The Gundlach Effect?

Michael Sheetz of CNBC reports, Jeffrey Gundlach says the S&P 500 is headed to new lows: 'I'm pretty sure this is a bear market':
DoubleLine Capital CEO Jeffrey Gundlach said Monday that he "absolutely" believes the S&P 500 will go below the lows that the index hit early in 2018.

"I'm pretty sure this is a bear market," Gundlach told Scott Wapner on CNBC's "Halftime Report."

"We've had pretty much all of the variables which characterize a bear market," Gundlach added.

The S&P 500 is not in a bear market yet, down 11 percent from its record high reached in September. Wall Street traditionally defines a bear market as a decline of 20 percent or more from recent highs. The S&P 500 fell as low as 2,532.69 in February, a little more than 2 percent lower from where it is now.

Stocks fall into a bear market typically after "something happens that doesn't make any sense at all," Gundlach said. Cryptocurrency is the "mania" this time around, he said. Gundlach said bitcoin is an indicator of the market getting ahead of itself, much like during the dot-com bubble when technology companies "were being IPO'd that had no sales" or in 2006 when subprime lending "went on longer than it should have."

Bitcoin began to fall early in 2018. "One after another you start to see various sectors of the market give it up" after cryptocurrencies sold off heavily, Gundlach said. After each of the major stock indexes "rolled over," he said the bull market was "down to the FAANGs." But even those bellwethers of growth didn't last. The five FAANG stocks – Facebook, Amazon, Apple, Netflix and Google parent Alphabet – are currently in or near bear markets.

"That was kind of the last straw" of the bull market, Gundlach said.

But it was only when the trade war between the U.S. and China collided with the Federal Reserve's rising interest rates that the sell-off began in earnest. In early October "suddenly the market seemed to wake up to the fact that this was real and the next day the stock market tipped over," Gundlach said. Additionally, he thinks that President Donald Trump's trade fight with China is not going to get better anytime soon.

"I think [the trade war] gets worse," Gundlach said. "We're probably going to ratchet up the tariffs."

He said his best idea for 2019 is "capital preservation." Gundlach defines that as "high-quality, lower-volatility, lower-duration bond funds," he said.

Gundlach predicted in March that the closely watched 10-year Treasury yield would hit 3 percent and send stocks tumbling. His call came true a few months ago, as October was one of the worst months for U.S. stocks since the financial crisis.

Gundlach revealed in February that he was betting against Facebook shares. He said his short was due to falling public perceptions of the company. Facebook's stock is down more than 13 percent since Gundlach's call.

He also in 2017 envisioned bitcoin cratering, saying that "if you short bitcoin today, you'll make money." At the time, bitcoin traded at about $16,000. The cryptocurrency now trades at about $3,400, losing about 75 percent of its value this year.

DoubleLine has more than $120 billion in assets under management, according to the firm's website.
As soon as Gundlach was dropping his truth bombs on CNBC, the market started selling off hard (click on image):

What else did the bond king say today? He said the Fed shouldn't raise interest rates this week:
"I think they shouldn't raise them this week. The bond market is basically saying, 'Fed you've got no way you should be raising interest rates.' Look at the twos, threes, five-year part of the yield curve, which are flat at 2.7 percent," Gundlach told CNBC's Scott Wapner in Los Angeles. "The problem though isn't that the Fed shouldn't be raising rates. The problem is that the Fed shouldn't have kept them so low for so long."

The Federal Open Market Committee — the Fed's policymaking arm — is expected to hike its benchmark overnight lending rate for a fourth and final time of 2018 on Wednesday. While fears of rising interest rates and an ambitious Fed have spooked markets throughout 2018, such concerns have evolved over the past month as inflation and growth expectations recede.

The so-called yield curve remains partially inverted, with the yield on benchmark 2-year Treasury notes exceeding the rate on 5-year notes. The recent fall in interest rates, as well as marked flattening in the yield curve, has pushed bank stocks lower, with the SDPR S&P Bank ETF down more than 20 percent in the past six months.

"The problem is that we shouldn't have had negative interest rates like we still have in Europe. We shouldn't have done quantitative easing, which is a circular financing scheme," he added. "The problem really is the deficit. The Fed is kind of helpless here. The fact that the deficit is so out of control this late in the economic cycle: We have never before had the Fed raise interest rates while the budget deficit was expanding."

Gundlach, a respected prognosticator across Wall Street, said in his webcast last week that it looks like the U.S. stock market is "going to break down" amid a rising deficit, signs of an economic slowdown and an ambitious Federal Reserve. The central bank has already hiked the federal funds rate three times this year.

Gundlach noted that consumer confidence readings lately versus economists' expectations are falling short by a magnitude and consistency last seen prior to the recession in 2007. This continued disappointment could be a sign of economic weakness ahead.

Gundlach said he agreed with President Donald Trump's Monday criticism of the Fed's rate hiking path. The president lambasted the central bank for "even considering" another rate hike just days before its final meeting of the year.

"Usually the budget deficit expands in response to a recession. It's a way of stimulating to get us out of recession," Gundlach said. "But instead, we did it as a last gasp of keeping this economic recovery going."

Gundlach made several bold calls on the financial markets this year which came true, including a decline in the S&P 500 after the 10-year yield hits 3 percent, Facebook's bear market and bitcoin's price cratering. DoubleLine's assets under management totaled more than $120 billion as of June 30.
I don't agree with Gundlach on quantitative easing or that the Fed kept rates "too low for too long", but he's right the Fed should raise this week and then, in my humble opinion, take a long pause.

Why? On Friday, I wrote a comment on why the market is so sick and stated the following:
It remains to be seen if "one and done" is the Fed's new mantra but if you ask me, the damage is already done.

Importantly, forget the circus show in Washington, Brexit, Frexit, trade tensions, the cumulative effect of soon to be nine rate hikes are starting to bite the economy. You see it in housing, the auto sector and other interest rate sensitive sectors.

From a macro perspective, even if the Fed pauses here, the damage is done. The US economy is slowing, the US dollar will stop surging higher in Q1 of next year, and the big wild card is what happens in the rest of the world.

If the Fed pauses, you would expect emerging markets to take off, global growth to pick up, oil and commodity prices to start bolstering and heading higher. This will benefit commodity currencies like the Aussie, loonie and kiwi.

But if global growth doesn't pick up, then 2019 will be the year of a synchronized global downturn, risk assets will languish, and US bonds will outperform all other major asset classes (click on image):

You'll notice that US long bonds (TLT) are doing well recently which is exactly what you'd expect when the market is selling off.

It's too soon to tell whether or not this trend continues into the new year. There are a lot of moving parts to the market and economy, a lot of risks in the background.

And they're not all financial risks. What if Trump is impeached next year? You will see the US dollar and stock market sell off hard and bonds take off.

Right now, all this uncertainty over the Fed, China, Brexit, Trump, is causing many investors to back off, stop buying the dips and start selling the rips to raise cash.
By the way, I'm not the only one who thinks the Fed should take a long pause here. Legendary investor Stanley Druckenmiller also stated Fed must pause because the economy can 'ill afford a major policy error':
The Federal Reserve should halt its interest rate increases as recent developments in the markets and economy signal caution, hedge fund manager Stanley Drunkenmiller said in a commentary for The the Wall Street Journal over the weekend.

"The central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity," Drunkenmiller, a former member of the Fed board and now CEO of the Duquesne Family Office, said in the op-ed.

There are enough indicators to suggest the economy might need some monetary accommodation, Drunkenmiller pointed out, citing the slowing global trade growth over the past three months and the U.S. financial markets' sell-off, particularly in bank stocks. The billionaire investor had managed George Soros' Quantum Fund and later oversaw $12 billion as president of Duquesne Capital Management.

"We believe the U.S. economy can sustain strong performance next year, but it can ill afford a major policy error, either from the Fed or the rest of the administration. Given recent economic and market developments, the Fed should cease—for now—its double-barreled blitz of higher interest rates and tighter liquidity," Drunkenmiller said.

The S&P 500 is down 11 percent and counting from its record high hit earlier in the year as recession fears mount. Bank stocks have led the decline with the financial sector in the S&P 500 down more than 20 percent over that same time span. Other economically sensitive sectors, like housing, transports and industrials, are down by double digits, underperforming the broader markets, Drunkenmiller pointed out in the op-ed.

Markets are now foreseeing a 78 percent chance of a hike when the Federal Reserve meets Wednesday and a 38 percent probability of a move anytime in 2019, according to the CME's tracker. The Fed has forecast three hikes for 2019, but recent dovish comments from Fed officials and a more tempered view of the economy for next year could make them rethink their rate path.

"The Fed should stop this option-limiting exercise entirely. And if data dependence is the Fed's new mantra, it should actually incorporate recent data into its forthcoming policy decision," Drunkenmiller added.
Take the time to read Druckenmiller's WSJ op-ed here.

There's a reason why Stan Druckenmiller has the best long-term track record in the history of money management, he's a brilliant macro thinker who is always looking ahead when investing and has a knack for picking turning points, often making a killing in the process.

Alright, the Federal Reserve is expected to hike interest rates on Wednesday, a move Trump calls ‘foolish’ and ‘incredible’, pretty much cementing the rate hike (Trump has to learn to shut it on many topics, including the Fed).

Here are four quick scenarios in my head:
  1. The Fed cuts rates. Not likely and it would send the wrong signal, the market will panic, US dollar will crash.
  2. The Fed leaves rate unchanged. Again, not likely and it wouldn't be interpreted a sign of confidence. The market and dollar will sell off but not as much as first scenario (rate cut).
  3. The Fed raises rates and pauses. This is the most likely scenario, it might be the one which sends stocks higher, at least initially but over the next quarter, nine cumulative rate hikes will squeeze risk assets. The US dollar might rally a bit but sell off quickly after due to pause.
  4. The Fed raises and signals more rate hikes ahead. Not likely and this is not a good scenario. Stocks will sell off and so will other risk assets all over the world, like emerging markets stocks. This will reinforce deflationary headwinds, send the US dollar higher and invert the long yield curve (10s and 2s).
There you have my four scenarios for what happens on Wednesday after the Fed decision.

Lastly, while everyone is focused on interest rates, Francis Scotland, Director of Global Macro Research at Brandywine Global, wrote a great comment, Forget about the Policy rate, It's the Balance Sheet. Take the time to read it here.

Below, DoubleLine Capital Founder and CEO Jeffrey Gundlach says in an interview with CNBC that he believes the S&P 500 is already in bear market territory. He also spoke of why he expects tariffs to get worse and why capital preservation is his best theme for 2019.

Lastly, Kathy Jones, chief fixed income strategist at Schwab Center for Financial Research, and Chris Verrone, partner at Strategas Securities, tell 'Squawk Box' what they're keeping an eye on in the markets.