Mr. Zulauf is one of
the more accurate members of the Barron's Roundtable gang, happening this month and which we'll link to after they wrap up next week. For now here he is at Switzerland's Finanz und Wirtschaft, Jan. 22:
According to
macro strategist Felix Zulauf, founder and president of Zulauf Asset
Management and Vicenda Asset Management in Zug, the almost
seven-year-old bull market is over. China is to the current cycle what
the US housing market was for the Global Financial Crisis in 2008. It
will take years to correct the excesses that were built up in China.
Mr. Zulauf, the markets had a terrible start into the new year. Is the almost seven-year old equity bull market over?
Yes, the bull market came to an end last spring. A new bear market
has begun. The coming downturn will be proportional to the excesses that
were built up during the boom years. The bull market lasted for a very
long time and was primarily fuelled by monetary excesses. And these
excesses will now be corrected. And bear in mind, there is no longer any
backstop for markets.
What do you mean?
In the past, investors could count on the Fed to bail them out – the
Greenspan and Bernanke Put, if you will. Now, however, the US central
bank – and it’s still the world’s most important central bank – is keen
on raising interest rates. It wants to normalize monetary policy and to
end quantitative easing. As a consequence, a sudden about-turn in the
Fed’s policy is unlikely.
How big a correction do you expect?
A typical bear market in the US since the Second World War was
about 23%. However, this time around I expect a more vicious downdraft.
I expect the S&P 500 to drop to a range of 1200 to 1400 – right now
the index stands at about 1870. Compared to its all-time high that’s a
correction of almost 50%. The German Dax could fall to around 7000,
while the Swiss Market Index will see a similar down-leg. There is a
real chance of a bigger correction than many investors realize. This is
particularly true when there is a weak economy – which I expect.
Do you think the Fed will continue to raise interest rates?
Hardly. I think that the December rate hike will remain the only
increase in this cycle and that there will be no additional moves.
Depending on how severe the impact of the falling stock market will be
on the economy, the Fed might even reverse their rate hike. That could
happen towards the end of this year or at the beginning of 2017. The US
economy could cool much more rapidly than many expect.
What makes you think that?
Right now, inventories both in the US but also in many Asian
economies are much higher than usual. If sales do not increase
materially from current levels – and that is my base case – companies
are forced to slash production. As a consequence, data from the
manufacturing sector are bound to disappoint in the months ahead. At the
same time the Fed balance sheet is shrinking slightly, whereas in China
it is falling precipitously, while in Europe we have the situation that
Mario Draghi’s verbal interventions might no longer work. We are at the
end of an era.
The end of the era of quantitative easing?
Exactly, the era of QE is over or at least nearing its end.
Central banks and economists have learned that printing money does not
solve any economic problems and does not lead to stronger growth. It did
not even help to push inflation higher. The Fed’s interventions during
the financial crisis in 2008 were crucial and the right thing to do.
Everything that followed, however, was a mistake. In light of the
lessons learned over the past years, I do not expect central banks to
resort to quantitative easing again anytime soon.
Even though in the past the Fed intervened each time the stock
market wobbled? Janet Yellen might start another round of quantitative
easing.
For 2016 this is inconceivable, in my view. The Fed is now
made up of different members. Granted, former Fed chairman Ben Bernanke,
who believes in printing money, would probably administer the same
medicine. Janet Yellen, however, has a different philosophy: she is very
much focused on labor data. And those look good at the moment. However,
labor market data are lagging and not leading. To focus only on
employment is like driving by looking in the rearview mirror.
Would it be positive for markets if the Fed unexpectedly announced QE4?
I believe that in such a scenario we would see a relief rally in
equities. The dollar would weaken and commodities and stocks would
surge. However, there would not be any impact on the real economy. Any
improvement would therefore be built on sand.
How bad is the situation in China?
China is the epicenter of the looming crisis. China in today’s
cycle is what US housing was during the financial crisis in 2008. In
2008, China reacted quickly, resorted to fiscal stimulus, which saved
the boom and even amplified it. In addition, however, the liquidity from
the QE-program in the US flooded into the country, which even
accelerated the uptrend – in terms of credit growth and investment, the
boom in China grew into the biggest excess in the history of mankind.
And this boom is now over?
Not even autocratic China can escape the laws of economics. If
you expand capacity to the point at which the return on capital no
longer covers the cost of capital, the boom will end and a correction
follows. And we have been in this correction since 2012. The rest of the
world has not fully grasped this, as it is used to growth rates of 10%.
However, China’s growth has been slowing to officially 6 to 7%. In
reality, I’d say it is closer to 2% – despite massive stimulus by both
the central bank and the government. This cycle will only be completed
when the excesses are dealt with. Hence, the downtrend will continue....MUCH MORE
