GURU OUTLOOK: FELIX ZULAUF & THE SECULAR BEAR MARKET
Courtesy of The Pragmatic Capitalist
This week’s Guru Outlook brings us the brilliance of Felix Zulauf. Zulauf is the founder of Zulauf Asset Management based in Switzerland and is well known for his appearances in Barron’s annual roundtable. Zulauf has nailed the secular bear market downturn and 2009 upturn about as well as anyone. More importantly, he has been nearly flawless in connecting the dots in the macro picture. From the de-leveraging cycle that led to the downturn to the government stimulus that led to the upturn – Zulauf has been remarkably prescient.
At the 2008 roundtable Zulauf recommended investors purchase gold and short stocks due to concerns with the consumer. He remained bearish throughout the year. At the 2009 roundtable Zulauf said stocks would bottom at some point in the second quarter after making a new 2009 low. He got aggressive and said stocks would rally after that. His recommendations to purchase oil, gold and emerging markets were home runs.
Zulauf’s macro outlook hasn’t changed all that much. He still believes the de-leveraging bear market cycle is with us and that we’re in the early stages. Zulauf sees a number of similarities with Japan and says the consumer is in the process of long-term balance sheet repair:
“we are in the early stages of a deleveraging process, which is marked by a shift from maximizing profits to minimizing debt. It is a multiyear process. The U.S. consumer is in bad shape, and the U.K. consumer is even worse.”
But Zulauf hasn’t turned bearish in the short-term yet. He says the markets have another 10% of upside before concerns over the end of the stimulus begin to weigh on the markets:
“Central bankers themselves are somewhat afraid of what they have been doing. Politicians are worried about public-sector debt. Therefore, the authorities will try to step away slowly from their stimulation efforts, because this policy isn’t sustainable. That’s the risk for the markets. The U.S. stock
market has enough momentum to rise another 10% or so. But the authorities will start leaning the other way as they see signs of economic growth in the first two quarters, and possibly a jump in inflation. That could push the market down.”
Although he is still bullish on emerging markets in the short-term, Zulauf sees growing risks in China. He says the potential for a bubble is growing and that government stimulus has the potential to initiate a second downturn:
“China is in a dangerous situation. Credit growth is the one factor that all the bubbles that burst had in common. Because China isn’t an open economy, the bubble there can probably keep inflating longer than it otherwise would have. But the Chinese can’t escape the laws of economics. If China’s bubble bursts, it would cause a second hit to the world economy, and that would be terrible.”
Another major risk to the sustainability of the rally is the small investor. Zulauf thinks the small investors is tapped out and lacks the trust in the equity markets to come back to the rodeo for a third ride after being bucked twice in the last ten years.
“In the past five years, the individual investor has been hit by two bear markets in stocks and a severe bear market in housing. He is just done. You see it in fund-flow statistics. Money is flowing into fixed-income investments that are perceived to be safe.”
So, with 10% upside left and a potential new low in the coming years how does Zulauf recommend playing the markets currently? Zulauf believes gold is the only currency that isn’t currently flawed. He says the likelihood of a correction this year is very high, but that the secular bull in gold will continue. He says gold will outperform stocks in the coming 5 years. Specifically, he likes physical gold and the GLD etf. Although gold stocks could perform well, he says there are too many outside influences in gold stocks.
Zulauf says investors would be wise to wait for markets to correct before diving back into stocks. After breaching 1,200 Zulauf says the S&P 500 should correct into the fall. At that time he says he would be a buyer of the following ETFs:
- Oil Services Holdrs Trust OIH
- SPDR Metals and Mining XME
- iShares MSCI Emerging Markets EEM
- iShares MSCI Hong Kong Index EWH
- iShares MSCI Singapore Index EWS
- iShares MSCI Taiwan Index EWT
- iShares MSCI Brazil Index EWZ
- iShares MSCI Canada Index EWC
In terms of currencies Zulauf sees an opportunity to short the Euro and Yen against the dollar.
“The euro is about 20% overvalued relative to the U.S. dollar. It could trade down to $1.25, from $1.45. You can see how the weaker members of the European Union are getting squeezed.”
As the de-leveraging cycle continues and governments continue to pour money into the global economy Zulauf says government bonds should continue to be underperformers.
“Governments and central banks will continue to support the economy. Short-term interest rates will stay low. Bonds aren’t attractive.”
Unlike several other hedge fund titans, Zulauf says the rally in the banks is essentially done:
“Previously I advised buying financials and metals. Now the financials are done, perhaps for a couple of years. Bank balance sheets aren’t repaired. It’s just camouflage. Today I like emerging markets and natural resources.”
Although we’ve avoided a total economic Zulauf says the difficulties are far from over. Like TPC, Zulauf says the biggest risks lie in the latter half of 2010 and into 2011 when governments pass the baton onto the private sector:
“The real danger comes from mid-2010 through 2011. This won’t be a conventional business-cycle expansion, but a bumpy road. The economy will look like a square-root sign followed by corrugated sheet iron. The good news is the potential collapse of the system has been avoided. It was an open question for a while.”
All of this will ultimately result in a new bear
“We’ll enter another bear-market cycle. I don’t know how low it will go. In March the market made a cyclical low in valuation, but it wasn’t a secular low. When the market makes a secular low, lack of interest in equities will be high.”
