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.

Elevated volatility is also a symptom of a potential regime change in the markets.

Gundlach also noted that large- and mega-cap indexes like the S&P 500 and the Dow Jones Industrial Average are no longer outperforming small caps as represented by the Russell 20000.

“The Russell 2000 had a strong negative return for most of 2020, then reversed due to vaccines,” he said.

Gundlach named his presentation Aqualung after Jeff Koons’ cast-bronze sculpture of scuba apparatus—the message being that the very equipment that purports to support life could also weigh a person down to their death.

“It signifies survival, death defiance, triumph over nature and voyages into the unknown—an apropos metaphor for American society currently,” he said. “Aqualung is about life support and artificial means of survival, but despite the uplifting themes of survival and achievement, the sculptor ultimately reminds us that these states of being cannot exist without their counterparts: demise, degradation and death. This dual aspect recasts it in a startling new light, as a symbol of inevitable decline.”

In Gundlach’s metaphor, stimulus was the aqualung helping to keep financial markets alive in a dangerous environment, but it could also come to weigh these same markets down.

“We remain mired in a house of mirrors with all these policies,” he said, pointing out that thanks to fiscal stimulus, the consumption of goods has grown even as employment has declined: Consumption is no longer a significant driver of job growth.

While U.S. stocks are supported by low-interest-rate policy, expectations of rising inflation may also signal a regime change with rising correlations between stocks and bonds. But it might also signify danger, as inflation can create negative real interest rates, allowing “zombie companies” with liabilities greater than revenues to survive far longer than they otherwise would.

Clarifying comments made on CNBC earlier this week, Gundlach said that he remains neutral on Bitcoin, warning those who seek to use it as an inflation hedge that it is more volatile than gold and maybe greatly overvalued. In fact, he credits most of Bitcoin’s recent run to record highs on support from institutional investors like Paul Tudor Jones.

And Gundlach took a moment to rail against technology as a driver of widened economic inequality, pointing out that while technology represents 38% of the market capitalization of the GDP, it accounts for just 6% of U.S. GDP and 2% of employment.

Gundlach also echoed a prediction he made several times during 2020, that a second wave of layoffs and unemployment looms for middle-management as work-from-home becomes a permanent reality.  December’s job losses may be the first sign of this second wave, he said.

“I’m wondering if [work from home] won’t have economic consequences,” he said. “At some point, business leaders will have to draw conclusions about whether they need to restructure their businesses in a more permanent way.”

Towards the end of his presentation, he repeated asset allocation advice he offered to investors in 2020: A barbell portfolio that hedges against both inflation and deflation, 25% in Treasurys, 25% in cash, 25% in equities (mostly emerging markets), and 25% in real assets.