New bond king Gundlach warns: If the Federal Reserve remains inactive, long-term interest rates will rise significantly

Author: Dong Jing

"Bond King" Jeffrey Gundlach issued three warnings on the eve of the Federal Reserve's interest rate meeting: if the Federal Reserve does not raise interest rates, long-term rates will soar; the inflation trend is eerily similar to the 1970s; the AI bond spread has nearly doubled, while U.S. stock valuations are high "like a hotel minibar—there are no bargains."

On the eve of the Federal Reserve's decision next Wednesday (FOMC meeting day), DoubleLine Capital's CEO and Chief Investment Officer Jeffrey Gundlach systematically outlined the current macroeconomic landscape in the latest episode of the "Gundlach Unlocked" live streaming program, issuing a series of warnings regarding interest rates, inflation, the credit market, U.S. stock concentration, and the dollar's trend.

Gundlach stated in the program that he is skeptical about the Federal Reserve raising interest rates next week, even though the market has priced in a roughly 60% probability of a rate hike. He made it clear: "I would not be surprised if the Federal Reserve does not raise rates next week. If that happens, I expect long-term rates to rise fairly significantly thereafter." Conversely, if the Federal Reserve does raise rates, the bond market may maintain the current status.

This judgment is based on his deep concerns about the current inflation situation and ongoing vigilance regarding the U.S. fiscal trajectory. He pointed out with extensive data that in the context of persistently high inflation and severely uncontrolled U.S. fiscal deficits, the U.S. Treasury market, U.S. stock valuations, and the hot AI credit bond market are all at an extremely fragile historical juncture.

If the Federal Reserve "stays put," long-term rates may face a huge shock

Regarding next week's FOMC meeting, Gundlach believes that the Federal Reserve's pace is once again out of sync with the bond market's pricing. He noted that currently, based on the short end of the yield curve, the market believes there is about a 60% probability of a Federal Reserve rate hike, but he is cautious about this.

"If the Federal Reserve does not raise rates next week, I would not be surprised. But if that is the case, I expect long-term rates to rise fairly significantly after the Federal Reserve meeting. If they really do raise rates, then the bond market may remain at its current level," Gundlach stated.

He presented his benchmark model for the 10-year U.S. Treasury yield (based on the 10-year German Treasury yield and the 7-year average of U.S. nominal GDP). The data showed that the model currently indicates the 10-year U.S. Treasury yield should be around 4.71%, while the actual figure is 4.78%, suggesting that the yield is within a reasonable range. However, he emphasized that after experiencing a massive 500 basis point rate hike, the market has not shown a substantial rebound, "the path of least resistance is likely to continue to rise."

Inflation has not gone away, CPI trajectory is "eerily similar" to the 1970s

The market's optimistic sentiment regarding cooling inflation has been ruthlessly criticized by Gundlach. He pointed out that both core PCE and overall PCE have a 6-month annualized growth rate higher than the 12-month annualized growth rate, "inflation has not truly improved, and we are far from the 2% target."

Even more concerning is the historical repetition. Gundlach compared the inflation trajectory since 2014 with the inflation surge from the 1960s to the early 1980s using overlay charts. He warned:

"The current trajectory is eerily similar to the inflation disaster before and during Volcker's (former Federal Reserve Chairman) tenure. It will be very interesting to see if we continue to replay that inflation disaster trajectory."

In terms of data mining, Gundlach emphasized his most valued unadjusted, non-seasonal indicator—the import and export price index. Currently, U.S. export prices have risen 8.25% year-on-year, and import prices have risen 5.95% year-on-year.

"If we average them, based on this purest inflation indicator, the actual inflation rate is about 7%." Coupled with Brent crude oil prices nearing $100 per barrel and global oil inventories at historical lows, he believes that the bottom support for oil prices will make inflation more stubborn than the Federal Reserve hopes.

Additionally, he listed multiple signals of inflationary pressure:

• Bloomberg Commodity Index has risen 34% since the start of the war, recently rebounding from the 200-day moving average, approaching a 10-year high;

• Residential electricity prices have climbed from about 12.5 cents per kilowatt-hour eight years ago to 18 cents, an increase of over 50%, with no signs of slowing;

• Brent crude oil is nearing $100 per barrel;

• Strategic Petroleum Reserve has dropped from a peak of 750 million barrels to 287 million barrels, a decrease of over 50%, marking the lowest level since the reserve was established; global oil inventories are also at their lowest since 2018—"this will continue to provide bottom support for oil prices, making inflation stickier than the Federal Reserve hopes."

Beware of secondary risks: AI corporate bond spreads have widened dramatically

In the credit bond market, Gundlach sharply captured a serious divergence phenomenon that the market has overlooked: corporate bonds related to AI are facing significant selling pressure.

Data shows that although the spreads in the broader investment-grade bond market have not changed significantly, the investment-grade bond spreads in the AI sector have surged from 50 basis points to about 125 basis points, widening by 75 basis points; in the higher yield (junk bond) sector, the AI-related spreads have dramatically risen from about 180 basis points to around 325 basis points.

"This is a huge divergence that we should really pay attention to," Gundlach stated, "Due to the astonishing demand for AI and adjacent businesses, this will undoubtedly exert further spread pressure on the AI sector… the market is clearly struggling to absorb such a large supply, and the bond supply in the AI sector will continue to be an avalanche."

U.S. stock valuations approaching extremes, "an extremely concentrated market means extreme danger"

In the stock market, Gundlach issued the most severe bearish warning. He pointed out that the current Shiller price-to-earnings ratio (Shiller PE) of the S&P 500 has reached 42 times, a figure that is even higher than during the bubble period before the Great Depression in 1929.

"At such a level of price-to-earnings ratio, the actual return rate over the next 10 years has never been positive. In fact, it often results in significantly negative actual return rates, negative 5% to negative 9% per year. Therefore, broadly buying the market-cap-weighted S&P index at this Shiller PE level means facing huge actual losses."

He specifically pointed out the "distorted" prosperity of technology stocks. Currently, the information technology sector's weight in the S&P 500 has reached a record 38%, far exceeding the concentration during the 1999 internet bubble and the pre-2008 financial crisis.

"This is an extremely concentrated market, which means this is an extremely dangerous market. Therefore, I would not recommend any market-cap-weighted stocks."

Dollar and emerging markets: bearish on the dollar, bullish on emerging market stocks and local currency bonds

Gundlach holds a clear bearish stance on the dollar. The dollar index (DXY) has fallen below 100 from a high of 110 at the end of 2024, "over the past year and a half, the dollar has hardly changed meaningfully; it looks almost manipulated," but he expects the dollar to continue to weaken.

He cited historical data to prove that there is a high correlation between a weakening dollar and emerging market (EM) assets outperforming U.S. assets. In the comparison chart he presented, the dollar trade-weighted index and the S&P 500 relative to the EM index show highly similar trends—"if the dollar falls, the S&P 500 is likely to underperform emerging markets."

Since the end of 2024, the S&P 500 has cumulatively underperformed emerging markets by about 20%.

He is also optimistic about the performance of emerging market local currency bonds relative to U.S. corporate bonds, with the logic similarly based on expectations of a weakening dollar.

U.S. debt and fiscal policy: $40 trillion debt looming, long-term TIPS "provide no protection"

Gundlach pointed out that the total U.S. public debt has reached $40 trillion (including portions held by the Federal Reserve and Social Security system), and based on the current trajectory, it may exceed $50 trillion by 2032.

Meanwhile, CBO forecasts show that the fiscal deficit as a percentage of GDP will continue to expand, and the current forecasts are based on relatively optimistic assumptions of "interest rates below current levels, deficit ratios below current levels, and sustained positive real GDP growth"—"once you press on these assumptions, it is clear that we are heading towards a path where the deficit will reach 7% to 8% of GDP within less than a decade."

He also specifically clarified a market misconception: some believe that those who dislike nominal Treasuries should turn to long-term TIPS as a hedge. Gundlach clearly disagrees:

"Long-term TIPS (30-year) have moved in complete alignment with 30-year nominal Treasuries since the end of 2021, with almost no change in the gap over the past five years. If you do not like nominal long-term Treasuries, there is no reason to believe that 30-year TIPS will protect you. Do not buy long-term TIPS thinking they will hedge your nominal Treasury risk."

He also expressed skepticism about the Treasury's recently announced bond buyback plan, believing that the plan is unlikely to have a meaningful impact on long-term U.S. Treasury yields.

The full text of DoubleLine CEO-CIO Jeffrey Gundlach's latest episode of Gundlach Unlocked is as follows (translated with AI assistance)

Thank you all for participating. This is our third episode of "Gundlach Unlocked," where I will share some macro themes and occasionally touch on some micro content. Interestingly, over the past three months, the S&P 500 index has actually outperformed the NASDAQ index. If you had constructed a 60/40 portfolio using NASDAQ instead of S&P 500, the return would only be about 8%.

Let's get started. The screen shows the Bloomberg Aggregate Bond Index's worst yield (Yield to Worst), with data dating back to the late 1990s. We can see that about four years ago, the yield of this index has been in a sideways oscillation range: the low end is just above 4%, and the high end is around 5%, except for a brief spike in 2024.

There are several horizontal dashed lines on the chart representing average yields: - Blue line: the average over the past 30 years is 4.03% - the average over the past 20 years is 3.25% - Interestingly, the average over the past 10 years is slightly higher than the average of the previous 10 years.

So the current yield can no longer be called "suppressed"; there are real actual interest rates in the Bloomberg Composite Index, which is certainly a good thing. Many of our funds are still trading at a premium on this basis, and many funds currently have yields reaching 6%. If you choose high-risk fixed income products, such as local currency-denominated emerging market bonds or bank loan indices, the yield is around 7%.

This is quite competitive for the stock market— we will see later that the stock market's Shiller Cyclically Adjusted Price-to-Earnings Ratio (Shiller CAPE) is basically at a historical high level.

We are currently in an environment of rising long-term interest rates, a trend that has lasted for six years and is about to enter its seventh year. We can see that interest rates in various countries are rising almost in sync, except for Switzerland. The most noteworthy is Japan, where interest rates have been suppressed near zero for many years and have now risen to 3.97%, with the gap to the U.S. 30-year Treasury yield of 5.24% being less than 150 basis points.

All these developed countries' interest rates are rising in sync, with the UK showing the most significant increase in yield.

We can see that the 30-year U.S. Treasury yield bottomed out in 2020, which was also the bottom of this upward channel. The red line in the chart represents the position two standard deviations from the center line. From the incredible historical low of 27 basis points in 2020, it has risen to today's 5.24%, and the price of the 30-year Treasury has cumulatively fallen by more than 50% to date, and we are still close to the peak, around 5.25%.

When the market is long-term sideways and unable to rebound, it often means one thing— we have experienced a significant surge in bond yields, but prices have hardly retraced at all. Generally speaking, if the market cannot rebound to correct the nearly 500 basis point surge in yields, it likely means the next direction will continue to move along the upward trend.

I established this model a long time ago to provide a benchmark starting point for the 10-year U.S. Treasury yield. The brownish-yellow line in the chart represents the actual yield of the 10-year Treasury, the dark line is the model fit value, and the yellow line is the model's forward-looking forecast value.

The model is constructed by taking the German 10-year Treasury yield and combining it with the 7-year average of U.S. nominal GDP, which astonishingly provides a reliable reference point for the 10-year U.S. Treasury yield. Note the box at the bottom of the chart— the R² (goodness of fit) of these two lines is an astonishing 0.93. If calculated from 1990 instead of tracing back to 1986, the R² would only be higher.

Currently, the model shows that the expected reasonable level for the 10-year U.S. Treasury yield is 4.71%, while the actual yield is exactly at 4.78%, which is very much in line with the model's predicted range. That said, the path of least resistance still seems to be upward, and we will explain the reasons further later.

I often talk about the relationship between the 2-year Treasury yield and the Federal Reserve, and they have once again shown some degree of "asynchrony." In 2022, we experienced a very severe asynchrony— at that time, the 2-year Treasury yield was far above the Federal Reserve's near-zero rate, with the 2-year Treasury yield exceeding the federal funds rate by 200 basis points. This was the largest gap I have seen in my 42-year career.

Subsequently, we saw that the Federal Reserve clearly moved to another extreme in 2025 (diverging direction). Now, judging by the position of the 2-year Treasury yield, the federal funds rate should be about 50 basis points higher than its current level. The Federal Reserve's monetary policy meeting will be held next Wednesday, and we will wait and see.

The "Warp Function" used to measure the probability of the Federal Reserve adjusting interest rates— it judges based on the shape of the yield curve— shows that, according to the pricing at the short end of the Treasury, the probability of a Federal Reserve rate hike is about 60%.

However, regarding Kevin Warsh, there are some places I do not fully trust, so I tend to disagree with this 60% probability, although I do not have a very strong conviction about it.

If the Federal Reserve does not raise rates next week, I would not be surprised.

If that is the case, I expect long-term rates to rise quite significantly after the Federal Reserve meeting; if the Federal Reserve does raise rates, then the bond market may remain around current levels.

Next is a chart that I also used in my last live stream, from JP Morgan Asset Management:

• The vertical axis (Y-axis) is the ISM Manufacturing Prices Paid Index. When "prices paid" rise, people naturally expect the Federal Reserve to be more inclined to raise rates rather than cut rates.

• The horizontal axis (X-axis) is the ISM Manufacturing Employment Index. When this index is above 50, people expect the Federal Reserve to be more likely to raise rates; when it is below 50, it is more likely to cut rates.

The chart is scattered with many small dots: blue dots represent Federal Reserve rate cuts (easing), and orange-red dots represent Federal Reserve rate hikes (tightening).

Based on the original chart from JP Morgan Asset Management, I drew a few rectangles and added some information:

In the rectangle in the lower left corner, almost all the dots are blue, with only three or four exceptions. I pointed to those three or four points— those were actions taken by Paul Volcker in early 1982, when he did not follow the bond market at all but took proactive measures, sometimes even acting impulsively, suddenly announcing interest rate adjustments without waiting for meetings. The most famous instance was when one Saturday night, he raised rates by several hundred basis points in one go, which is known as the "Saturday Night Massacre."

The rectangle in the upper right corner represents another situation— in this range, people should expect to see more tightening actions because the prices paid index is high (indicating inflation), and the employment index is also high. Both aspects of the Federal Reserve's dual mandate point to tightening monetary policy, and the chart indeed shows almost all tightening orange-red dots, with only about four blue exceptions. Those exceptions occurred during Arthur Burns' tenure, when he was pressured by the then-president to keep rates artificially low. Of course, this largely contributed to the U.S. entering a high-inflation era. We will see related charts later.

There is a larger orange dot in the chart, located above the 70 line on the vertical axis and to the right of the 50 line on the horizontal axis. This somewhat suggests that if action is to be taken, the Federal Reserve should be tightening rather than easing rates.

However, if you observe all the small dots around that large orange dot, you will find that some are red and some are blue, with no clear conclusion. For the current specific stage, although there is no definitive conclusion, I believe that the tightening dots slightly outnumber the easing blue dots.

Now we are starting to see some changes in spreads in the bond market. On the left side of the chart, the light blue line represents the spread in the U.S. corporate investment-grade bond market excluding the AI sector, while the dark line represents the spread of the AI sector. One thing is quite clear: the broader investment-grade bond market has not shown any significant spread widening, but the AI market has experienced a huge spread expansion relative to the investment-grade sector. We see the spread of the AI sector widening from 50 basis points to about 125 basis points, expanding by 75 basis points during this period, while the investment-grade spread has shown no change.

On the right side of the chart, we did the same analysis for higher-yield bonds, and the situation is even more dramatic— the spread of the AI sector widened from about 180 basis points to about 325 basis points, significantly widening. Meanwhile, the higher-yield bonds in the non-AI sector, represented by the light blue line, are actually close to this year's historical low. So we see a huge divergence, which is what we really need to pay attention to.

Everyone knows that the U.S. Treasury is borrowing heavily with a fiscal deficit of 6% to 7% of GDP. Now, with the AI and AI-related businesses generating a large amount of financing demand, this will undoubtedly further pressure the spreads in the AI sector. I really am not sure who is buying these AI-related bonds. Perhaps it is those insurance companies held by private credit firms, which in turn are held by private equity firms that are leading the investment behavior of their insurance companies. But the market is clearly struggling to absorb such a large supply, and the supply in the AI sector will continue to come in like an avalanche.

So we are facing the situation where the Treasury is borrowing too much, coupled with companies seemingly having an endless demand for issuing bonds, and the market— as can be clearly seen from the dark line in the chart— is starting to demand higher return compensation.

I often hear people talk about the comparison between Treasury Inflation-Protected Securities (TIPS) and nominal bonds, and we also like TIPS, holding them in some lower-risk funds. We prefer short-term TIPS because we believe that the implied inflation expectations in the comparison between nominal bonds and TIPS are too low. They basically imply that the Federal Reserve will immediately reach the 2% target and maintain it there, which I think is extremely unlikely to happen, so I believe short-end TIPS are undervalued.

But what I am showing on the screen now is the comparison of long-term TIPS, specifically the 30-year TIPS versus the 30-year nominal Treasury. Many people say they like TIPS; I have even seen some guests frequently appearing in financial media talking about how they now like long-term TIPS because they are not optimistic about nominal long-term rates, due to the large scale of Treasury borrowing. But it is evident that these two lines are very similar. Just look at the bottom of the chart, which shows the difference between the two; you can see that this difference has remained completely stable over the past five years.

So TIPS cannot hedge your risk. If you are not optimistic about nominal government bonds, there is no reason to believe that 30-year TIPS will protect you, as its interest rate increase has been exactly the same as nominal bonds since the end of 2021. Please do not buy long-term TIPS thinking it will somehow hedge risk—if you are not optimistic about 30-year nominal government bonds.

Now let's look at the inflation situation. Kevin Warsh clearly stated at the last press conference that 2% is their target, and they will achieve it. He committed to using the PCE deflator to measure inflation. He cited the 12-month PCE deflator, correctly pointing out that the value is 3.7%. He further noted that the 6-month annualized change in the PCE deflator is actually higher, meaning that the increase over the past six months has been faster than in the previous six months. So the PCE deflator has not really improved much. The 6-month annualized rate of core PCE is higher than the 12-month annualized rate, and both are far from 2%.

Let's look at the year-on-year data, including core and overall indicators. The core inflation rate is 3.3%, and the overall inflation rate is 3.7%, both of which seem to be on an upward trend since mid-2024, although the increase has stopped in recent reports. The next inflation data will be very noteworthy, as I believe it will largely influence the future direction of the Federal Reserve's policies.

The next chart is more for fun. We overlay the inflation experience from the 1960s to the early 1980s (measured by overall CPI). In the 70s and 80s, the CPI once rose to 12.5%, and then further broke through in the early 80s, approaching 15%. Then we have the recent rate increase experience from January 2014 to 2026. Surprisingly, the blue line (recent experience) is remarkably similar in shape to the red line (experience around the Volcker era). At least the blue line has turned, but whether we will continue to replay that inflation disaster will be very interesting to observe.

Everyone knows that my favorite inflation indicator is the import and export price index, because it has no adjustments, is not seasonally adjusted, and is purely price data. Currently, export prices have risen 8.25% year-on-year, and import prices have risen 5.95% year-on-year, both at quite high levels. Averaging the two gives about 7%. So based on this purest measure of inflation, inflation is actually running at about 7%. No wonder consumer confidence is at such a low level.

Here is the Bloomberg Commodity Index, which experienced a pullback mid-year and then rebounded, bouncing right off the 200-day moving average (red line). It currently looks like it is breaking through highs from the past 10 years or even longer. Regarding inflation, let's take a look at the retail electricity prices for residential users. I am not particularly focused on year-on-year data; I am just looking at this dark line, which is the price in cents per kilowatt-hour, which was about 12.5 cents eight years ago and has now risen to 18 cents, an increase of 50%. Moreover, this line shows no signs of slowing down, which is another reason for consumer confidence being undermined, and why the current officials' polling data is not satisfactory.

Another inflation issue, of course, is oil. Brent crude oil, as a true global benchmark price, is currently close to $100 per barrel. We can see that since the outbreak of war, the strategic petroleum reserve has significantly decreased, currently at its lowest level since the reserve was established in the 1980s. The current reserve has dropped to 287 million barrels, down from a previous high of 750 million barrels, a decrease of over 50%.

When the strategic petroleum reserve begins to replenish—this will inevitably happen at some point—it will provide a bottom support for oil prices and make inflation stickier than the Federal Reserve hopes to see. But the issue is not just the U.S. oil reserves. Looking at global oil inventories, tracing back to 2018, about 10 years of data shows that the level represented by the dotted line is basically at an all-time low, comparable to levels in 2025. This further increases the pressure for oil price bottom support.

This is a very interesting chart. This shows the performance of various assets since the outbreak of war at the end of February this year. The results we see are quite striking. Commodities, especially the energy sector, have delivered excellent returns. The Bloomberg Commodity Index has risen 34% since the outbreak of war. The stock market has also performed quite well, especially emerging market stocks, and the Japanese market has also performed well. Almost all assets have performed well, achieving double-digit gains. The worst performers seem to be MSCI Europe and the UK, but basically all assets have achieved double-digit or even over 20% gains. All commodities are rising, and the Bloomberg Commodity Index, as mentioned earlier, has risen 34%.

However, the bond market is in trouble. The best-performing bond category is leveraged loans, which have only risen 3.1%. Emerging market sovereign bonds have also seen slight increases, while investment-grade categories—government bonds, mortgage-backed securities, and corporate bonds—have all recorded negative returns, with mortgage-backed securities experiencing the smallest decline. This is very peculiar. We see a huge "donut hole"—the outer circle of assets has rich returns, while the fixed income sector's returns are negligible.

Debt growth is clearly a problem. The nominal GDP of the United States is represented by the blue line, and the total public debt of the U.S. Treasury is represented by the red line. We can see that the growth rate of the red line is much faster than that of the blue line, especially since the global financial crisis, where it has started to accelerate significantly, and there seems to be no end in sight; this trajectory is only getting steeper. Currently, total debt, including portions held by the Federal Reserve and the Social Security system, has reached $40 trillion, and at the current trend, it could reach $50 trillion by 2032, which is almost certain.

More notably, even the Social Security Administration itself states that under the current funding and benefit system, Social Security will exhaust its funds by 2032. Of course, their assumptions have always been overly optimistic, which means we may actually face this issue by 2029 or 2030—at which point Social Security must reform, or it will have to cut payments by about 22%. This is likely unacceptable for those who have paid into the system for many years and are still alive today from the baby boomer generation.

But let's wait and see. We face a very serious problem. And the situation is clearly not improving. This is the federal annual deficit calculated by fiscal year, with data tracing back to 2021. We set a new record here—there was a period this year when the deficit for fiscal 2025 was slightly lower on a year-to-date basis. But it ultimately set a new high. The current "leader" is the fiscal year 2026, and this fiscal year is about to end. We will soon enter fiscal year 2027, and it looks like this fiscal year will set a new record again.

Here is the percentage of the federal budget deficit relative to GDP, with data from the Congressional Budget Office's forecasts extending to 2035. The yellow line represents interest expenses, and the gray vertical line to the right shows future forecast data, which is not optimistic. These forecasts are built on quite optimistic assumptions—assuming interest rates are below current levels, the deficit-to-GDP ratio is lower than current levels, and that real GDP continues to grow positively throughout the forecast period. Once you question these assumptions slightly and apply some pressure, it becomes very clear: according to the current trajectory, within 10 years, the deficit-to-GDP ratio is likely to reach 7% or even 8%, but still below 10%. This is certainly not a good thing.

The trend of gold is quite similar to that of commodities. Gold experienced a strong rise in the first quarter of 2026, followed by a significant pullback, dropping below $4000. Now it has started to rise again. I believe gold should be a part of every portfolio. And it is very clear that as the dollar weakens, central banks and institutional investors are generally beginning to prefer holding gold over fiat currency.

Now let's look at this chart—the Shiller PE ratio is currently at 42 times. It was higher in 1999, but not by much. We can see that we have traced this data back to the 1870s, and the current level is far above the level during the 1929 bubble period. So, stocks are definitely not cheap. This is a very interesting study.

This is a scatter plot covering data from 1965 to 2015, showing the actual returns over the next 10 years based on the CAPE ratio (Cyclically Adjusted Price-to-Earnings ratio). There is a downward sloping regression trend line in the chart. It is clear that when the CAPE ratio is at the current level (currently at 42 times), there has never been a positive actual return over the next 10 years. In fact, the actual returns are significantly negative, averaging about negative 5% to negative 9% per year. This means that buying stocks in a market-cap weighted S&P index at this CAPE ratio level will face substantial actual losses. Interestingly, there have also been many instances of large negative actual returns at historically lower price-to-earnings levels, which seems somewhat counterintuitive. However, over the past 15 to 20 years, we have become accustomed to higher price-to-earnings levels than in the past. Nevertheless, this is definitely not an endorsement of heavily weighted market-cap stocks; quite the opposite.

In fact, I do not recommend any of the above. Interestingly, the concentration of the stock market is very high, a fact that everyone has come to understand with the growth of the technology and AI sectors. Here we can see a light blue line representing the weight of the information technology sector in the S&P 500 index, and then this light blue line suddenly disappears. The dark blue line represents the sector with the largest weight. This means that since 2008, the technology sector has been the largest weighted sector in the S&P 500, currently reaching a 38% concentration, a level that not only exceeds the peak concentration of the top sector in 1999 but is also far above the levels before the global financial crisis. Therefore, in the S&P 500 market-cap weighted index, there are not many real bargains, just as there is nothing affordable in a hotel minibar.

Here we see the historical trend of market concentration, tracing back to the railroad era. I cannot guarantee the accuracy of the data around 1840, but if we look at the 1920s, the early 1970s "Nifty Fifty," the stock market bubble of 1987, the situation before the internet bubble burst in 1999, and now the market conditions brought by the AI Big Ten. This is an extremely concentrated market, which also means it is an extremely dangerous market. Therefore, I would not recommend any market-cap weighted stocks.

The internal mechanisms of the stock market have also undergone some changes. Here we see the rolling 120-day return correlation between the AI sector and the S&P 500 excluding the AI sector. From 2021 to 2025, even into the first half of 2026, the correlation between the two is quite high. However, in the past few months, this situation has changed significantly. If calculated based on 20 trading days per month, this is roughly equivalent to an average of six months. Now the two have shown a negative correlation.

This is interesting—when the AI market performs well, the rest of the market moves in the opposite direction. Currently, the two show a slight negative correlation, dropping from about 0.5 earlier this year to the current negative 0.14, and this trend is strong. Therefore, I do not believe this situation will reverse quickly.

It is worth noting that the equal-weighted S&P 500 index has started to outperform the market-cap weighted index. This chart starts from 2017, but the equal-weighted index began to outperform about one to one and a half years ago. Once a certain trend begins to show possible reversal, we can refer back to the situation in 2020—where we can see that the relative performance of market-cap weighted versus equal-weighted began to consolidate sideways, followed by a significant correction, with equal-weighted significantly outperforming. Now the equal-weighted index has begun to outperform, although it is not yet enough to make one fully confident that this is the beginning of a major trend, at least it is no longer lagging behind.

Moreover, U.S. stocks are no longer outperforming other global markets. When this line is up, it indicates that U.S. stocks are performing stronger relative to non-U.S. stocks; when this line is down, it indicates that non-U.S. stocks are outperforming. Over the past year and a half, this line has basically consolidated sideways, but U.S. stocks have clearly stopped outperforming. Looking at a shorter time frame, the same chart shows that this actually started nearly two years ago—U.S. stocks' relative strength peaked nearly two years ago, and there was a considerable relative underperformance from mid-2025 to the first quarter of 2026. I believe that from a trend perspective, this line will continue to decline in the future. Therefore, I think it is meaningful to think from a long-term perspective rather than just a short-term one. Regarding foreign stocks, I have previously invested in foreign stocks. But now, I want to shift my focus back to closer options because I do not like the current risk landscape of the market.

The U.S. dollar has been declining since the end of 2024, when it was at 110 on the U.S. Dollar Index (Dixie Index), and has since fallen below 100, currently hovering just below 100. Its movement has been unusually smooth, almost appearing to be manipulated. I mean, for over a year, it has hardly experienced any meaningful changes.

But interestingly, as the dollar declines, we see non-U.S. stocks starting to outperform the market, with the global price-to-book ratio severely imbalanced. This is an argument against the valuation of U.S. stocks. The price-to-book ratio of the MSCI U.S. Index is 5.72, while the price-to-book ratio of other regions (excluding the U.S.) is only 2.49.

You might think that the U.S. is the best investment target in world history, but you will notice that during certain periods, especially during market corrections, the brown line and the light blue line in the chart tend to converge, leading to significant underperformance of the Morgan Stanley U.S. Index relative to the Morgan Stanley Global Index.

Looking again at the comparison between the S&P 500 and the Morgan Stanley Emerging Markets Index, the underperformance is quite evident. The excess performance of the U.S. stock market stopped at the end of 2024, and it has now underperformed by about 20%, which is not to be underestimated.

I further believe that this gap will continue to widen in the future. Here is the relative performance of the S&P 500 compared to the MSCI Emerging Markets Index, represented by the red line. When the red line rises, it means the S&P 500 is outperforming the emerging markets index; when the red line falls, it means the emerging markets are outperforming the S&P 500. The blue line is the Federal Reserve Trade-Weighted Nominal Broad Dollar Index. You can see that the shapes of the red line and blue line are very similar. Therefore, if the blue line (i.e., the dollar trade-weighted nominal broad index) falls, the S&P 500 is likely to underperform the emerging markets.

I am now also very sensitive to seasonal factors. It is early September now, and September and October are usually difficult months for risk assets, which is one of the reasons affecting my upcoming recommendations.

Looking again at the U.S. local bond market, this is the situation in the bond market, comparing the total return of U.S. corporate bonds with the J.P. Morgan Emerging Markets Local Currency Index, where the brown line represents the performance of the local currency index relative to the Bloomberg total return.

Here I have a dark line representing the dollar index (inverted), so when the blue line rises, it means the dollar is falling. Similarly, the brown line and blue line have very similar shapes. Therefore, if the dollar falls (which I expect to happen), we anticipate that emerging market local currency bonds will outperform U.S. corporate bonds.

Alright, with that said, let's dive into the holiday season. Thank you all for participating in this conference call, thank you for your support of Double Line, goodbye!