Bond guru Jeff Gundlach said the Republican tax plan could have “unintended consequences” on high-yield bonds, also known as junk debt.
Gundlach, fund manager and founder of DoubleLine Capital, says the tax plan’s changes to interest-rate deductibility could hurt the $1.5 trillion market, which has seen little gains this year even as equities have steamed ahead with their impressive rally. The GOP is close to passing its tax cuts after House and Senate Republicans agreed to a finalized bill on Wednesday.
“There’s probably going to be some unintended consequences, it will probably harm some companies and some sectors,” he said. Gundlach made his remarks during a Wednesday interview with CNBC.
See: Why tax-bill fears may be one big contributing factor in junk bond slump
His thinking is that high-yield bonds have been remarkably steady since oil prices fell below $30 in early 2016 thanks to very few overindebted companies defaulting on their debts. But with the tax plan capping deductibility for interest expenses, high-yield issuers could be left in the lurch.
Gundlach said the mechanism for widening fissures in the market would then be a new “narrative about defaults in the junk bond market.”
Companies that issue high-interest debt tend to have the most debt-laden balance sheets and benefit the most from deducting their interest expenses from their taxable earnings. Limiting these tax benefits would raise the risk of the most indebted issuers failing to pay their creditors.
Read: A third of junk-rated companies at risk from Republican tax plan, Moody’s finds
In November, Gundlach had highlighted in tweets how fissures in the junk-bond market could spill over into stocks. Though equity markets hit some turbulence, the initial selloff all but subsided within a few days. High-yield bonds and stocks are both seen as comparable risk assets as both are relatively volatile and underperform during market turmoil.
For the most part, stocks have soared even as junk debt have shown muted gains. The SPDR Bloomberg Barclays High Yield Bond ETF JNK, +0.00% has been largely flat, rising 0.7% this year. In contrast, the S&P 500 SPX, -0.05% has climbed 19% and the Dow Jones Industrial Average DJIA, +0.33% has risen 24.4% over the same period.
Also check out: Stock-market investors are starting to freak out about this ugly chart
“If you look at junk bonds, unbelievably it was the same price today as it was at the beginning of the year, even though the stock market has gone up,” said Gundlach.
Putri Pascualy, a portfolio manager at PAAMCO, said one way the GOP tax plan could lead to the diverging performance of the risk assets was that corporations intending to repatriate their earnings would mostly use them for stock buybacks instead of paying down debt.