"The New Bond King": The moment of reckoning is inevitable; a fully defensive stance should be adopted in the next 6 to 9 months

The market's good days are over?

Dubbed the "New Bond King," Jeffrey Gundlach stated unequivocally in a recent interview with The Julia La Roche Show that the market has "crossed over to the difficult side." He anticipates the next 6 to 9 months will be a period of high risk, advising investors to shift entirely to defensive positions and has already reduced his own portfolio's AI exposure to zero.

He recommends allocating stock exposure to equal-weighted indexes, holding about 440 companies with the highest revenue in equal weight, "so your AI exposure is virtually zero, and you're as far away from that sector as possible." He said that last quarter he still held 40% in equities, but now it's down to 30%, and he has recently completely exited any AI-related positions. "If you're still in, good luck. But we've already passed that 'everything is wonderful' stage."

Gundlach also warned that fractures are widening in the AI-related credit market, and capital expansion in the AI sector has reached an extreme. Hyperscale cloud providers and AI companies have an insatiable appetite for borrowing, "they don't care if spreads widen, and wouldn't care if rates rise another 200 basis points."

Meanwhile, the complex interconnections between private credit and the insurance industry expose deep-rooted risks that will have severe consequences in the next downturn. He stated bluntly: "Private credit is the fuse, insurance companies are the bomb."

Valuations in the Danger Zone, Real Returns Could Be Negative for the Next Decade

Gundlach pointed out that the S&P 500's Shiller CAPE (cyclically adjusted price-to-earnings ratio) has now reached 42. "Historically, every time this indicator exceeded 35, the real return for the next 10 years—i.e., after adjusting for inflation—was negative without exception. The most common outcome was about 5% real loss per year."

He further calculated: "If inflation stays at 2%, it means the nominal return for the next 10 years will also be negative, with no exceptions."

At the same time, Treasury yields have risen by about 75 basis points over the past six months, but stock valuations have continued to climb—"the stretch is only getting worse."

AI Credit Market Fractures Emerge, Ratings System Integrity in Doubt

Gundlach shifted his focus to divergence in the credit market.

He noted that a few months ago, credit spreads across different rating tiers were tightening in sync, but now triple-C (CCC) assets have started eroding. Specifically, triple-C bank loan prices have fallen by several percentage points, with total returns dropping by about 5% to 6%, while higher-rated bank loans are still up about 4%.

Of even greater concern is the divergence within the AI sector. He stated: "If you break down high-yield bonds and bank loan markets into AI-related and non-AI-related parts, the non-AI part remains strong and spreads have barely widened; but for AI-related junk bonds, spreads have widened by about 50 basis points from the lows, and bank loan spreads have widened by about 130 basis points."

Using SpaceX as an example, he pointed out that the company's bonds were rated BBB-, the lowest investment grade, yet the market priced them three notches lower on credit quality. "The bond market just isn't buying it." He questioned the independence of rating agencies and implied that some smaller rating firms engage in "pay-for-ratings" practices, highlighting widespread systemic rating arbitrage between private credit companies and their affiliated insurance operations.

Gundlach further warned that capital expansion in the AI sector has reached extremes. He noted that hyperscale cloud providers and AI companies have an insatiable appetite for borrowing: "They don't care if spreads widen, nor if rates rise another 200 basis points." These companies expect their addressable market to be up to a quarter of global GDP, "which is simply not possible." He asserted that this AI "Holy Grail race" will inevitably produce losers and disruption, sparking a major pullback in risk assets. "We're close enough to that tipping point, so I want to get out of the epicenter."

Portfolio: Zero AI, Shift to Equal-Weight, Gold, and Emerging Markets

Faced with these risks, Gundlach revealed his current investment allocation framework.

Stocks (30%): All allocated to equal-weighted indexes, holding in equal weight about 440 companies with the highest revenue, "so your AI exposure is virtually zero, as far away from that area as possible." Last quarter he still held 40% in stocks, now down to 30%, and has entirely exited all AI-related positions. "If you're still in, good luck. But we've already passed that 'everything is wonderful' stage."

Fixed Income (30%): Using a barbell strategy, half is in high-credit-quality total return funds (without corporate bonds), and the other half is allocated to local currency emerging market debt, which yields above 7%. "This is the best-performing fixed income sector; it was the best last year, and I think it will continue."

Physical Assets (20%): 10% in gold (he had cut this when gold traded over $5,000, but increased it back to 10% when the cash price fell to $4,300), and another 10% in commodities ETF (DCMT), which is up 38% year-to-date.

"Dry Powder" (20%): Allocated to short-duration commercial real estate ETF (DCRE, yielding about 6%) and flexible bond funds (DLEX). The overall portfolio yield is about 6.25% with a duration of just 2 years. "Even if rates rise another 200 basis points, we can still maintain positive returns."

Private Credit is the Fuse, Insurance Companies Are the Bomb

Gundlach issued his sternest warning about the chain of risks woven between private credit and the insurance industry.

He described a closed loop of interests: private equity acquires insurance companies, insurance companies are required to buy the private credit products of their private equity owners, then transfer risk to offshore reinsurance companies (like in Barbados or the Cayman Islands), beyond the jurisdiction of U.S. regulators.

"Reports show that certain firms’ reserves for future $100 liabilities might be less than $100, but you can't see it because U.S. regulators have no authority." He also noted that related investments from insurers of a troubled investment firm soared from 3% to 42%, with 50% of ratings coming from an agency with only 25 staff that completed 3,200 ratings last year. "It's simply not possible. They don't have the manpower to do that."

He compared this structure to the 2006 CDO rating fiasco: "Those AAA mortgage-backed securities fell below 30 in March 2009, and stayed well below 60 for a long while. Something similar is very likely to happen to certain insurance companies."

He suggested that investors buying annuities or life insurance "should only choose mutual insurance companies, because they serve policyholders—not private equity owners."

The Moment of Reckoning Is Near—and It Will Be Even Harder to Resolve This Time

Gundlach admitted that his level of concern about the current situation is greater than ever before.

"The peak of optimism was probably around June this year. The vibe was like 1999, like 2006—a mentality that ‘it's impossible to lose.’" He said that AI-related bonds dropped well below their issue price just days after launch, "which is a clear sign of a turning point."

He expects that when the reckoning in AI and private markets comes, there will be massive calls for bailouts. "But this time it will be very hard to explain to the public—you can't dress it up like 2008 as ‘protecting ordinary families,’ while really rescuing Wall Street's smartest investors."

He concluded: "Six months ago, I said this year would get harder and harder. Now, I think we have crossed over to the difficult side and that will continue for the next 6 to 9 months."