When the tide goes out, the destructive power of this crisis may far exceed that of 2008.

Written by: Long Yue

Source: Wall Street Insights

Two seasoned macro investors sat down together and reached almost unanimous conclusions: this round of AI-driven upward cycle is nearing its end, and the subsequent decline will not be single digits, but rather a bear market of 30% to 50%.

On June 22, the latest podcast from American asset management company DoubleLine Capital featured a deep interview where "Bond King" Jeffrey Gundlach and Swiss hedge fund manager "Stock Market Prophet" Felix Zulauf discussed the world shifting from unipolar to multipolar, with geopolitical conflicts and sanctions bringing structural inflation. Against the backdrop of the old order's collapse, both the tech craze in the US stock market and the seemingly bottomless American fiscal black hole have reached an extremely dangerous critical point.

From left to right: Felix Zulauf, host Grant Williams, Jeffrey Gundlach

AI frenzy approaches its end, US stocks to face a decline of 30% to 50%

"This is definitely not a 20% pullback, but rather a bear market driven by economic recession and valuation contraction, with declines between 30% and 50%." Zulauf bluntly stated his judgment, predicting that US stocks could peak as early as the third quarter of this year, and at the latest by the first quarter of next year.

He provided a clear logical chain: the capital expenditures of super scale cloud computing companies (super expanders) have soared from 10% of revenue to 30%, semiconductor memory chip prices have risen by 200%-300%, and free cash flow has begun to turn negative—Oracle is already negative, and the next will follow. "When these companies start to finance in the market and their free cash flow begins to shrink, the entire AI cycle starts to slow down."

To precisely escape the peak, one must closely monitor the performance of semiconductor stocks that "sell shovels to gold miners."

Gundlach fully agrees. Currently, the top ten AI concept stocks in the S&P 500 index account for as much as 41% of its weight. This extreme concentration figure aligns astonishingly with historical peaks from past major market cycles.

"I advise people not to hold any momentum-driven or market-cap-weighted US stocks." Gundlach laid out a direct hedging strategy.

He also mentioned his "famous judgment error" on September 30, 1999—when he turned strongly bearish on the Nasdaq, only for the index to rise about 80% in the fourth quarter. "But 18 months later, from that point on, the Nasdaq fell from 100 to around 20. So when the fundamentals deteriorate, but stock prices keep rising, it is the most dangerous moment. We are right here now."

The recession is here, US Treasury rates won't come down, US-style YCC and "major restructuring of US debt" are inevitable

This is one of Gundlach's core judgments and his biggest divergence from traditional economic logic.

The usual logic goes: economic recession → Federal Reserve cuts rates → long-term rates decline → bond prices rise. But Gundlach believes this time is different. Even if the US economy falls into recession in 2027, long-term US Treasury yields will not experience a meaningful decline.

The reason is that the fiscal issues have reached a structurally uncontrollable level: US interest payments have soared from about $300 billion seven years ago to nearly $1.4 trillion per year now. Meanwhile, the fiscal deficit expands by $2 trillion each year, accounting for about 6% of GDP.

"Once the recession hits, the deficit will not be 6% of GDP, but 10% or even higher. This will trigger a bondholder strike." He said, "We have already seen this in developed countries—even Japan’s long-term rates are rising, which many thought could never happen."

Gundlach believes that policy responses at that time will have two directions:

Option A: Yield curve control (YCC). Treasury Secretary Yellen may choose to suppress long-term rates, as the US did after World War II—while inflation rises, long-term rates are artificially kept low, resulting in sustained negative real rates and the following 40 years of bond bear market.

Option B: Restructuring US debt. Gundlach revealed that he had reduced the coupon rate of bonds with maturities over ten years in the funds he managed from 4.75% to 1.5% two years ago, to guard against restructuring risks. After publicly discussing this idea in an interview last year, he was pressed by the media to get a comment from Kevin Hassett, the Chairman of the White House Council of Economic Advisers, who stated, "It is absolutely impossible."

Gundlach's reaction was: "In the investment world, 'Never' is synonymous with 'Imminent'."

Zulauf has a slight disagreement on long-term rates: he believes that during a recession, the yield on 10-year Treasury bonds could still fall from about 5.25% to around 3.75%—but this window will only last for about 6 months, not 12 months. He added that short-term rates will be pushed very low by the central bank.

Private credit crisis: "It feels like 2006 now," "Everyone is lying"

Compared to the public market, private credit, hidden beneath the surface, has raised stronger concerns. It is filled with rating fraud, liquidity illusions, and accounting games that mask losses.

Gundlach said:

"This gives me a strong feeling that is exactly the same as what I felt in 2005 and 2006: everyone is lying, lying about credit quality, lying about software exposure—they say it's 15%, but it's actually 28%—creating a completely illusory liquidity, which has now shattered."

Ratings are bought. "These private ratings agencies have only 30 employees, yet they rate hundreds of loans, each with 200-250 pages of documentation. I don’t think they are really analyzing; I believe they are selling price sheets. Want a CCC rating? That’ll cost you $1; want a single B? That’s $10. In the end, everyone ends up with a BBB-."

The credit quality is severely overstated. A large private credit fund claimed in its promotional materials that "investment-grade corporate bonds are the backbone of the portfolio," but in reality, in the private world, securities rated B+ or above only account for 2% of all securities. "Securities rated single B+ or above are less than 2%, so what are you using to serve as the backbone?”

The risks of software assets are understated. Some funds claim software exposure to be 15%, but the actual figure is 28%.

The liquidity illusion has already burst. Many investors who bought interval funds through financial intermediaries thought they could redeem in full every quarter, but in reality, the redemption limit at the fund level is only 5%.

Valuation marks are chaotic. Gundlach cited that the same loan is held by 8 different private equity firms, but the valuations vary from 95 to 8—one asset is marked 95 while another is marked 8. In another case, a PIK bond with a principal of $100 million, even though the underlying private equity has been marked down by 98% to $800,000, the bond itself is still marked at face value of 100.

Offshore reinsurance is the last black box. A closed loop is formed between private equity, private credit, and the insurance companies they control, transferring risks to offshore reinsurance companies in Barbados, the Cayman Islands, Bermuda, etc., with no regulation and no transparency. "I’m not certain those risks have truly been hedged. Once a recession hits, fixed annuities and life insurance will need to be paid out, but those assets do not have sufficient reserves."

Zulauf added: "All issues will surface when the market turns and the tide goes out."

AI funding chain and private credit are actually the same line

AI and private credit appear to be two markets, one in equity and the other in credit. But within this framework, they are connected through the cost of funding.

As AI capital expenditures continue to rise, they will suppress free cash flow. After free cash flow declines, companies will either issue shares or incur debt. When incurring debt, if long-term rates do not decline, financing costs will not ease automatically as they did in past cycles.

Lower-rated companies face more trouble. In past economic downtimes, spreads widened, but as risk-free rates declined, they sometimes offset some of the pressure, allowing struggling companies to refinance and survive. Now, if risk-free rates rise instead of fall, the refinancing window will narrow.

This will directly transmit to bank loans, CCC-rated loans, and private credit. Gundlach mentioned that these markets have already started to show cracks. The core reason is not that one particular industry has suddenly gone bad, but rather that the past reliance on low interest rates and refinancing patterns are no longer smooth.

Thus, AI trading is not only about looking at Nvidia, cloud providers, or data center orders. Ultimately, it also depends on whether the financing market can continue to provide funds and whether the credit market can withstand higher rates.

The US dollar weakens, US stocks underperform, the "second round" has just begun

Gundlach mentioned a historical pattern: in the past 13 major declines in US stocks, the first 12 were accompanied by a rising dollar, with an increase of about 8%-10%. However, during the tariff storm in 2025, the dollar actually fell by 8%-10%.

"This confirms my judgment—during this round of rising interest rates, the market's response function has changed."

He believes that the long-term outperformance of US stocks relative to global markets has ended, and emerging markets are beginning to outperform the S&P 500. "We are now in the second round, not the eighth round or the ninth round."

Zulauf added a risk point: Asian sovereign funds have bought a large amount of US dollar assets in the past 12 months, but they are no longer buying US Treasuries; they are instead buying AI stocks. "Once the market turns, they will sell stocks while also selling dollars. This is completely different from holding US Treasuries, which will accelerate the dollar's decline."