best,
Oildog

Oildog,

I certainly hope that you are right, and Gundlach himself suggests a 60% percentage that you are right.  But as he also writes "Never confuse hope with investment strategy."

By the way, the word "terrifying" was my choice of words, not Gundach's.  He used the adjective "catastrophic."
I guess it all comes down to your word against Gundlach's.

I also apologize for not getting the link right; I actually tested the HTML code elsewhere and it worked perfrectly. I guess there's a bug in Morningstar's application--sure wouldn't be the first time! 

Jagor 

So, a 80% chance that we retest March lows?  OK.  It will take some really serious trouble to take us below that, IMHO. 

I agree with Gundlach that the fundamentals are terrible.  I don't know what to do except watch the macro trends and try to figure out how bad the damage will be.  Of course the markets will probably be months ahead of me.

Looking at the CME city house price futures, Los Angeles is already off about 27% with no sign of a bottom.  But most other cities look healthier.  Should the market degrade from here with a leap in foreclosures, it would be trouble for a lot of banks.  The empty home level is already scary and will take years to work its way down.

So far this has been a consumer-led slowdown with few company credit defaults.  If insolvency trends start to climb ...

Just some quick musings ...

well? maybe so..but If one just uses History, it's a pretty safe bet to say things like he does for the upcomming April and May's of history..

> " The Sell in May and Go away till fall" method

To a 1/2 dozen other historically proven things that have happend 51%+ of the time

Can be said about the Bears that If One is Timing the market to Being a short Term Investor? Be my guest and play on it.. and  Just Hope and Pray you Get back in, intime to capitalize on the recovery ( ie: 03' )

But if one is " Well Diversified/Balanced" they best Stay In the market, for They will miss the Recoveries

Of course is one is Top Heavy in Large And Int'l? Not so much.. Those sectors got really burned in the last Bear Market ( 00-02') and took them several Yrs to recover to just break even.. ( LC- 42% and Int'l - 51% )

And if I was in this Top Heavy in  LC & Int'l  postions?, I WOULD be very nervous

All it's going to take is for the FED to make a turnaround and Strengthen the $ and Int'l goes down the tubes ( again) and it's just around the corner..

  It's a Crap Shoot

Gundlach articulates his "Havens from the Storm" in the last paragraphs of his report:

"I believe a break below the March lows in the mortgage sector would push a number of our banks into Bear Stearns-like insolvency. That in turn could touch off a massive sell-off in stocks and corporate credit…The only defensive strategy…would be a move to hard value assets—storehouses of value such as gold, gems, prime real estate and so forth..."

So, we have been warned. 

Jagor  

I'm actually saying he's wrong for a pure logical reason - in the event that the market falls further, he's assuming the results will be catastrophic.  I don't see why that should be the case.  Why won't we just have another routine bear market during which the Fed will intervene again to stave off financial disaster?  Personally, I'd be inclined to say this is the highest-likelihood scenario. 

Best,
Oildog

Wasn't it "logical" to assume that Bear Stearns, the nation's sixth largest security firm, wouldn't collapse "catastrophically" over one weekend?  A lot of investors and pundits--not forgetting Jim Cramer--certainly thought so.

Jagor 

Given the events of the past few weeks is it fair to say that Gundlach's worst fears were realized, the market fell, but Oildog was correct, the Fed stepped in and prevented catastrophe?

TGMNX seems to have held up very well despite its portfolio, which M* shows having 79.44% CMOs as of 8/31/208. In addition, the top 25 has names such as Bear Stearns, Lehman, and Indy Mac.

How has this fund survived and is there undo risk in the future?

Rossby

So far, I think that's accurate.  Things have turned out quite bad, and the Feds probably made things worse by letting Lehman go.  I wasn't expecting them to take the risk of letting a major investment bank fail outright.  However, at this point, we're getting worldwide government intervention on a scale unprecedented since the Great Depression.  So I think we're landing somewhere in between what I suggested and what Gundlach was predicting. 

Best,
Oildog

Well, to quote one of Yogi Berri's famous oxymorons, "It's not over till it's over." And the president of the San Francisco FED just confirmed that "the U.S. is in a recession," for the handful of people who didn't already know it.

By the way,  you can read Jeffrey Gundlach's latest letter here: http://www.tcw.com/cmRoot/Funds/CIOLetters/TCWCIOletter_9-12-08.pdf

Jagor