In its slow grind higher, the S&P 500 has only closed more than 1 percent higher or lower on four trading days this year.
As a result of the muted market performance, the CBOE Volatility Index (.VIX), widely considered the best gauge of fear in the market, has persistently held near historical lows around 10 or below this year and hit an all-time low of 8.84 on July 26. The VIX was near 10.1 midday Tuesday as the S&P 500 edged up to a record high.
“I think going long the VIX is really sort of free money at a 9.80 VIX level today,” Gundlach said. “I believe the market will drop 3 percent at a minimum sometime between now and December. And when it does I don’t think the VIX will be at 10.”
Gundlach reiterated his expectations for a snap higher in the VIX once volatility picks up, since hedge funds have piled heavily into bets that volatility will remain low.
The investor believes the VIX could double to 20, he said.
On June 29, the VIX jumped from below 10 to above 15 when technology stocks dropped.
That said, if the stock market pullback is driven by seasonality or a change in investor sentiment, Gundlach said he thinks “it will be contained and you can buy it.”