DoubleLine Funds CEO Jeffrey Gundlach laid all his cards on the table late Tuesday, explaining just why things are volatile in early 2016 and are likely to stay that way – at least through midyear.

“We could be looking at a really ugly situation during the first quarter of 2016, ”Gundlach said Tuesday during a webinar with investors. “It’s particularly more likely to happen if the Fed keeps banging this drum of raising interest rates against falling inflation.”

Driving his negative perspectives are low oil prices, weak corporate profits, rising wages, weak commodity prices and a poor outlook for economic expansion in China.

“Falling commodity prices are signs of China’s weakening economy, which will lead to more destabilizing devaluations of the yuan,” Gundlach said.

Furthermore, moves by the Federal Reserve to raise interest rates in a fight against “nonexistent inflation” are hurting gross domestic product growth, he states. In this environment, stocks are likely to follow high-yield bonds down, while low oil prices could lead to further geopolitical instability.

Gundlach compared market returns to a sled being pulled by a tractor. The Federal Reserve’s low-rate policies have, until recently, “pulled returns forward, and markets are now having a hard time keeping up with these returns,” he said.

Last year was one of the worst years for the “best return” ever, the fixed-income guru quipped. “It was a hard time making money last year,” Gundlach says, noting that 2015 was the worst year since 1937 for the “best” asset an investor could have owned. The S&P 500 was up about 1.4 percent.

“This is a preserving-money not a making-money environment right now,” Gundlach explained. As for today’s markets, “I think we’re going to take out the September [2015] low of the S&P 500,” he added.  

The market could move in a V-formation this year, moving down for the first six months and then coming back up, but that is just one possible scenario.

“What is going to happen is that we’ll have a continuation of what began after the [first interest rate] hike …. The markets will struggle in the first half, and then we could see buying opportunities in the later part of year,” he explained. “It’s the tale of the V, struggle and rebound.”

Tense times

“Junk bonds continue to be under pressure,” said Gundlach, reminding investors of the recent closure of a Third Avenue fund, which reported a 30 percent drop in value from 2015.

“Clearly the assets can’t be sold where they’re marked,” he explained. “There’s plenty of credit [funds] that do the same thing. If you get a statement [that you’re] down 20 percent, I would recommend getting out, even if you’re not concerned about the market.”

“We’ve been talking about them for a year – and it’s really glaring. We’ve said junk bonds will be the next problem and [were] right in spades … the Fed really needs to focus on junk bonds,” he said.

His outlook for corporate bonds is also negative, and he points to Standard & Poor’s research showing the level of potential downgrades as topping that of possible upgrades by the widest margin since 2009.

The fixed-income specialist emphasizes that profit margins are compressing while hourly earnings for workers are now rising, which could help them cope with rising rents for housing, for instance. The Fed, however, doesn’t see it this way – and cites increasing shelter costs as proof that interest rates need to move higher, he adds.

“What’s wrong with average hourly earnings going up a little bit? What’s wrong with the middle class getting higher earnings?” Gundlach asked.

“The Fed is very frozen in how it is thinking about things,” he added.

As for energy bonds, “The market says a lot of these bonds [are] going to default unless we have monster rally in commodity prices,” said Gundlach.

“We could be at a bottom” in commodities, he added, “given that gold has started to rally and it usually rallies first.” Still, he isn’t expecting a big upswing any time in commodities, given weak global demand and other factors.

Gundlach reminds investors that the price of gold-mining stocks has “refused to break down.”

In terms of the price of the underlying precious metal, “I thought gold would hit $1,400 [an ounce] in 2015. It didn’t rise as I expected or even close to it, but I still see it going there – to $1,400,” he said.

On the flipside, Gundlach doesn’t agree with the widespread view that the U.S. dollar will strengthen further.

See also:

MetLife unit’s SIFI off-ramp may pressure AIG as Icahn looms

More investors to agitate for change at life insurers in 2016

Investors in for ‘wil market ride’ in 2016: Janus