RAOUL PAL: Felix, my friend, great to see you.
FELIX ZULAUF: It's my pleasure, and thank you for having me, Raoul.
RAOUL PAL: It's a really complicated world out there. So I wanted to pick your brains
and what the hell you think is going on, where we are in this whole phase,
because we seem to have restarted an economic cycle straight into a bubble, which
is something unusual for us. And so I want to see what you think this is. Is this a bubble?
What's really going on? How are you thinking about it? So what are your top level thoughts on this?
FELIX ZULAUF: Well, we have certain signs of a bubble-- excesses in speculation, et cetera--
that is late cycle material. But at the same time, we have the economy that is slowly coming out of
a recession and still pretty depressed. So that's certainly not late cycle. So it's a mixed bag.
You have certain industries that are in a deep recession depression, like travel,
and restaurants, and events industry, while at the same time you have semiconductors
running very hot with all sorts of shortages, et cetera, et cetera. It's a very mixed bag.
I think what we are witnessing is really a structural shift in how policymakers are
guiding or setting the framework for our system. I've been a deflationist or disinflationist
for most of my life. And I always thought the end game would be a deflationary problem
of some sort. And if you had free markets, that would be the most likely outcome. But I think
over the years, our policymakers have moved away from free markets. When you think about our
system, our system is built on growth. So the system itself needs economic growth to function.
And we have structural factors like demographics that is very bad. Demographics,
population growth is the best in the US with half a percent growth, and the trend is
declining. In Europe, it's 0.2% growth, trend is declining. Japan is below 0, China is at 0, and
the trend is declining everywhere. The labor force is actually shrinking. And when you look at the
demographic setup over the next 10 to 15 years, the trend is accelerating downwards.
And as it accelerates downwards, it means that you have less and less population
growth. And economic growth is population growth plus productivity growth. And productivity
is another problem, because we create ever more zombie companies. And zombie companies reduce
productivity growth. The US, the latest statistic I have seen has about 17% of the companies are
zombie companies. Europe is at 20% already. So we won't have the economic growth that we need. Over the last 10 years, central banks tried to
create the growth by pushing money-- creating more and more money, cutting interest rates
to 0 or even below, and it didn't work. And I think now, the next thing is wherever
you go and talk to government officials, the slogan is the great reset, or build
back better, or whatever that means. I think it's the conclusion that the
government has to spend more money because the private sector doesn't do it --
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think it's something you can afford to be without. FELIX ZULAUF: whatever that
means. I think it's the conclusion that the government has to spend more money
because the private sector doesn't do itto create growth. So I think we are seeing
a shift from a free market economy to a planning economy. And instead of having a free
market resolution to the deflationary side, we get a changing shift in how the economy
works. We are moving away from a free market economy to a planning economy where
the government share keeps growing. The government share in the US before these
pandemic crisis, the lockdown, was about 22%. It is now in the upper 30%. In the EU, the
average is 59%. So more than half is government. France is at 64%. Germany, the best, is at
54%. So we are moving into more government type of planning economy. And the bear market
and the deflationary collapse you see in freedom. The individual freedom and corporate freedom
will be in an ongoing structural bear market. And that's how they try to save the system.
And I think this is what I didn't understand for a long time-- that instead of letting the
free markets run into the deflationary washout, they shift the system, they change the system
to prevent that. And of course, this means that we will have more government involvement, we
will have less efficient economies, we will have less growth, we will have more regulation,
we will have more inflation of some sort due to not well-functioning free markets anymore, and things like that.
So we are moving towards what Eastern Europe had for so long. And most
of the people alive today in the Western world never experienced that. The Cubans know what
that is. The old people in Eastern Europe know what that is. But others do not know what it is.
So as a young guy, I traveled to those places, and I saw the queues in front of shops.
A shoe store, they had two models and three sizes for each men and women. And
the people were standing up and queuing up just to get a pair of shoes. And if they couldn't
use them, they traded them barter for something else and things like that. And you had shortages
because it was a planning economy. And that's my biggest fear-- that our children and grandchildren
will end up living in a planning economy. And I think the guys who really didn't see that
coming were the guys who initiated that, and those were the central bankers. The central bankers
tried to steer the business cycle and smooth it. And by doing that, they structurally weakened
our system, pushed it ever deeper into debt, et cetera, et cetera. And here we are, and we
cannot let the business cycle work itself out. And therefore, we have this sort of planning
economy situation we are just about to enter. And they are using this pandemic-- the politicians,
of course, love it, because they will get more important, they will have more decision power, et
cetera. A deflationary outcome is a no-go for any politician who needs to be elected. That's clear.
In a crony capitalist type of economy or planning economy, you can hand out gifts to this
and that group, and therefore makes you an important person. And this is what I see
is in the early stages of developing. That doesn't mean that equities
should be bad investments. They should not necessarily-- they
can be very good investments, because we will have plenty of liquidity-- probably
more than plenty of liquidity around. They will provide whatever extra liquidity is
needed to keep the system going. And they need high asset prices to keep the system going. The
world economy today, GDP is about $90 trillion in size, and risk assets are about $500 trillion in
size. So basically, if risk assets decline by 10%, that chops off about roughly 1% of GDP growth.
So therefore, they are afraid of letting the market to run down into a full-blown bear market.
And therefore, they are intervening. And that's the world we are seeing structurally.
That's the structural change, I believe. RAOUL PAL: So do you think there's another
outcome, which is the other power I've been looking at is the kind of 1940s and '30s with
the New Deal. And it actually didn't generate long-lasting inflation, and it actually set off an
economic boom. Is it possible that the governments allocate capital in this massive fiscal giveaway
in ways that are potentially productive? Or you think it's going to be not productive?
FELIX ZULAUF: Well, I would say my guess would be that probably half will be productive and half
will be unproductive and has to be written off over time. I see what you are saying about the
1940s and then entering the 1950s. The difference to that period is that we have a very different
demographic setup. You had the baby booms there. And the baby booms created the population growth
on which our economies could thrive and grow. This is just about the opposite what we
are seeing right now. So that's why I doubt that's a repeat or a similarity
to the 1950s. I see that we had high government debt after the
war, et cetera, et cetera, and we had easy money for a while to help overcome
the problems. And then the government's brought down the debt levels because of inflation--
they inflated, which worked out very well. Our governments and central banks have
tried to inflate for, what, 20 years? And it doesn't work. It doesn't work.
There are some shifts that could bring on inflation in the short run. On a
structural basis, I don't think we have a major shift yet because of demographics and
the high debt situation also in the private sector. That means the private sector cannot go
beyond a certain limit of the debt they take on, because they need to borrow from somebody, and
that somebody needs to check their balance sheets. You have technology that is very disrupting
and very deflationary. Of course, you have the movie of the globalization running
backwards. And you move more to regionalization, and that will bring on some inflation. The supply
chains will be not the more efficient ones, but the ones that are the safest which are in
your region. And that makes it more expensive. In the short period, we have disruptions in
shipping. We have shortages of shipping capacity. We have disruptions in some supply chains. We
have some disruptions and destruction of supply capacity in some industries. So in the short
run, I think we have a setup for a rise in inflation. And we have a change in
the behavior of the Chinese companies. The Chinese companies, like the
Japanese companies in the old days, they didn't care about profitability. They cared
about market share and conquering the world. And that's what the Chinese companies did.
Now, I think the Chinese companies have so weak balance sheets that they need to restore
their balance sheets, and they need profits. And as they need better profits, I think they
are going to raise prices. And combined with a declining dollar and rising Asian currencies,
you get a swing from constant and chronic import deflation to import inflation. And this gives a
swing effect that could carry CPI inflation to 3% this year at some point. I don't know whether that
will stick or not. That could only stick if the governments came out very quickly and very soon
with infrastructure projects with all sorts of infrastructure and investment type of programs
to really create the demand out there. So far, they are just talking.
There is a European recovery fund, and the biggest effect it had so far was
a collapse of the Italian government, because they are fighting how to spend
those $200 billion they get from the EU. So they do not even know yet how to spend the
money. And I think the same is with Biden. The Biden administration wants to move in that
direction, but there are no concrete plans yet. We need to see them. And if we don't see them for the
next 12 months and we don't get them for the next 12 months, it won't do much good for the economy.
RAOUL PAL: One of the things that I've thought about-- I'm sure you're probably in the same
camp as me, because we have very similar macro frameworks-- is in a very highly indebted economy
with low productivity, if inflation picks up, it actually acts like a tightening on people. And
so I find that these inflationary impulses tend to deflationary waves-- so one of the reasons
we see bond yields keep falling over time. So let's say you're right and inflation
picks up to 3% over the course of this year, it probably doesn't increase demand. It's
not demand-led inflation. So in fact, it probably reduces demand. What do you think?
FELIX ZULAUF: Yeah, that could very well be. I think the consensus scenario right now
is that with the vaccination in place, the economy will normalize, and you have
a bounceback of the economy-- 4% growth or whatever the number is-- above-trend growth for a
few quarters. That's the consensus view. However, if the vaccination doesn't work as expected and
the infection fears stay high, and due to the mutation of the virus, et cetera, et cetera, it
may very well be that there is a caveat emptor, and that the economy does not recover, and that
the bond yield does not jump up, and that all what they have been talking about and doing about to
get the economy moving does not work. Then we have deflationary problems and the deflationary risk.
And then I think this will just move forward very quickly infrastructure projects by the government.
RAOUL PAL: Yeah, part of me feels that for them to get these things across the line--
these big fiscal stimuluses-- they actually need another bout of weak economic growth.
FELIX ZULAUF: That could very well be. So the risk is that there could be a window of deflational
risks, and they drop in the stock market for a while, particularly by cyclicals--
not by growth stocks, because bond yields would not go up. They would stay low.
But I think if that would be the case, I would expect the governments to panic and come
up with infrastructure projects very quickly. Our governments all panicked in a way. The only
government that didn't was the Chinese government. They kept calm and quiet. They handled the
virus situation relatively well, aside from not letting the world know that something strange
was going on. But they handled it very well. They recovered. They didn't
go into a major fiscal push. They actually even tightened monetary
policy. They hiked interest rates. It's the only place in the world, major
market, where you have positive real returns in the fixed income area. So they've stayed calm.
They didn't panic. Our governments all panicked, and many are still in panicky mood, so to speak.
RAOUL PAL: Yeah, because we noticed that split between the Asian economies and the Western
economies, where the Asian economies, just because a more compliant society, they were able to get
rid of the virus quicker-- just how society acted. And they didn't rack up debt. It's pretty true
of South Korea, Taiwan, all of these countries. The West, on the other hand, as you said, this
is unprecedented outside of World War II now. This is the largest budget deficits
all of these nations have run. So a, it feels like there's a competitive
advantage to Asia coming. We'll come into that in a bit. But I want to think about this debt load
now, right? We've got these bloated central bank balance sheets that can never be reduced.
And now we've got massive fiscal deficits, and we're about to spend more. How does this play
out? It's kind of unprecedented for all of us to look at this and think, OK, what happens?
FELIX ZULAUF: Well, most of the increase in government debt ended up on the
balance sheets of the central banks. And central banks, as you know, cannot go bust.
That's the first point-- they cannot go bust. And when interest rates and bond yields are as low as
they are, you can at some point switch all your bonds you hold on your balance sheet and go and
change that into a perpetual. A perpetual has a 1% coupon or a 0 coupon-- doesn't matter much.
So then you save the system. And you save the balance sheet of the central bank. And then you
can just build on that again, the next tower of debt in the economy. So the
box is pretty deep where there are all sorts of new tricks and gimmicks they can
come up with. They want to keep the game going, and I don't blame them. Of course they want to.
They feared cleaning the situation over the last 30 years. And because of that, we have ended up
in a situation where we cannot do it anymore. We cannot clean the system and clear the system
anymore. All we can do is freeze what we got with the perpetual, for instance, and then go from
there and behave as it wouldn't be there, because it doesn't bother you due to low interest rates.
RAOUL PAL: So you kind of issue a massive x trillion perpetual bond at 1%, and then
try and run the economy slightly hotter than that. And over time, it diminishes the debt.
FELIX ZULAUF: Yes, and you repeat that a few times so that in 10 years' time, the Fed
balance sheet is, instead of $7 trillion, is $40, or $50, or whatever.
RAOUL PAL: So obviously, there is a payback. Nothing comes free. And what is that?
That's the devaluation of fiat currency overall? What's your view on the payback for this?
FELIX ZULAUF: Yes. Well, the payback is that you lose more and more. Prosperity goes
downhill in such an environment, and you lose an ever-increasing number of your people
to the government-- that they have to rely and be supported by the government.
So they become victims and prisoners of the government's policies, and the
government has to take care of them. So this is the slow move back to the communist
system, in a way. And I think that is the big backdrop. Our prosperity for the broad mass of
people goes down, and our freedom goes down, and those are the structural bear markets.
RAOUL PAL: On that topic, there's two other areas. One is coming hand-in-hand with
that is going to be regulation-- whether it's regulation of monopolistic
enterprises in technology, regulation of oil businesses and polluting industries-- there's
a lot of regulation to come in all of this. FELIX ZULAUF: Absolutely. It's a bull
market in regulation-- absolutely. Trump was just a correction in the trend.
RAOUL PAL: Yeah, that's right. It feels like that is going to reduce some of the supernormal profits
that many of these businesses have made, because governments are going to come after that, right?
FELIX ZULAUF: Yes. But until they attack, let's say, the social media or things like that,
it will take a while, because the politicians need somebody to support them. And they have
bought the media-- Germany hands out 250 million to the media, to the print media every
year. And Merkel basically bought the media. So the mainstream media has become a loud-speaker
for the government's policies basically. Social media always said, we are free. You
can say what you want. That's over. As we know that during the US election, that changed
dramatically, and that's over. But I think the politicians will not immediately go
after them. That will come some day, but I think that is probably a few years down the road.
RAOUL PAL: And the other pillar of all of this, in government trying to get out of this mess, is obviously a rise in taxes.
FELIX ZULAUF: Yes, of course-- yes, of course. We, Switzerland, we are one of the few countries
with a wealth tax. So whatever you own worldwide is taxed. And it depends on the
canton where you live how much it is. It varies between about half a percent to 2.2%.
But it's very unpleasant in an environment of very low or negative interest rates,
because then it really turns into confiscation. In Switzerland, we have our 10-year bond,
the government bond yields, are negative-45 basis points or something like that. And then
if you live in Zurich, you have 0.4% wealth tax. So you cannot make it on your capital income.
You lose money-- that's confiscation, basically. And then on top, you get a wealth tax. And
this, when you add it all up, moves your income tax rate, if you include it, to very high
levels. And that's the situation you end up with. It's only attractive if you are a huge cash
flow rich entity. If you are a guy who makes $100 million every year and you have only $500 or
$400 million wealth, then it's fine. Then you have low taxes and then it doesn't matter. But for
retirees, it's murder-- it's absolutely murder, because it forces you to move out of the negative
fixed income investments, which are less volatile, into more volatile investments.
And your life span that is left is 5, 10, 15, or 20 years. So you have a relatively short lifespan.
If you come into the market at the wrong time, it's murder. It's murder.
RAOUL PAL: I've been really worried about this, because, as you said,
it's pushing retirees out the risk curve-- FELIX ZULAUF: Absolutely.
RAOUL PAL: When they should be the opposite. So let's say an event does happen
that the market stays down 30%, 40% for a year or two. That's
going to destroy everybody's pensions-- FELIX ZULAUF: Absolutely.
RAOUL PAL: That's one of the reasons you said that the governments can't allow
the market even to go down anymore. FELIX ZULAUF: Yes. And pensions right now,
I don't the percentage, but I would say there is a very high number of pension funds that
are actually under water-- that are not earning, they do not have the income to pay for their
liabilities. So they are running down their assets in a way at the cost of the younger people.
They are paying out to the older, to the pension, to the retired people at the cost
of reducing the assets for the contributing younger people. So this is a very unpleasant
chapter, and I think at some point of time, the governments have to address that, because
otherwise, you have social riots. And then this means more government involvement. It's just
more taxes and more government involvement. Basically, if I'm right with the
structural shift the way I described it, it means that at some point of time, you come to
a tipping point where the people begin to revolt against the governments, like the French
Revolution in the 18th century. You have something like that. And that was a very unpleasant
affair for the top 1% of the population. They chopped the head off of all of them.
RAOUL PAL: But the reality is lives for the kind of average working class person are pretty
miserable. So I think that initially, it's going to perceive to be good, because that becomes a
safety net. But as you said, the trade-off is freedom, and also probably lower productivity. So
it becomes a trap. It looks like a great benefit at first-- here's free money, here's a bunch
of things-- welfare state-- and those are good. But in the end, it becomes the trap.
FELIX ZULAUF: And at the end, you will have higher inflation. So all these guys will
be trapped, because they think they are well off, and a few years down the road, they realize
this is not true. So I think we are going down a very dangerous path in economic policies
that I see in the Western world, particularly. I think the Asian world is managing better.
They are probably one generation behind us with those problems. They will run
into the same problem down the road. Because at the end of this century, the Chinese population
will only be about half of what it is right now. Most people do not know that. But that will
create huge problems for China down the road. They will run into the same problems down the
road, but not for the next couple of years. RAOUL PAL: So let's flip to markets now. I'm
looking at this seeing all-time record retail speculation, all-time long positions, all-time
record short bonds, all-time record short dollar, mutual funds with the lowest cash in history. It's
kind of marker after marker to say the market's very one- sided. And it makes me nervous. What's
your read on the-- let's talk about the equity market to start with-- what's your read on that?
FELIX ZULAUF: Well, obviously, the consensus is that the good news, because the economy will
recover, the good news will come. And therefore, the risk is very low because earnings will go up.
And there is plenty of liquidity around. And if there isn't, they will provide more. So therefore,
we are safe. That's the consensus view. I just wrote in a publication to my subscribers
that there are similarities to the 1987 situation. RAOUL PAL: I've been looking at that.
FELIX ZULAUF: In 1987, we had one of the biggest declines in a few weeks in the history of
the US stock market, or most stock markets around the world. We didn't have a recession, and we
didn't have central bank tightening. It happened without central bank tightening, and it happened
without the recession. So what happened then? What happened was we had a strong dollar into
'85 because President Reagan's fiscal push and Paul Volcker's stability-oriented monetary
policy. And then the dollar peaked in '85, and a few months later, there was the Plaza Accord
where the G5 at that time came together and said, the dollar is too high. We need a lower dollar.
So the US central bank began to ease, and all the other central banks started to sell
dollars. And the dollar started a big decline. And then in August of 1987, Greenspan took over
from Paul Volcker. And he, of course, was an easy money guy. And the market knew that he was an
easy money guy. And so every day, the dollar went lower, and every day, bond yields went up. Bond
yields had declined from 14% to 7% at the end of '86-- from '84 to '86-- and then from beginning
of '87, 10-year treasury yield rose from 7% to 10% into the crash. This was just a rebound of
half retracement of what it'd lost before. We had inflation rising from 1.5% to 4.5% due to
a sharply falling dollar, and import inflation rising and pushing the inflation rates up.
And at some point of time, the models at the time said, well, if bond yields
go to that level, we have to sell. And then there was portfolio insurance. And when the stock
market was very overheated, everybody was long. And when the stock market started a short-term
correction, the portfolio insurance guys kicked in and started to sell. And the rest is history.
And the similarity today is we have a declining US dollar. We have easy money. The US doesn't
care whether the dollar goes further down or not. We have easy money out of the US. Even
the Treasury is compounding it by reducing its general account at the Fed and injecting over
the next six months $1.1 trillion into the system, which is huge on top of what the Fed does.
So you have very excessive money creation and liquidity creation in the US
banking system. You have a declining dollar. And you have a rising yield in the bond market. So it
wouldn't surprise me. I do not know at what level, but it wouldn't surprise me if 10-year bond
yields at some point this year reached 2%. That's about my target zone-- about 2%.
At some point on the way to 2%, it could very well be that certain
models say, well, we have to cut back in equity risk, and they start selling. And then
the robots, the machines, the algorithms come on and start selling. And all of a sudden, you
have a very nasty decline without the recession, without central bank tightening, et cetera,
et cetera. It comes out of capital flow. A declining currency is reflective of
capital outflow of a system. And if a system loses capital as it flows out, it tightens the
situation. And most people do not understand that, because they look at monetary aggregates and
things like that. And there is no tightening visible, of course. But this is how it could play
out in the second half of this year, in my view. And this would particularly be the case if,
let's say, bond yields stayed soft here into early summer, and the growth stocks did accelerate
on the upside, and we had a buying panic, and then all of a sudden, inflation rate
picked up, and bond yields picked up, and you had a sharp move towards 2%, and then
you had the cocktail for a nasty decline. And then it would be a washout. And if you have a
washout, you know what policymakers do-- the same thing they always do. So the game begins anew.
RAOUL PAL: Yeah, I'm looking at this and thinking-- I hadn't really thought so much
of the second half-- I've been thinking over the first half that there is a risk that
you talked about early on that maybe the virus situation doesn't clear up as much. Maybe
the mutations mean it accelerates, whatever it may be-- or maybe bond yields spike, because as
we know, the year-on-year comparisons of inflation are going to look strong for a few quarters now
coming up. I feel like there's an air pocket there. And I've been looking a little bit at
1987 as well thinking, it feels a bit like that. FELIX ZULAUF: I see that. Right now, my
cyclical trend and momentum indicators are still fine. They are in good shape. The
medium-term tools are warning. They are warning, and I think we could have a multi-week correction
very soon. It could happen from late February on, it could happen through March, April. I do not
know, but I think we are moving towards that. If that correction is shallow or less than 10%,
then I think we have another attempt higher into the summer. And I look at cycles also, as you
do-- I know you do. About every seven years or so, there is a high in the stock market--
1973, 1980, '87, '94, 2000, 2007, 2015, and '21-'22 would be the next one. And
then when you look at the four-year cycle where you have the lows-- 2008, 2012, 2016,
2020, and 2024 would be the next ideal low. So '23-'24 would be the point for a low, and
'21-'22 the point for a high. So we are moving into the time window. And I looked at seasonal
cycles, et cetera. So I think that sometimes between, let's say, late summer of this year and
spring of next year, that would be the ideal high for the cycle. So then we are into high-risk
territory, so to speak, for equity investments. RAOUL PAL: I mean, that's on nobody's radar screen
except people like John Hussman and others-- Grantham Mayo who are looking at the forward
expected returns of equities. And they're saying, developed market equities between negative-5%
and negative-10% over the next 10 years. But nobody else is thinking this right now. Everyone's
like, everything returns back to normal, and everything just keeps going higher.
FELIX ZULAUF: Yeah, that's why because Wall Street and the investment community doesn't
think in cycles. They think in linearity. RAOUL PAL: Always.
FELIX ZULAUF: And the life of the world, everything in the world goes in cycles. And
I believe in cyclical recurrences. It's not mechanical, but there is a cyclical recurrence.
RAOUL PAL: Let's look at asset allocation in this kind of tricky environment. How are you
thinking about it in the shorter term, the next three, six months, and how are you
looking at bigger opportunities across the board? Where's your head at with asset allocation?
FELIX ZULAUF: A stock market cycle that started in March of 2020 usually has at least three
medium-term uplegs-- sometimes more. We are near the end or about ending the second upleg,
in my view, in my world. So I think we will have a correction and then a third upleg. And then I'm
checking out trend and momentum-- how the health situation of the stock market is. If trend and
momentum is powerful, and useful, and vigorous, there is not much that will happen
on the risk side to the market. However, if it's weakening, if it's aging, if it's
done confirming new highs et cetera, et cetera, then the risk is growing higher. And I think
we are moving into a cycle top from late summer onwards. And therefore, you can still play, but
you have to be aware that it's in the late cycle. And when you compare the cycle from 2020
to the secular cycle from the 2009 low, then you see that in the whole period from 2009
to 2020 low, the retail investor was absent. And from '22 onwards, all of a sudden, the retail
investor is here. And it's here in a powerful and highly speculative way. And the retail investor is
going gangbusters, and the pros are invested long as never before in the last 20 years, and things
like that. So risk is very high, and return is probably relatively low. That doesn't mean that
you cannot make some money over the next six to nine months or six to eight months.
But I think over 12 months, you could get disappointed that at the end
of this year, all of a sudden, you look back and you said, oh, I didn't see that, you know?
RAOUL PAL: What about other markets? What about the dollar? Because, obviously, that's important--
it's sold off a lot. It's pretty oversold. Do you think it kind of bounces for a while before
we get some clarity? What's your view on that? FELIX ZULAUF: The dollar is a fiat currency since
1971-- since the US went off the gold standard. And since then, we have had three bear cycles
and three bull cycles within a secular downtrend. And the bear cycles have on average lasted about
seven years. And you can make the case that it topped in 2020 or it topped in 2017 because
we have a double top. And whatever it means is that we have at least three to four more
years to go on the downside with the US dollar. And I would say that the US
dollar index probably can hit 70 or so at the end of this decline. And keep
in mind that I think the Asian currencies will be stronger than the European currency, which
is heavily weighted in the US dollar index-- the European currencies. So the Asian
currencies will do much better than that. In the short term, I see that we are in the
later stages of this decline from March. And the best part of the decline is behind us.
I think from here, it will be very erratic. My cycle work suggests the most important low
to near mid-year of this year. So I think from here to there, we will make minor new lows, but
it will be more erratic-- like fours and fives and things like that-- very complex trading.
You should not take too many large positions. Everybody out there with short
positions, they will sweat through that. And then all of a sudden, when the stock
market gets hit in late summer or so, then it's really risk- off. And then the dollar
goes higher, and not because the fundamentals will be stronger, because I think then it's
a risk-off. And all the people with risk-on have to reduce positions. They have to reduce
their long positions in commodities, in equities, and their short positions in bonds and the dollar.
And it all moves at the same time. So I think the second half is developing into a very attractive
situation for macro traders-- very attractive. RAOUL PAL: How are you thinking for emerging
markets? They're on my radar screen. I think if we're in a weaker dollar environment, or even
if the dollar's stable in a range, I kind of think that emerging markets are going to be the next
10 years of growth. I can't get comfortable with an entry point because of what you're talking
about. Somewhere within all of this is a bunch of risk. What do you think about emerging markets?
FELIX ZULAUF: Yeah, the way I see it is emerging markets usually move counter to the dollar. And
they outperform when commodities outperform. And I think that as long as we have a dollar bear
market, let's say for the next four years or so, we have an outperformance by emerging
markets, and an outperformance and very bullish performance by commodities.
So I'm waiting for a big shakeout or a nasty decline sometimes in
the second half into next year for a good entry point. I would not enter now,
because you have a little bit left on the upside. But the good emerging markets are those that are
performing so well are growth-tilted, like Korea or Taiwan. And it's only a few stocks. Because
when you really look into emerging markets in the broad spectrum, the emerging markets
economically speaking are not doing well. They have been hurt more by the pandemic than
the developed markets. And I think they will have difficulties to come out because very often, the
corporations are burdened with much more debt than ours. And therefore, I would think that they have
a difficulty to come out of it. They will come out of it, but not necessarily strongly. That does not
mean that their stock markets could not do well. If you have decent growth, but not
high growth, but decent growth, and you have plenty of liquidity, and you have
a situation where a country is running chronic external account surpluses, you have sort of
a vicious circle, like the Asian economies. When they have strong currencies-- strong
currencies puts you into a virtuous circle, whereas weak currencies put you into
a vicious circle. So I would avoid the weak currency countries, then, for investment except
for a few companies that are star performers. But on a broad basis, I would go for those
with a strong currency that are in a virtuous circle and have capital inflow. And capital
flows are changing. Last year for the first time, foreign investment has been lower in the
US than in China-- for the first time. And this is just another sign that the
flows are changing, that the future will be in Asia and not in the Western world.
And I would look at markets like India, of course, as a very developing market story. But Taiwan is
a great story due to technology. But Taiwan is politically very exposed. I'm a little bit afraid
of them, because Taiwan is the technology leader now in semiconductors. Taiwan semiconductors is
the leader. They just recently announced they can come out and print 7-nanometre
chips, and in two years' time, 3-nanometre chips-- Intel cannot do any of those.
And so the leadership in chips has gone to the East, to Taiwan. China has no semiconductor
industry. So China looks at Taiwan as a renegade province, and they want to bring it
home. And that will make it best for them to get that semiconductor industry that is ahead of
the US. And therefore, Biden is, in my view, a president that is in line with other
presidents that have been weak on foreign policy like Obama or Jimmy Carter. And therefore, the
next four years is probably an option for China to intervene and bring Taiwan home, so to speak.
RAOUL PAL: Yeah, that's a big risk. That would be a big market event, right, if that were to happen.
FELIX ZULAUF: Yeah, and you don't see it in monetary policy. Everybody's focused
on liquidity and monetary policy, and I think the driving forces will come from
different sides. Capital flows is one, and that's the currency. And politics is another one.
RAOUL PAL: So I'm guessing you think of the commodity cycle roughly in the same way as
the emerging market cycle. You're interested, you think it's going to run over time,
but it's probably a bit overextended in the short term. What are you thinking?
FELIX ZULAUF: Most of the commodities-- and I follow all of them-- most of them are near
the end of the second upleg in my model. And they might have a third upleg-- an interim correction
and then a third upleg. But it's relatively late in the first mini-cycle of a new secular
up-cycle in commodities. That's how I see it. RAOUL PAL: Yeah, makes sense to me. And if you
say the dollar goes up again, commodities come off for a bit, they kind of test breakouts,
that kind of stuff-- do a bit of consolidation. That makes sense. What about gold and Bitcoin,
the two other kind of anti-central bank plays? How are you thinking through both of those?
FELIX ZULAUF: 20 years ago, if you told a gold bug that we would have the
sharpest decline in the economy, we would have the biggest increase in a few weeks'
time of the central bank balance sheet, the money printing, we would have fiscal deficit running
in the double-digits, et cetera, et cetera, he would have jumped up and down and say, this
is great. This is bullish for gold. It wasn't. And this is one of the biggest disappointments
for all the gold bugs. You had all the news you usually have to make a bull market in
gold, and it didn't work. And in my model, I got the cyclical sell signal last August, and
I told my subscribers, for the next 12 months, you won't see much by gold. It's in a cyclical
correction, most likely within a secular uptrend. And we had a huge run to that August high.
It was from 1,200 or from almost 1,000 to over 2,000-- it was a double. And it needs to correct.
And I think gold is still in a correction, and it probably hasn't hit the low of
that correction yet. So I think gold is dead money for this year. But it's going
to build a platform for a great next year. So I love gold, because what I was talking
about at the beginning-- the change of the system, et cetera-- in the long run will be
inflationary. And it will push central banks to increase their balance sheets more, and
more, and more, and to debase currencies more, and more, and more. And this eventually
will get reflected in a higher gold price. So I'm buying gold mining companies that I like
fundamentally on each sell-off during this year, because they, to me, are a long-term
option on the gold price-- not just the gold they produce and sell, but also the
gold they own in the ground. At the end of a great bull run, they usually
value the gold in the ground to justify the highs. So that's what I'm doing.
And that's my view on gold. I think silver will probably outperform gold for this year.
Bitcoin for a guy my age is challenging. I always thought that the authorities will declare
Bitcoin and other cryptos as illegal for payments. I think they have missed that point, because
it's too big now. Because if they would it, goes to 0 right away. So they cannot do it.
It would create too much havoc probably. So I think it's understandable that it is a rare
asset. You know that it is rare. There is a limit, and you cannot increase it-- although there are
7,000 cryptocurrencies around. And there will be new ones coming at some point. But I think as long
as people, and millennials have more affinity to technology-- as long as they believe this is a
great way to store your savings, it will work. And every mania and every great bull market-- and
it's probably not over yet on a secular basis-- has its bubble item. And I recall the Chicago
Board of Options Exchange, all the regulations are basically the same that the Dutch used in the
17th century. And we had the tulip bubble then. At the peak, the tulip bubble was selling for the
price of a townhouse in Amsterdam, which today would probably be a few million bucks. And so
Bitcoin could go to such a crazy price level. It could. But where the tulip bulbs
trade today, a dozen for $1.90 or something like that. So that's how I see.
RAOUL PAL: Here's an interesting question-- what's your kids' view on it?
FELIX ZULAUF: My son owns it. He has been in it early. And I should
have listened to him. He always said, dad, put 1% of your assets into Bitcoin, and just
write it off and forget it. And if I had done it, I would do much better. My performance would
have been much better, of course-- of course. But I'm glad for my son, and I'm glad
for all the guys who make money. I just do not have the full conviction. I
see that with rising prices, my conviction is growing. Of course, that is obviously human
nature. But I do not have the full conviction, because I do not see the inherent value behind
the currency. I can see an economy that can create surpluses in the current account. And that
surplus recycles again, and again, and again, and pushes the value of the currency up. Of
course, the central bank leans against it. But there is an inherent value I understand. The
Bitcoin, I must admit, I do not fully understand. But I think it's the technology companies who
want their own payment system, they want their own monetary system. And I doubt that someday
we will all pay our items with Bitcoin. But I rather think we will pay by digital currencies.
The central banks will go to digital currencies, which is the death of the banking industry.
RAOUL PAL: Yeah, I totally agree. And also, I just think that, like many of us use
gold as our own personal reserve asset, in a digital world, people will use Bitcoin as
their personal reserve asset. And we've seen that. Switzerland's already pretty advanced in
accepting Bitcoin payment for taxes and stuff like that. They say, fine. You can have Bitcoin,
we're still going to tax you, but we'll accept it into the system, but not as the main method of
payment. Governments are always going to own that. FELIX ZULAUF: I live in Zug. And Zug is where the
Crypto Valley is. It's called Crypto Valley. So here is a center of cryptocurrency experts and
cryptocurrency companies. And I recall I talked to a guy who is a leading lawyer in the field many,
many years ago. And I always told him, look, they will declare it illegal at some point of time.
And he just put a little bit of his money here and there, et cetera. And he's doing very well.
RAOUL PAL: So just to sum up-- it's been fascinating, it's given us
a really good framework-- what do you think people should be doing now?
Because you've identified that this is not clear. Your view is we've probably got some correction to
come-- whatever size that is-- 10%, 15%, whatever it is. We then probably build a
larger top that goes into the summer. What should people do? Just continue
holding some risk but reduce it a bit? Or what is the trade to do?
FELIX ZULAUF: Well, I think it depends on everybody's personality
and mandate. And what I would do is I would circle the assets that I would
like to hold for longer term, because I really have a fundamental conviction. And the
rest, I would single out for reduction of risk in my portfolios. And then I would define what
my risk tools are to hedge against the decline. And I would put that framework in a ready state
that I could pull the trigger and push the button when the tools say, now it's time to reduce risk.
And that goes for equities as well as for commodities. In the currencies, as
I said, as an American investor, I would look for Asian currencies and Asian
assets-- the same goes for the Europeans. The euro will do somewhat better than the dollar.
But it's a mis-constructed currency. It won't break apart. The political will is too is too
high. The integration will deepen, which is very bad for the economy, very bearish news, because
it weakens the European continent structurally. So yes, be prepared for, I think, the second
half to put on your risk management tools. It's too early to sell out now. For short-term
traders, it's probably right to sell a little bit here. For those who play the cycle, it's a little
bit too early. But most of the move on the upside is behind us. You have to be aware of that.
And I think there will be a better time-- whether it is late this year or over the next year-- that
will be offering great entry points again into commodities, emerging market equities, and great
companies that you can buy at cheaper prices. RAOUL PAL: Felix, phenomenal as ever.
Really, really good to pick your brains, always good to hear your thought process.
I think people are going to find it really insightful. Thanks again as ever.
FELIX ZULAUF: Thank you very much, Raoul, for having me. I hope we can see each
other in- person sometimes in the future again. RAOUL PAL: Yeah, I'm waiting. Both of us
are stuck traveling. We will do something, we will get together.
FELIX ZULAUF: OK, great. Thank you very much. This was fun.
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