Stimulative monetary policy by the Federal Reserve Board is creating major distortions in the financial markets, according to DoubleLine CEO and CIO Jeffrey Gundlach. In a webcast yesterday, the bond fund manager said that even while Fed policy has triggered a rebound in junk bond prices, the default rate of these securities could double in the next few years.

Gundlach gave attendees a wide-ranging overview of topics, including the presidential election, consumer sentiment, the labor market, the current level of stock prices and global currency markets. It’s been a year of extremes. For example, growth in the basis measure of money supply, M2, has hit a historical high while the velocity of money, a measure of how fast money changes hands, reached a historical low. That has never happened before.

Regarding the presidential election, he maintained that President Trump is still the favorite to be re-elected. However, he produced a chart showing how the president’s popularity has fluctuated in fairly close correlation to America’s incidence of the novel coronavirus. If the nation were to experience another spike in cases, Trump’s re-election prospects could be jeopardized, Gundlach said.

Starting his presentation with a look at the global economy, Gundlach described the economic environment as strange. Early in 2020, global GDP was expected to grow by 3.0%. Now it is expected to shrink by 3.9%.

Global trade has slumped by about 60%. The changes in both the three-month and 12-month averages in trade declines closely mirror the fall in cross-border economic trade during the financial crisis 12 years ago.

Sadly, the picture in America is worse. U.S. GDP  is expected to decline about 5.0% this year, according to data compiled by DoubleLine and Bloomberg. “That’s pretty strange because the U.S.” fiscal and monetary policy response was among the strongest in the world, Gundlach said.

There also is another disconnect: The U.S. stock market has outperformed most equity markets in the world, he noted.

But if the U.S. entered the recession in a relatively healthy position with an 3.7% unemployment rate, that masked certain underlying weaknesses. Gundlach pointed out that the index of Leading Economic Indicators had been declining for nearly two years before the recession began in March.

Among sentiment indicators, Gundlach observed there is a high dispersion of results. More consumers say jobs are hard to find even though more than 10 million new jobs have been created since the economy bottomed in May.

“It’s foolhardy to believe the economy can sustain this kind of shock” and then recover back to normal with only a single round of fiscal and monetary stimulus, he said. The ongoing ripple effects of the March lockdowns are simply too powerful.

That said, he quickly noted the wild swings among homebuilder confidence. Attitudes among this group of business executives rose from the depths of despair in March and April to near exuberance this summer as the work-from-home economy began to take shape, Gundlach said. Fully 37% of remote jobs are located in large metropolitan areas and many of these high-income workers are contemplating relocating to less expensive areas with larger living spaces.

Other areas of economic activity remain way below normal levels. Gundlach pointed to TSA figures on airplane travel, which were still off 60% on Labor Day weekend. On a seasonal basis, hotel occupancy rates have rebounded to 50% of last year’s figures.

Small business, considered by many to be the backbone of the U.S. economy, “is taking a disproportionate hit,” Gundlach said. According to one survey, small business revenues were down 20% in August.

Two small businesses that Gundlach never imagined would close in his neighborhood—a coffee and tea shop and a dry cleaner—folded this year. If small businesses remain some of the major casualties of the pandemic, there are likely to be consequences across the entire economy, he said.

He expects the damage from the recent downturn to exert a more severe impact on defaults in the junk bond market than either the 2000-2002 or 2008-2009 recessions did. Yet one wouldn’t know it if they just looked at price levels in today’s high-yield market.

During the 2008-2009 period, spreads between Treasurys and junk bonds with comparable maturities “blew out” as the high-yield market got clocked, he said. This time, he noted, it hasn’t happened, thanks in large part to the Fed’s decision to buy junk bonds and backstop that market.

Still, there have been a series of downgrades and Gundlach doesn’t expect it to let up. That could be the harbinger to a wave of insolvencies, he said.

Finally, Gundlach turned to the equity market. The S&P 500 is in “nose-bleed territory,” he said, but it’s not as bad as 1999.

The dominance of Microsoft, Apple and the four FANG stocks—which accounted for 29% of the S&P 500’s market capitalization—is a warning sign. “The generals are leading the privates into battle,” he said.

The surge in IPOs of special purpose acquisition companies (SPAC) is another “warning sign of imprudent behavior,” he said. The melt-up over the last six months was one of historic proportions.

Equally disconcerting is the participation of retail investors. Gundlach called it “a terrible sign.”