Emerging markets and commodities present the best investment opportunities for this year, according to Jeffrey Gundlach. Those to avoid include the S&P 500, which he claims will show a loss for 2018. His larger warning was that most of the good news on the economic front is already priced into the capital markets.

Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, a leading provider of fixed-income mutual funds and ETFs. He spoke to investors via a conference call on January 9. Slides from that presentation are available here. This webinar was his annual forecast for the global markets and economies for 2018.

Before we look at his 2018 predictions, let’s review his forecasts from a year ago. His highest conviction forecast was that investors should diversify globally. The S&P 500 (SPY) returned 21.7%, but the MSCI world index ex-U.S. (ACWI) returned 24.4%, so Gundlach’s prediction was correct.

Gundlach predicted that the Trump presidency would correspond with better-than-2% GDP growth and that there would not be a recession. Both of those predictions were correct – GDP grew 2.48% through the first three quarters of last year (Q4 data is not yet available).

He also correctly predicted moderately higher inflation. In 2016, inflation was 1.26%, but in 2017 it rose to 2.13%.

He forecast that the German bund rate would increase from its level of 25 basis points a year ago. Yesterday, it was 0.42%.

He predicted two Fed rate hikes and a 50% probability of a third increase. In 2017, the Fed raised rates three times, by 25 basis points each.

The benchmark 10-year Treasury yield was to increase by the end of the year, according to Gundlach. It went down three basis points in 2017 (but his prediction would have been correct using the next-to-last day of 2017).

Gundlach was bullish on India and Japan, but bearish on Mexico and Europe. India was up 36.08% (INDA); Japan was up 24.27% (EWJ); Mexico was up 14.5% (EWW); and Europe was up 24.86% (IEV).

With this strong record of accurate predictions, let’s look at Gundlach’s forecasts for 2018.

Global economies

Markets are “levitating” as if from a magical source, Gundlach said, because of quantitative easing (QE). But things are changing, he argued, as central banks are, or will soon, be tightening monetary policies.

Global markets have been characterized by strong economic and market performance on an absolute basis and relative to expectations.

“What’s obvious is obviously priced in,” Gundlach said. He warned investors not to expect strong performance based on strong economic data or the absence of a recession, because those likelihoods are already incorporated into market prices.

Every single country – even Brazil, which has been in a major recession – is growing and will continue to do so for at least the next two quarters, Gundlach said. PMIs across the globe “look pretty good,” he said, except for a couple of countries, including South Korea, which are slightly below 50. The Citigroup economic surprise index looks particularly strong in the U.S. and at a historically high level globally.

But even the South Korean market has gone “vertical” (up around 25%) despite the rhetoric from North Korea, according to Gundlach.

The recently passed tax package will be “bond unfriendly” because it will lead to deficit growth, according to Gundlach. Citing research by former Budget Director David Stockman, he said the tax plan will “scoop” $4200 billion out of the Treasury in the next year and will strain entitlement programs. The plan could require $1.9 trillion of issuance to finance a $1.3 trillion deficit, based on Stockman’s work.

In Europe, the ECB has raised its forecast for economic growth by 0.5% real, but it is not indicating it will tighten, Gundlach said. A more hawkish ECB is not priced into the market, which is why the euro has been strong, he said.

The flow of central bank balance sheets has been highly correlated to equity price increases and to junk bond spreads, according to Gundlach. By the middle of this year, he said the Fed and ECB will be shrinking their balance sheets, and potentially Japan will as well.

The question, Gundlach said, is whether you believe in the magic of the economy and market growth. The current expansion is the third longest in history, but considerably slower than its predecessors. By next year it will be the longest in history.

No recession is in sight, according to Gundlach. Leading economic indicators (LEIs) are strong and signal a recession is at least a year away. The unemployment rate is at a new low and will fall further (by another 75 basis points in the next year) if the current rate of hiring continues. The service and manufacturing PMIs are strong, but are at levels that historically indicate a recession could happen in the next year, although it would take a precipitous drop in those indicators for that to be likely, Gundlach said. The small business optimism index (NFIB) is not signaling recessionary caution either, Gundlach said. Similar strong signs are in the factory order and consumer confidence data.

According to Gundlach, the granddaddy of recession indicators, the high-yield spread to Treasury bonds, normally “blows out” by at least 200 basis points at least four months before a recession. There is no sign of a recession in that respect, he said, unless spreads widen “very soon.”

“This is a magic moment,” Gundlach said. “Every single one of those indicators is at cyclical highs. But that must be priced in, so we need to understand what that means.”