May 03, 2012

Felix Zulauf Market View

One of legendary and best investors of Switzerland, Felix Zulauf of Zulauf Asset Management gave his views on the market in an interview for the Business Spectator. He stated that the current risk-on situation and uptrend will likely end soon and that the global equity markets will start soon or maximum at the second part of 2012. Felix, who has also a member of the well known Barron’s Roundtable since more than 2 decades shared his worries about the debt-loaded industrialized countries and explained that the CB have no other choice but to run the printing press to stop the huge deflationary issues. Not only that but he also believes that the problematic consumer demand in the developed countries will force one of the biggest commodity consumers: China, to press the printing press even harder and stimulate its economy to offset the West’s decline.

When asked what he believes about Greece, he stated that the country has no future in the Eurozone. Money cannot fix competitiveness and it is what Greece lacks. Money can only fix the banks problems and help the ECB or the banks. Felix believes that eventually Greece will exit the EZ and will have its local currency cheaper by 50% at minimum against the EUR. Of course that will bankrupt the banks and the economy. Still Greece will recover because the tourism will go parabolic and in few years the country might even go back to the markets for capital. He even goes to say that the country might join the Eurozone again after a decade. Portugal is in the same position of Greece. Their bond show that the country is in a default territory and only time is needed. So Felix thinks that after Greece, the next in line for a debt crisis is Portugal.

When asked if there is a way for Europe to escape the debt crisis Felix said that austerity imposed by the Germany will not allow it. It brings the PIIGS into a downward spiral. Cutting the spending and getting the taxes raised causes recessions and this is exactly opposite of what should happen for the debt crisis to be escaped. The main problem is that with an economy that is in over-debt, there is no way and you can’t use monetary policy to counteract deflation because monetary policy does not work anymore, and only fiscal policy works really. As you see politicians realize countries need programs for growth but how is there a way to have these two both ?? Austerity and growth programs …

On Felix outlook for the equity markets:

The LTRO by ECB reduced and will reduce risk for a while. The balance sheet of the European central bank is exploding much faster than the one of FED did in qe 1 and qe2 … It is obvious that the central bankers think that big balance sheets means bigger final demand and better economy but Felix do not believe it is that because the transference mechanism is not working and is broker. It is only true that these operations will reduce system risk and risk assets will somewhat recover (which we have witnessed so far the in q1 2012). Felix admits that these money printing situations and flooding of the markets with cheap credits might postpone the issues and the cyclical in his opinion correction. He is worried mainly that from now until the fall of 2013 the markets are vulnerable.

 Felix Zulauf believs that we will not see QE3 soon because the economic trends are favorable and can not justify it. There is no need of another program at this moment. The production is growing but we have rising inventories so if the final demand don’t increase and justify the sales rations expected by the producers, they will have to reduce productions and it will crash the markets. If sentiment changes hugely and we experience significant (market correction), the Fed might do another quantities easing program, but it would be very counter-productive because it doesn’t increase final consumer demand but only leads to risk assets going up and inflation going up. (How a higher gas bill can be positive?). QE3 only leads to higher oil prices and punishes the savers and the average citizens who don’t have a balance sheet full of risk assets. But the FED of course will try another qe3 when the economic numbers deteriorate as that is all they know and they are in a hopeless position. People believe that they save the system, but in fact they only give it time by making some people richer and increasing the disparity in the society which leads to social unrest, riots, worse middle class. The Fed push the top 20% up in wealth, and they push the other 80% down in wealth and prosperity.

 Felix Zulauf’s outlook on commodities:

The prices of all commodities have risen hugely because of the growth of China and that is the main driver behind it. What will happen in China will determine what commodities will do in terms of price movements? Even though Felix doesn’t expect China to stop rising, it is at critical stop to decide its future. China sells cheap stuff, and feeds its people … they rely on exports and have invested in manufacture, infrastructure and plans much. But now we have a big weakness in consumption in the developed world and the real income of people is going down. It means China must change its way of work and model. Also the wages in China went up so they are not as competitive as before. That is why today, China has to focus more on the consumption inside the country. The issue is that the domestic consumption doesn’t have the same kind of multiplier effect to the economy as the exports and investments. That is why China’s growth will have to slowdown and will be lower than before (probably about 6% per year).

All that means a lower demand for materials and commodities and of course the their prices will underperform the equities in risk-on times.

 There are only 2 commodities that will make an exception. OIL & GOLD. Oil’s price depends on geopolitical issues and is problematic while gold can be viewed as a true currency. FED and ECB have no other tool to stimulate and will dilute the fiat currencies.

 When asked if there is a way to fix the deficit problem in USA, Felix said:

If the government in USA wants to cut the deficit from 10% to 0%, it means that the economy will go in a depression. Over the past 10 years, Felix calculated that if the USA did not have the deficits it had, the GDP in USA would be about 25% lower. This is the big problem. There is no solution to the problems and governments will continue to accumulate debt. Of course, at some point, buyers will take-over the market and will really decide the interest rates and then they will explode higher like in some European countries. Once it happens it will break the current system and who knows what will happen.

 The other way which Felix believes is the likely way and path is of central banks monetizing debt and taking the role of financiers. The issue is that judging by history, when a central bank financed more than 30% of the government expenditures, the currency collapses and hyperinflation occurs. So at this time, we have two forces: a super high level of debt which is extremely deflationary and leads to higher unemployment, lower growth, riots and declide of wealth and prosperity and if not stopped, means depression and collapse of the banking system. It means also risk-off. Governments and CB do fiscal and monetary stimulus and offset these pressures, which means risk-on. Eventually, down the road a decision will have to be chosen: a system collapse (depression) or hyperinflation. The problem is that hyperinflation usually leads again to depression and system collapse.

 Felix Zulauf on emerging markets position

The Emerging economies have lower debt levels and don’t have welfare systems that they cannot finance. That is why they are in better structural position. Also the demographics are much better and that is why they have natural growth. Emerging markets are definitely a place to in the long term. Of course when the world suffers system collapse, the emerging markets and economies will also suffer.

 Felix Zulauf on the view of the Australian economy

He believes that Australians are blessed in some ways. The country benefits from the rise of China and the rising commodities prices leads to wealth creation and economic growth in Australia. The issue is that once China goes in its normal cyclical downturns as the one we probably experience now, Australia will sooner or later goes into a recession.

Felix Zulauf was born 1950, and is the owner and president of Zulauf Asset Management, a Zug, Switzerland-based hedge fund. Felix has worked in the financial markets and asset management for almost 40 years. Mr. Zulauf has been a regular member of the Barron's Roundtable for more than 20 years.