Felix Zulauf, the founder of Zulauf Asset Management, has worked in the financial industry and asset management arena for almost 40 years. He was one of the first successful hedge fund managers in Switzerland, and he is well known for his excellent market timing and market cycle predictions. Based on his unique expertise, Felix has been a prominent member of the Barron’s Roundtable for almost 30 years.
Felix is a good friend and strategic advisor of BFI. We have the privilege to regularly consult with him on the financial market and geopolitical trends and gyrations. In this section of Insights, we have summarized some of his latest outlook and logic for you.
Overview
The economy moves in cycles. Currently, the industrialized world and a large part of the Emerging markets are in a down cycle. Government interventions are failing to bring the economy back on a growth track, and the mid-term assessment is that the world will somehow continue to “muddle through” for another few quarters.
The recent Brexit vote has brought to light the widespread and growing public discontent with the establishment and presented real challenges and concerns over the future direction of the EU. Additionally, significant risks are arising from China, that could trigger another downturn for the world economy. These factors, combined with geopolitical tensions and systemic problems in Western economic structures, raise concerns that sometime within the next 3-4 quarters, and the years thereafter, we could see another major economic crisis beginning.
Brexit Aftermath
The surprising victory of the Leave campaign in the UK referendum was a clear manifestation of the growing disillusionment and discontent of large parts of the population against the establishment, a trend that is also present in most industrialized countries. The Brexit vote, far from being an isolated incident, is in fact part of a process at work: the democratic process, whereby the public can express their disagreement with the direction of the European project. This type of populist movements could persist in years to come, and increasingly affect capital markets. It is therefore important to monitor closely both the institutional and market reactions, as well as the developments in political and economic policy directions.
Even after the initial Brexit shock is overcome, the EU will still be faced with an historic challenge: Reevaluating its political and economic strategy and aims, rethinking and reshaping the monetary union into a more sustainable entity and addressing the public’s and the market’s concerns could be decisive in shaping the future of the EU.
Concerns Over China
In response to the 2008 crisis, China unleashed a stimulus program of an unprecedented scale that kept the world economy afloat. This move, however, led to a gigantic investment and credit boom, which in turn created an excess, and overcapacity of dramatic proportions. At some point, this will have to be addressed, by supporting restructuring. This policy direction will require substantial liquidity for the banking system to support the necessary write-offs, which could lead to a lower yuan in the currency markets: that would be seen as a devaluation of the Chinese currency. Since China is the largest exporter in the world, a devaluation would put pressure on earnings of its competitors and on profit margins, and it would increase the deflationary pressure on their economies.
US Fiscal Policy
Uncertainty and doubts are steadily increasing over the promised rate hike that now seems unlikely to be enforced in the coming months. Although new highs in the S&P 500 are possible in the short-term, we do not see this move supported by improving fundamentals at the moment. Current valuations are elevated and any further increase carries the seeds of an exhaustion that could lead to a temporary trend reversal and ensuing medium-term correction sometime later this year.
Structural problems, however, remain lodged at the core of the American economy; a major restructuring of the tax system, addressing the debt burden, reducing the size of government, would be necessary steps to allow the economy to “breathe”. Tackling such issues, however, would without a doubt require fiscal support, which could take the form of government projects and much-needed infrastructure investments.
Gold Prospects
Loose monetary policy adopted by all central banks and rising uncertainty over when the monetary direction will be normalized have contributed to a renewed interest in gold, even after the latest correction. It could trade erratically in the short-term, however, the longer-term expectation is that we will see a gradual upward trend in the gold price, towards our target level of $1400 and later even beyond that. Therefore, a strategic bullish position is recommended: As long as the overall sentiment of unease continues about the monetary excesses by central banks around the world and about the rising political uncertainty, investors are likely to seek refuge, for at least part of their capital, outside of the credit and banking system.
Investment Implications
Overall, the long-term view is that in the next five years we could see vast changes in the world economy and financial markets. Agility, adaptability and an open mind will be essential tools for investors. In the grim period that lies ahead, it could become increasingly difficult to earn decent returns with traditional assets. It is unlikely that equities will generate returns similar to historic levels without a major technology or innovation boost. Treasury bonds can also no longer be considered the go-to “conservative investment” option that they once were. Bond yields are so low that inevitably they will have to pick up at some point, which would translate as a severe blow to bond holders.
In the short-term, Brexit indeed shocked the markets, but since it was a political and not a credit event, the expectation is that a highly volatile summer lies ahead, followed, however, by a rise in the global equity markets into late 2016/early 2017, before returning to the norms of this multi-year worldwide bear market. Bond yields are temporarily overshooting on the downside, but are expected to bounce back, in tandem with stocks, as soon as the shock is overcome. However, the upside potential will still be limited by the fundamental deflationary pressure that remains unchanged, along with increasing political uncertainty. Regarding money market rates, their decline is expected to persist and could reverse only after the next major crisis.
A successful investment strategy should be focused on preservation of capital. Risk management is key and a precautionary approach will be essential in the defense against the negative economic surprises that lurk ahead. Naturally, given that world markets are in a constant state of flux, outlining a specific and detailed strategy plan, would be as unwise as it would be ineffectual. However, as a general rule, in the coming years it might be best to err on the side of caution.