A series of market regime changes punctuate the opening of 2021, and investors should not be caught unaware, according to DoubleLine Capital CEO Jeffrey Gundlach.

In “Aqualung,” a presentation yesterday afternoon that served as his 2021 market outlook, Gundlach described an ongoing shift from benign inflation and a market that favors U.S. large-cap equities and corporate bonds to rising inflation and a market that favors Asian emerging market equities, small-cap stocks and developing market bonds.

“I don’t believe we’ve left the recession yet,” despite a return to GDP growth and a market recovery, he said. DoubleLine manages more than $140 billion in assets in mutual funds, ETFs, closed end funds and other investment vehicles.

By his definition, a recession does not end until GDP returns to pre-Covid levels. U.S. GDP growth has averaged about 2.5% over the past five years, and even with the recovery in the third and fourth quarters, the economy is about $1 trillion below where it was in production.

While a return to air travel—which hit post-Covid highs in December—might signify a recovery, it could be “ultimately drowned by the weight of the consequences of the policies we’ve already embarked on and are likely to ramp  up further,” he said.

He warned that valuations are overheated across most financial markets, especially in U.S. stocks and bonds.

Bonds, in particular, are overvalued, said Gundlach, noting that signals like the copper-gold ratio suggest that the 10-year Treasury yield should be over 2%. Throughout the year, interest rate spreads should widen until and unless the Federal Reserve engages in a policy of yield-curve control. A decline in foreign purchases of Treasury bonds should support an increase in interest rates in 2021.

As the pandemic induced central banks and policymakers to inject monetary and fiscal stimulus into the global economy, valuations have become stretched, said Gundlach.

Gundlach cited a Deutsch Bank survey showing that investors “extremely dislike” Asian equities, a sentiment he called unfounded. “I would put them much higher on the ‘like’ list," he said.

In recent weeks, financial markets have shifted, said Gundlach, with Asian stocks in Korea and China outperforming their U.S. counterparts, perhaps a sign of a more lasting change. He also noted that U.S. equities are starting to underperform other global equities.

He expects this trend to continue, noting that the forward PE ratio of the S&P 500 is now 6% greater than that of the rest of the world, its widest difference since 2008, perhaps signifying that U.S. equities have reached a top versus foreign equities.

Emerging market securities should be buoyed by a weakening of the dollar catalyzed by monetary and fiscal stimulus, said Gundlach. An expansion of dual deficits—trade and budget—is hastening the dollar’s retreat. A retreating dollar should lead to rising commodity prices.

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