Gundlach: Emerging Markets To Drop 40%

The Fed made a critical error when it hiked rates back in December. That's one of the many bearish takeaways from Jeffrey Gundlach, who spoke at today's Inside ETFs conference in Hollywood, Florida.

Fed Has No Need To Hike

The founder of DoubleLine Capital spent much of his presentation outlining the troubles facing financial markets, while blaming the Fed for making the situation worse.

Based on its forecasts, the central bank anticipates raising rates eight times over the next two years. Either the Fed dials down its hawkish rhetoric or "markets will humiliate them by going down," he said.

Gundlach hammered home the point that there is simply no reason for the Fed to tighten, and it risks repeating the mistake of other central banks that attempted to raise rates back in 2011―such as Sweden's Riksbank―but then had to reverse course as economic growth deteriorated.

In fact, the difference in growth rates between the U.S. and Europe is marginal at best―2.2% versus 1.6%―yet the two regions "have diametrically opposite monetary policies," with the Fed hiking while the European Central Bank loosens.

Moreover, the inflation rate in the U.S. is below much of the rest of the developed world, he says, further undermining the case for tighter monetary policy. "The only place there is inflation is in rents," said Gundlach.

US Recession Risks Growing

Why then is the Fed intent on hiking? It's because wage growth is trending higher, according to Gundlach. But "what's wrong with the middle class getting higher wages?" he asked rhetorically.

The Fed should hold off on rate hikes and let the economy grow faster than its current paltry rate.

In Gundlach's view, the Fed's actions risk tipping the U.S. economy into a recession. He said that the ISM Manufacturing Index is already in recessionary territory, with the ISM Non-Manufacturing (Services) Index trending lower. If the latter falls a little more, the whole economy will likely be in contraction territory.

Junk Bonds & Emerging Markets Horrible Investments

When it came to the markets, Gundlach was as bearish as ever. He reiterated his negative stance on junk bonds. Despite yielding 800 basis points more than Treasurys, "do not buy a junk bond index fund," he advised: "You're going to end up selling it at a loss as they get more and more populated with distressed energy and mining issues."

Gundlach was just as bearish on emerging markets. He made the shocking claim that China's growth rate may really be negative, rather than the officially reported 6.9% figure. If that's the case, world GDP growth would be a meager 2%.

The forward outlook for the world's second-largest economy looks bleak as well, he explains, with Chinese demographics similar today to what Japan's were in 1990 before the start of the lost decade.

"If you're going to do something in emerging market equities, my recommendation is to short them," said Gundlach. "They may fall a further 40%."

The one exception is perhaps India. Gundlach remains a staunch bull on that particular country due to the massive growth in its labor force. "When there's blood in the streets, buy India," he suggested. "Maybe you can buy it now if you have a really longtime horizon, but it may get caught in the broader emerging market sell-off."

Bearish On The Dollar

Gundlach had a host of predictions on other areas of the markets as well. When it comes to the 10-year bond yield, watch nominal GDP, he says, as the two have a tight correlation.

As for the 30-year bond yield, he says to keep an eye on the 2.22% low from 2015. He doesn't anticipate it will break, but if it does, "You want to instantly go long, as you'll probably make 20%."

"The only way we'll take out the low is if there are really serious threats [to the economy]," he said.

Interestingly, Gundlach was bearish on the U.S. dollar. "Once the Fed backs off its rhetoric, the dollar will [likewise] back down." He adds that even if the Fed tightens, it's not necessarily a good thing for the greenback. With the exception of 1983, the dollar has gone sideways or has fallen during past Fed tightening cycles.

Contact Sumit Roy at [email protected].