"The New Bond King": Liquidation is inevitable; a defensive posture should be adopted for the next 6 to 9 months.

Are the good days over for the market?

Jeffrey Gundlach, known as the "New Bond King," recently stated in an interview with The Julia La Roche Show that the market has "moved to the tough side." He predicts the next six to nine months will be a high-risk period, advising investors to shift entirely to a defensive stance, and has already eliminated all AI exposure from his portfolio.

He recommends allocating equity exposure to an equal-weighted index, holding shares in the top 440 companies by revenue with equal weighting. "This way, your exposure to AI is almost zero, as far away from that area as possible." He stated that he held 40% equity last quarter, which has now been reduced to 30%, and he recently completely exited his AI-related exposure. "If you're still in there, good luck. But we've moved past that 'everything' phase."

Gundlach also warned that the cracks in the AI-related credit market are widening, and capital expansion in the AI sector has reached an extreme. Hyperscale cloud providers and AI companies have an insatiable need for loans; "they don't care if interest rate spreads widen, and they won't care if interest rates rise by another 200 basis points."

The intricate web of risks between private lending and the insurance industry will have serious consequences in the next downturn. He bluntly stated, "Private lending is the fuse, and insurance companies are the bomb."

Valuation has reached a dangerous level; actual returns over the next ten years may be negative.

Gundlach points out that the S&P 500's Shiller Cyclical Adjusted Price-to-Earnings Ratio (SHP) has now reached 42. "Historically, every time this indicator has exceeded 35, the real returns over the next 10 years—that is, the returns adjusted for inflation—have invariably been negative. The most common outcome is a real loss of about 5% per year."

He further calculated: "If inflation remains at 2%, it means that nominal returns will also be negative over the next 10 years, without any exceptions."

Meanwhile, Treasury yields have risen by about 75 basis points in the past six months, but stock market valuations have risen instead of falling, with the "stretch becoming increasingly severe".

AI-driven lending cracks emerge, casting doubt on the credibility of rating systems.

Gundlach turned his attention to the differentiation within the credit market.

He stated that a few months ago, credit spreads across all rating tiers tightened almost simultaneously, but now triple C-rated (CCC) assets are beginning to show signs of erosion. Specifically, triple C bank loan prices have fallen by several percentage points, with total returns declining by approximately 5% to 6%, while higher-rated bank loans are still rising by about 4%.

More noteworthy is the divergence within the AI sector. He said: "If we split the high-yield bond and bank loan markets into AI-related and non-AI-related parts, the non-AI part remains strong, with spreads barely widening; however, spreads on AI-related junk bonds have widened by about 50 basis points from their lowest point, and bank loan spreads have widened by about 130 basis points."

He cited SpaceX as an example, pointing out that the company's bonds received the lowest investment-grade rating, BBB-, but market pricing reflected credit quality three notches lower. "The bond market simply doesn't buy it," he said. He questioned the independence of rating agencies, implying that some smaller agencies engage in "price list" rating practices, and pointed out systemic rating arbitrage between private lending firms and their affiliated insurance companies.

Gundlach further warned that capital expansion in the AI sector has reached an extreme. He pointed out that hyperscale cloud providers and AI companies have an insatiable need for borrowing, "They don't care if interest rate spreads widen, they won't care if interest rates rise by another 200 basis points." These companies expect to reach markets that are even a quarter of global GDP, "which is simply impossible." He bluntly stated that this "holy grail race" in AI will inevitably produce losers and shocks, which will trigger the next very significant pullback in risky assets. "We're close enough to that tipping point, so I want to leave this epicenter."

Portfolio: Zero out AI, shift to equal-weighted, gold, and emerging markets

In response to the aforementioned risks, Gundlach has made his current asset allocation framework public.

Equities (30%): Allocated entirely to an equal-weighted index, holding approximately 440 companies with the highest revenues, "so that your exposure to AI is almost zero, as far away from that area as possible." He stated that he held 40% equities last quarter, which has now been reduced to 30%, and he recently completely exited AI-related exposure. "If you're still in there, good luck. But we've passed that 'everything' phase."

Fixed Income (30%): A barbell strategy is employed, with half allocated to high-credit-quality total return funds (excluding corporate bonds) and the other half to local currency emerging market debt, the latter yielding over 7%. "This is the best-performing fixed income sector, the best last year, and I believe it will continue to do so."

Physical assets (20%): 10% allocated to gold (previously reduced to 5% when the price of gold exceeded $5,000, and then increased back to 10% after the price of gold fell back to $4,300), and another 10% allocated to commodity ETFs (DCMT), which have risen 38% year-to-date.

"Dry powder" (20%): Allocated to a short-duration commercial real estate ETF (DCRE, yield approximately 6%) and a flexible bond fund (DLEX). The overall portfolio yield is approximately 6.25%, with a duration of only 2 years. "Even if interest rates rise by another 200 basis points, we can still maintain a positive return."

Private lending is the fuse, insurance companies are the bomb.

Gundlach issued the most severe warning about the risk chain formed by the intertwining of private lending and the insurance industry.

He described a closed loop of interests: private equity firms acquire insurance companies, which are then required to purchase private credit products from the private equity firms, and the risk is then transferred through offshore reinsurance companies (such as Barbados and the Cayman Islands), which are beyond the jurisdiction of U.S. regulators.

“Reports show that some companies may have less than $100 in reserves for every $100 of future liabilities, and you can’t see it at all because US regulators don’t have the authority.” He also mentioned that the proportion of related investments in an insurance company under a troubled investment firm surged from 3% to 42%, and 50% of its ratings came from an institution with only 25 employees that completed 3,200 ratings last year. “That’s simply impossible. They don’t have the manpower to do that.”

He likened this structure to the CDO rating chaos of 2006: "Those AAA-rated mortgage-backed securities fell below 30 in March 2009 and remained below 60 for quite some time. Something similar could very well happen to some insurance companies."

He advised investors who want to buy annuities or life insurance to "only choose mutual insurance companies, because they serve policyholders, not private equity firms."

The reckoning is approaching, and this time it will be even harder to end.

Gundlach admitted that he was more concerned about the current situation than ever before.

“The peak of optimism was around June this year. It felt like 1999, like 2006—a ‘can’t lose’ mentality,” he said. Within days of the AI-related bond issuance, market quotes were significantly discounted from the issue price, “which was a clear signal of a shift.”

He anticipates immense pressure for bailouts when the liquidation of AI and the private markets arrives. "But this time it's difficult to explain to the public—you can't package a bailout for Wall Street's savvy investors as 'protecting ordinary families' like you did in 2008."

He concluded, "Six months ago I said this year would get increasingly difficult. Now I think we've entered the difficult phase, and it will remain so for the next six to nine months."

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