The End Game Ep. 9 – Felix Zulauf

The End Game Ep. 9 – Felix Zulauf

October 16, 2020

Bill and Grant welcome the incomparable Felix Zulauf to The End Game.

What follows is a true masterclass in macro thinking as Felix joins a complicated series of dots to lay out both a cohesive vision of the present, and an impressive roadmap for the future.

The likely end of a 40-year bull market in bonds, the all-important inflation vs deflation debate as well as gold, the dollar and so much more all come under Felix’s acute gaze.

Once again, this episode of The End Game will have your head spinning…

 

The Grant Williams Podcast
The End Game Ep. 9 - Felix Zulauf
/

Bill and Grant welcome the incomparable Felix Zulauf to The End Game.

What follows is a true masterclass in macro thinking as Felix joins a complicated series of dots to lay out both a cohesive vision of the present, and an impressive roadmap for the future.

The likely end of a 40-year bull market in bonds, the all-important inflation vs deflation debate as well as gold, the dollar and so much more all come under Felix’s acute gaze.

Once again, this episode of The End Game will have your head spinning…

 

Grant Williams:

Before we get going, here’s the bit where I remind you that nothing we discuss during The End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets. And now, on with the show. Well, welcome everybody to another episode of The End Game. Joining me as always, my partner in crime, Bill Fleckenstein.

Bill Fleckenstein:

Hello, mate. Happy to be here with you today. And hopefully this will be an interesting conversation we’re about to have.

Grant Williams:

I would be shocked if it wasn’t given who our guest is. And that is, for those of you who don’t know, I don’t know how you would because you would have seen him on the title of the podcast, but the great Felix Zulauf is going to be joining us shortly. Felix is, to my mind, one of the best macro thinkers in the world. And he’s been around for a long time, he was a member of the Barron’s Round Table and he has his own consulting firm out of Switzerland. If you haven’t checked his work, please, please do so felixzulauf.com. Bill, I’ll just say, I’ve spent many hours talking to Felix in the past, and every time I do, I come away with a wealth of new things to think about and new ways to think about things that I thought I already understood. So I’m really looking forward to this conversation today.

Bill Fleckenstein:

Me too.

Grant Williams:

Well, why don’t we just bring him in, what do you say? Well, Felix welcome to the podcast. So good to see you again, it’s been a while, my friend.

Felix Zulauf:

My pleasure. Thank you very much for having me on your podcast.

Grant Williams:

It’s a very different world from the one you and I were looking at the last time we had a chance to chat. And really what bill and I are trying to understand is while the world outside finance is very, very different, in many ways, the world inside finance is boringly the same. More stimulus, more government programs, more checks, more debt. We’re just trying to get a sense of what comes next and how do we transition from here to there and what does it look like. So you’ve been someone who has been exceptionally prescient in calling big secular turns. So I just wondered to kick off if you feel as though we’re approaching any of those in any particular places in the world you look at, and if so what’s on your radar?

Felix Zulauf:

Well, I do not know the future, of course.

Grant Williams:

Damn it.

Felix Zulauf:

But I think about it, I think about it, and I do believe we are trapped because based on the demographics we see in the OECD countries plus China, it’s impossible to create the economic growth that the system needs to function properly for the next five to 10 years or whatever. So something has to happen. First, we have tried to de-value currencies, we have tried to bring interest rates down to zero or below by monetary stimulation, nothing worked. We didn’t have the economic growth we needed, we didn’t get the inflation we needed to get the debt down relative to GDP and all that things. Now we bring on the fiscal side, I believe.

Felix Zulauf:

So far what we see on the fiscal side is gigantic but it’s not stimulus, it’s support but it’s not stimulus, most people misunderstand that. The current fiscal support is simply replacing most of what has been lost in income by the corporate and the household sector and it’s not more than that. I think they have to do more than that. So today the Financial Times quoted the OECD and the IMF calling for more fiscal stimulus to bring economic growth along, and I think they will eventually do a lot more. If you do not have the fiscal stimulus that’s needed, then there is no way we can save our system as it is. If they bring on stimulus as is needed to create the growth, then of course, government debt explodes to even higher level. And not only government debt explodes, but also the government share of our economies.

Felix Zulauf:

In the second quarter for the US economy, government share of GDP, nominal GDP, jumped from the mid 20s or what it was to the upper 40%. In Europe, the Eurozone on average has about government share of 50%, France is very high up with a few Scandinavian countries in the 55%, 58%. I think that share has jumped by another 10% at least if not more. So that means the government share is already bigger than the private sector in those economies. That’s what I’ve been calling for quite some years, that we are moving into a planning economy, it’s a government led, it’s government manipulated, it’s government intervened, the free market is pushed out, and the planning guys are running the show.

Felix Zulauf:

The fiscal authorities, the governments, as well as the central banks, they work together and they are running the show and this is what it. We lose our freedom because when they do that, you get a lot of unpleasant surprises that comes out of market mechanisms that are still to some degree working. Of course those unpleasant surprises cannot be and therefore they manipulate and they intervene more, they regulate more, and they dictate more, et cetera, et cetera, so I think that’s the path we are going.

Felix Zulauf:

Usually in a situation like this, when you go through history, you usually end up in hyperinflation and then a monetary. The demographics we have, it’s very difficult to create the hyperinflation, they have tried now for some years. Once we get up to 3%, 4%, 5% of inflation, if they can achieve that, then there is a chance that we could have a much higher inflation when the central banks begin to directly finance the governments, as the Brits have announced they will do or they are doing and some others as well, Brazil, I think is another one.

Felix Zulauf:

So the weaker, the structurally weaker economies like Brazil and Turkey, et cetera, they will most likely run into a hyperinflation. I’m not sure the industrialized economies can achieve that. What is more likely in my view, and I’m not 100% sure about that, I think they will, at some point try to get rid of cash, money, paper currencies, make all the money electronic, and then they can guide us through monetary reform. We do not know how it looks like, but the bottom line of that will be that a lot of people will lose a lot of money, that’s for sure. Those who are stuck with nominal investments, they will lose a lot of money, those that are invested in real assets may do better or will do better, but they will also lose money. So I think there is no winner coming out of this.

Felix Zulauf:

And if you knew exactly what they would do, the authorities, and you did the right thing and you came out as a big winner, I guarantee you that all the profits you made would be taxed away by the authorities. So there is no real winner coming out of this, all you can do is lose less than others, that’s how I see it all over the long term.

Felix Zulauf:

I think the situation is not just economic, it backfires into the social arena, of course. It becomes very political because the policies that they are applying are really creating an ever bigger rift between the haves and the have nots and this leads to ever more socialist policies and redistribution policies, et cetera, et cetera. That in turn makes the whole system less efficient and makes the whole economy less prosperous and therefore we are all losers. We end up in a race to the bottom so to speak. This is along the lines I’m thinking, but I do not know exactly what the exact next steps will be. The next steps next year I think will be a lot more fiscal support, that’s what I expect. I think monetary policy will remain easy for some years. So that’s the combination for the next few years.

Felix Zulauf:

Then you have to mix it up all on a geopolitical situation that is not very stable and is in flux. You have the fight between the Chinese and the US. And potentially if Trump gets reelected, I think he will take on Europe next in the next term. It’s probably less dangerous if Biden gets elected because Biden will take the US to the European socialist model actually, so then the risks of tensions is probably less. But I think there is a move away from the globalization trends that we have the movie running backwards, we have a regionalization. I think China has realized that it doesn’t make a lot of friends when they treat the rest of the world as aggressively as they did. So I think they are focusing for the short-term, next few years, they are focusing on Asia to strengthen their position in Asia, to make sure they can integrate Taiwan, which could play havoc with the markets and geopolitics. But they need the semiconductor industry that is located in Taiwan. I think the US is also turning inwards.

Felix Zulauf:

The big loser in all of that is Europe. Europe is the most exposed to exports, it is a large net exporter, and it’s getting squeezed by both, by the Chinese and by America. I think America will not tolerate, even Biden, will not tolerate the trade policies that Europe is running against the US. So they will try to bring the dollar down to a level where the Euro gets higher and then the trade surplus disappears more or less. And if the trade surplus disappears, it is a deflationary shock to the European economies and then you have the risk again whether they can stay together in that misconstructed EU and Euro, et cetera, et cetera.

Felix Zulauf:

So there is a lot of moving parts in this whole scenario. And I think for macro guys, it’s going to be fantastic five years with some very big moves. But one should not have firm preconceived ideas what exactly and when exactly he has to apply as a trade. I think you have to be very open-minded, you have to think through several scenarios, and then be ready when the opportunity appears to shoot shop. The problem with all of that is that you pray that in markets that may not stay free markets anymore. Therefore, the logical consequences that you would expect in markets may be prevented by government intervention, be it market intervention or regulation intervention or whatever. So that’s the tricky part of it, that the game is not the game that plays to the same rules over the next five years as they are in place today. The rules are going to be changed constantly, and that makes it so difficult.

Grant Williams:

Well, I think all that’s left is just to say thank you and wrap that up because that was extraordinary. What a fantastic backdrop for this discussion, and there’s so much that I think we can dig into. That was a really beautiful way of framing this whole discussion and so many things that I really want to unpack with that. I’m got to try and go back to the beginning and work my way forward, otherwise we’re going to get stuck on the dollar, which is one of the last things you did and work it backwards, which could be tricky.

Grant Williams:

So when you talk about the rules changing and you talk about how this free markets are under threat, I think anyone that has spent any time watching this can see that that is now a very real threat. How should investors think about that in terms of things they can do with, signs they should be looking for? Is there any way to maybe move yourself higher up the tree so that when they start pulling all the low-hanging fruit off, you’ve got a few more layers between you and the government?

Felix Zulauf:

Well, it depends what sort of investor you are. If you are a benchmark relative performer, then I think it’s relatively easy because the rules for the benchmark is changing so that doesn’t affect you as much. If you are an absolute investor, as most private individuals are, family offices are, then it’s very tricky because you have no other… If you want a certain return, you have to move up the ladder of risk. I think you can move, you have to move to riskier investments, but you should stay with quality or at least what is perceived as quality and has a certain liquidity in the market. Because if you are in less liquid investments, those could get very illiquid or totally illiquid, and then you are stuck, and that’s the worst thing that can happen to an investor or a speculator. So I think you should stay with large cap equities with some of the commodities.

Felix Zulauf:

Actually, I think commodities will probably be the least affected by the interventions because they are not really system relevant. If equities go down by 50%, it may break the system, if commodities go down 50%, that’s not the case. Therefore I think commodities are probably the safer bet if you have a firm view of where the commodity should move to. I’m quite constructive on agricultural commodities.

Felix Zulauf:

The commodity sector has been out of favor for virtually 10 years and I think it’s bottoming on a circular basis. Not because I think we will have dramatic demand in the next few years, but I think there are problems with supply and it’s probably an asset class that seems, from a regulatory standpoint and from a systemic standpoint, less affected than other assets and therefore capital could feel safer moving into those commodities like the food part. I like the food part a lot because I think the climate will turn cooler and not warm and that is not very good for harvest results, et cetera. The world population is still growing, but it’s not growing by much, and therefore there is a steady growth of demand for food and therefore I see higher prices. So the next five years, I think food commodities could be fantastic.

Bill Fleckenstein:

Felix, if we see the governments do what you suggested, which seems like it’s about a sure thing as we can guess that, I would think at some point bond markets would start to maybe get a bit concerned. Obviously you’re talking about more supply and of course the central banks will monetize some amount of that. Do you think it will cause a problem in the bond market anytime in the next year or so or is that unknowable or too far in the future to worry about it? How do you think that dynamic might play out?

Felix Zulauf:

I have been a bond pool since 1981, and I wrote a piece in ‘81, The Buy of a Generation. I think about two months or so ago or three months ago, I wrote a piece, The Sale of a Generation, so I think the big bond pool is over. I do not see bond yields rising dramatically yet. Of course they could double easily, I think there is an upcycle coming next year because I expect more fiscal stimulus and as more fiscal stimulus comes, it means more supply. I think the supply will be eaten up by the central banks to a very large if not all part. But the credit quality of the borrower goes down and therefore you have to price it differently. Therefore those who can move away will move away and therefore bond yields next year, I see pointing up.

Felix Zulauf:

I do not know exactly how the next five years developed, but I could see one or two cycles at relatively low yields, let’s say 10 year treasuries between 0% and 3% or 3.5% or so or 3.25% I think was the last high point, up and down. But at some point, we will break through the upside. The generation cycle is turning, we are in a cycle of bottoming process now for some years. Bottoms in yields are source type of bottoms, whereas peaks are spike peaks usually. Therefore I’m very bearish on bonds longer term. But I have not pulled out my shorts yet, I have reduced my long-term holdings, and I have shorter duration, and I have only US paper because the yield is still more attractive than elsewhere, except for emerging markets. But I don’t want to move to emerging markets because I feel that the liquidity there may at some point very quickly disappear.

Felix Zulauf:

So yes, I’m bearish on bonds. I think next year is a bear market in bonds, and then we will see what that does to the stock market. Because in the stock market when you have rising bond yields, usually stock prices for value stocks go up, but for growth stocks go down. And we have now these structural change, we have the big discussion growth versus value. I think what most people didn’t quite understand yet is that these lockdown due to the pandemic or what they call a pandemic has really accelerated structural changes that have been in place before. We made a quantum leap towards more online retailing, less mall retail shopping, less commercial offices, more homework, home office work, and things like that. I think those changes are permanent, they are not temporary. They are permanent to a pretty large degree. Not to the full degree we saw at the height of the crisis, but to a very large degree, maybe half of what we have seen.

Felix Zulauf:

I think as long as interest rates stay low, capital flows to those structural winners that are perceived as beneficiaries in a new world. And because interest rates are near zero or at zero, you can peak any PE you like as long as the market believes it’s continuing. It’s like Japan trading at 100 in 1990, it all changed when the central bank hiked rates for the first time and when the companies involved had to stop repairing their balance sheets, and that is an important item.

Felix Zulauf:

Right now I think the balance sheets of the corporate sector is in disarray and there has been a lot of damage to a lot of balance sheets of a lot of corporations. I think it’s very clear that the CEO must repair the balance sheet, the corporations must repair their balance sheets. As they do that, they have to cut costs, they have to cut marketing, they have to cut the advertising, they have to cut labor, they have to cut the inventories, or whatever they have to cut costs. As they cut costs, they cut income, as they cut income, you get a much higher permanent level of unemployment than we had in the years before because of the structural changes. Therefore I was talking about an economy that has first a hiccup bounce from the low and then it keeps retarding because the corporate sector must continuously cut costs maybe for two years or whatever.

Felix Zulauf:

Therefore the fiscal support must come in in a bigger size to push the economy further up. Then you create, in some areas, you create supply problems because some of the suppliers are gone and then you may have some cyclical inflation. If the Chinese, which have always cut export prices, if the Chinese would change and would raise export prices because those corporations are in weak financial conditions and need better revenues and therefore could raise prices, then of course you have a double effect that could raise inflation next year. Then you have your bear market in bonds and these could be very beneficial to value stocks, but it could really hit the growth stocks very badly. Usually the growth stocks, when you look at past periods, usually you have a two year run in the end to the peak. Actually it’s about two years by late this year and you can be off by six months or so.

Felix Zulauf:

So I think sometimes within the next six to nine months, the growth stocks will most likely peak. I’m not quite sure whether the current sell-off or correction that is ongoing is just the mini correction we had in ‘99 before the final run to the peak or it is already past the peak. I tend to the former, that we have another attempt maybe early next year or so to the upside and that would make the peak, After that, you have value stocks outperforming growth stocks and then it remains to be seen what it means for the indices. Indices that are very heavily weighted to growth like the S&P or the Nasdaq will not do well in such an environment. Whereas the DAX or the Nikkei index are heavily value oriented and weighted, they could do much better. That would mean that we are coming when growth value changes in favor of value, it’s the end of the outperformance by the US stock market. You see, because all the other indices in general are more value-oriented, maybe with the exception of Taiwan and Korea where those indices are also very heavily weighted in growth and technology.

Felix Zulauf:

So we are coming to a very interesting point where important macro calls become valid, and I think this is the next big call, the call from growth to value. And it will most likely happening a downmarket and not in an up market. Once that happens, most people miss it because they will be concerned and carried on by working on preventing losses with their baby darlings in the portfolios that are heavily represented in the portfolios and not so much on focusing what should I buy. Usually leadership shifts take place during down markets, so I think we could have quite a good downmarket. Whether it is a short term occurrence, let’s say 30%, 40% down or something like that in three months and then it’s over. Then you get the new leaders coming up and going to new highs whereas the former leaders begin to lag and fall behind, et cetera, et cetera.

Felix Zulauf:

I do not know exactly, but I think an important macro call is coming up and it has all sorts of implications for the world. It goes together with the bond market call, it probably goes together with a dollar call, it goes together with index all on the S&P, Nasdaq. So it’s all sorts of things coming together, it’s all the same trait.

Grant Williams:

Is there a key to that? When you look about this, is there anything in particular that you think is the key to that whole trade coming into focus? Is it the dollar? Is it the bond market? What do you think it might be?

Felix Zulauf:

I think it’s the bond markets, I think it’s the US bond market more than the other bond markets. I have said once you break 70 basis points on the 10 year, at the same time you break 160 on the 30 year together, it’s probably the important term and that’s probably the trigger. So we have broken the 10 year marginally and the 30 year has not broken yet. It may break marginally and fall back into the range before it really breaks out sometimes next year, I believe. I believe it’s probably next year.

Grant Williams:

There’s a couple of things I want to wrap in if I can because there’s so much to think about what you just said. But when we talk about the bond market getting out of control and we talk about some of the steps that the authorities are going to have to take, do you see them mandating treasury holdings? Do you see them mandating that pension funds need to up their treasury holdings? Because something here doesn’t work, you cannot have higher rates with the amount of debt we have because the whole system will break. At the same time, the longer this goes on, the more debt that has to be issued. The central banks are going to struggle mightily to absorb all that, so they have to find someone to take that debt on. So do you think that we’re going to get into that fairly soon where government starts say, “Okay, there are levels you need to hold in your portfolios?”

Felix Zulauf:

No, I think in the first step it’s all central banks that take up the paper. I think in the next step, later on, you will get those mandates, yes. And that’s part then of the new game as we discussed before, yes.

Bill Fleckenstein:

When you say, this is all tied together, but when you describe the situation that could argue for structurally more unemployment and given the Federal Reserves knew jihad for targeting unemployment very aggressively and they’re more willing to let inflation run hot, it seems to me that they are going to be required to be even more activist, potentially. Especially when you layer in the fact that the government’s going to issue more debt because it’s going to be bigger from a fiscal stuff side. So it sounds me like the central banks are going to be actively not only printing money and buying bonds to finance the deficits, but they might have to even up their QE to try to get the employment down if the bond market rates try to back up a little bit. Does that seem logical to you?

Felix Zulauf:

Sure. By the end of this decade, I would say that the Fed’s balance sheet is probably at $40 trillion or $50 trillion or something like that.

Bill Fleckenstein:

Oh my God.

Felix Zulauf:

It’s basically-

Bill Fleckenstein:

Maybe come to [crosstalk 00:33:14].

Felix Zulauf:

I think, Grant, we talked about that at another instance.

Grant Williams:

We did.

Felix Zulauf:

And I said at the end of the day, the debt of the system will end up on the balance sheet of the central banks. That will only be prevented if you change the rules such that you force pension funds and insurance companies, whatever, to take it up. So yeah, that’s the way we are going, somebody has to pay for it. And the easiest way to pay for it, the pension funds can probably not pay for all that because they don’t have that much money and they are not that liquid, but the central bank can create the money. And if you create the money and the money… Most people think when you create money, when the central bank creates money and injects it to the banking system that creates inflation, it does not. Because for inflation, you have the banks to lend and borrowers to borrow to make a transaction in the real economy. Only then you can get inflation in a bigger way.

Felix Zulauf:

Other than that, it’s stocks in the banking system, the money, and it then gets arbitraged into all sorts of assets, but not into the real economy and that’s important. Therefore, I think they will first move the way they have moved so far, just bigger. And step by step, they are moving towards a more directed system where they tell the players what they have to do and what the rules are.

Grant Williams:

Felix, as this most recent phase that the pandemic has triggered of balance sheet expansion by the central banks has picked up pace, people have been estimating, “Oh yeah, sure. We’re going to be at $10 trillion by the end of the year.” And now we’re talking about a world where at the end of the decade, possibly $40 trillion to $50 trillion. If we try and imagine that world, which seems such a difficult thing to do, but if we reach that point, what does world look like? What does the dollar look like? What does gold look like? What does oil look like? And obviously your commodities play should perform spectacularly well if we do end up in that place. But what do things like the dollar and gold look like in that world you described?

Felix Zulauf:

Well the dollar measured in its own way will decline, measured relative to other currencies it’s another question because it always takes two to tango. Therefore you have to measure the dollar against other regions. Of course the dollar here goes down a little bit against the Euro and maybe the Euro goes up to 125 or whatever, at some point the next year that is possible. But the Euro is a misconstruction, and if the Euro goes up to 130, let’s say 130, then the trade surplus is cut in half if not more, and then the European economies go into a deflationary condition. And then when you have a deflationary condition then the pressure inside the Eurozone will become dramatic. Then the question is up to what point are the Northern states willing to finance the Southern states that have not really improved much during the past or since the currency is active.

Felix Zulauf:

So therefore there could always be big moves both sides because there is no sound currency anymore. In the past, we had a strong deutschemark, Germany had its house in order, that’s not the case anymore. We had a strong Swiss Franc because Switzerland had its house in order, the house is in order but the central bank is going wild because the central bank is a prisoner of the ECB. And if the Euro declines too much and too fast, it destroys the Swiss export industry, tourism industry, et cetera. So it’s all interconnected and therefore I do not see a catastrophe of the dollar against other currencies. Although any major reserve currency has always declined, that was the case with the British pound before and before that with the Dutch guilder and all that. So that’s the normal way. But I do not see like in the ‘70s, a big decline of the US dollar against other currencies, I do not see that.

Felix Zulauf:

The dollar is maybe overvalued by 10% and the Euro may be undervalued 10%, so the big moves are not there. The big moves could come when some countries move to currency controls because they cannot handle their situation and what’s showing up and maybe money tries to flow out and it creates a balance of payment crisis. To not lose the money, the capital, they may close the doors. Because if they lose the capital, it implodes the banks because the banks lose the deposits, it’s all interconnected. In that sense, the European situation is very interesting because the European stocks are all trading below book value and some are trading at 40%, 50% of book if you believe book is right. But let’s assume book is right, they trade below that.

Felix Zulauf:

That means they cannot issue a new equities, they cannot raise equity capital, it’s too expensive, it doesn’t make sense. So you recently saw the European Central Bank is already at negative interest rates which is punishing the banking system, by the way. If they cut rates further and lower it further down, they punish the banking system even more, so they cannot lock or rates anymore. They misused the tools of cutting rates in a situation where they should not have done it, it was a dumb thing that Draghi and his crew because they wanted to save a misconstructed currency. Now, what the ECB did was they lowered the leverage ratio, which means they need less equity capital underlying for certain balance sheet items. It’s basically saying if you don’t have enough equity capital, you can leverage more, you can leverage more. I’ve never seen any dumber thing than this, but these shows how desperate the situation is. And we will see many of those things.

Felix Zulauf:

And therefore let’s say the Spanish banks are probably the worst banks in Europe. If the European economy at some point weakens, there is a risk that Spain will lose a lot of capital because the capital flow is away because there is a bail in clause. That means if you are a depositor with a bank in Europe, in the Eurozone, and the banks could get in trouble. The bank could use your deposits and turn it into equity capital. So when you see that risk is going up, the capital runs away. Therefore at some point we may see capital controls to prevent capital from moving out to save the banking system. At the end, within the next five years, the major European banks that are system relevant will be nationalized, there is no way out, there’s no way out. When they nationalize the banks, they usually do not at the much higher price, but usually at a controlled price.

Bill Fleckenstein:

Well, all of that sounds like it would be a bullish backdrop for the gold market.

Felix Zulauf:

Yes. The gold market is basically a barometer of the trust and confidence in our authorities and in our system. If that trust goes down, the gold price goes up. We have a situation where rates are negative, real interest rates are negative, and I think real interest rates will stay the negative for years to come. Must stay negative otherwise you cannot support the system. And as a result, this is bullish for gold on a major trend basis. Of course you can have shakeouts, temporary shakeouts, et cetera from time to time. The big run in gold usually comes in the last two or three years of a cycle of bull market. It’s usually because the investors buy gold not because central banks or anybody else or the normal purchases by the Indian savers or the Chinese savers, it’s when they begin to fear that the system could fall apart and they could get trapped and then they run to gold.

Felix Zulauf:

Therefore I’m very bullish on the major trend basis. And I think gold mining socks are options on the gold price because they have a lot of gold in the ground. That gold at the height of the bull run and near the peak, people will talk about how well you build those assets in the grounds are. Therefore I’m on a major crime basis, I’m quite bullish. My technical work is not so bullish for the medium term, it’s overboard, momentum oscillators are wrongly positioned. So I don’t like it for the next few months, but on a long-term basis, you have to own it, next five years

Grant Williams:

Felix, it’s funny, as the last, I don’t know how many years have unfolded, you can’t help but get this feeling at every turn that the entire system is reaching that point where, as you said, there is no way out. I think what you’ve done here is really articulate, better than anybody I’ve heard in the last decade, just how fragile the system for want of a less simplistic word is. One of the things that obviously wasn’t necessarily a big problem at the beginning of this last decade, but certainly since maybe 2016 in America, maybe 2012 in Europe, a problem that has increased in its size and its importance is geopolitical tensions. And not just international ones, but interstate ones.

Grant Williams:

Obviously we’re heading towards the US election in 26 days now I think. And clearly that has the potential for all kinds of deleterious effects in the aftermath of that. So she looked forward to that, how are you thinking about this both in terms of the overall outcome? You don’t need to make a prediction, none of us know that, but things you might want to hedge against, the possibility that we could have a lot more domestic unrest in the US, how are you looking forward to that?

Felix Zulauf:

Well, I really don’t think it matters much who will be president in the next four years.

Grant Williams:

Certainly you’re probably right.

Felix Zulauf:

I thought that after 24, if Trump would get reelected, we would have see a US president who is left from Bernie Sanders, that was my expectation anyway. The society is so divided, the reef between the haves and the have nots are more extreme than in Brazil. When you look at the statistics, the Cine effect, the Cine factor and all those things, the US is more extreme with those excesses than Brazil, which is already quite excessive. So it’s an explosive situation. And Trump has probably a lot of followers among the lower middle class, middle class and lower middle class, not the very poor, but the lower middle class. And if they do not get what he promised, they turn to the left.

Felix Zulauf:

I recently saw a survey in the US among age groups, and the age group 18 to 29 years, they favor socialism more than capitalism. When you see things like that, there is a big term, the Zeitgeis as I call it, the pendulum is swinging much more toward the left. Trump is not a right-wing person, Trump is a nationalist and has some socialist things in his program like spending like crazy. So that’s a populist socialist, but he caters to the conservatives in his talking, but actually he just continues what all the other presidents have been doing. They ruin the finances of the government in the long run.

Felix Zulauf:

There is nothing new under the sun, it is a continuing trend and the trend is accelerating and you can pick whoever it was, except for Bill Clinton, who had the luck that Greenspan was pumping it up for him and it created a lot of tax revenues. But other than that, every other president has an accelerating trend in debt, and that’s the normal trend of a democracy or what they call a democracy. It’s not the real democracy, but that’s what they call a democracy. So I think the difference between Biden and Trump will be how they act internationally not so much nationally. Nationally we know Trump will keep tax rates low, Biden will raise tax rates for the wealthy, of course, that’s a difference. Maybe even raise tax rates for the corporate sector, so that may make a marginal difference.

Felix Zulauf:

But the main difference is how they will behave internationally. Biden would probably get the US back into the Paris Climate Treaty, he would still be confrontational with China, but confrontational and more goal oriented to have a deal quicker instead of going for the home run like Trump was trying. I’m glad that Trump brought the issue with the Chinese because nobody else did and it was about time. If somebody doesn’t behave well, you have to tell that things have to change. Actually every nation coming up, when you look historically, has behaved like China, even the US at that stage of development. So it’s a normal thing, but you have to tell them, “Listen, this is the limit, we don’t accept it anymore. You have to change.”

Felix Zulauf:

I think Biden would probably be more pro-NATO and could probably work better with the European socialists because he seems will probably also have some key socialists as members. And therefore they could work better with Europe. Trump has a problem with the Europeans and vice versa. So I think it makes marginal differences. But when you look at it I think geo strategically, we are in a multipolar world that is in flux. You have a challenger coming up challenging the dominant hegemon, that creates problems.

Felix Zulauf:

And Thucydides wrote that over 2000 years ago, then you have a problem. There is going to be further tensions between China and the US, and what it all does is economically the movie of globalization is running backwards. So we have different supply chains, there will be dual supply chains, one for China and Asia and one for the rest of the world and things like that. At the end of the day, it will probably mean we will be less efficient, less productive, and less prosperous. Whether we can distribute these evenly through our dowel societies is another question. The windfalls of globalization was not spread out evenly, the big winners were the upper 1% in the Western world and the new middle class in the emerging world. And the middle class in the developed industrial world in the West, they were the big losers. Whether they would become the big winners, I really doubt. And if they do not become big winners, then you will have revolutionary type of attempts., and these attempts may lead to cessations.

Felix Zulauf:

I would think that 20 years from now we will probably have more nations in the world because some nations will split the part, some regions will go away. It’s not even sure whether California will stay a US state, it could easily move away. It’s probably the seventh or sixth largest economy in the world, it could do that, and we do not know that. This is all in flux and we have to prepare for that, we have to be prepared not that we are shocked. All of these means that financial markets have to adapt to the new situation. And these adaptions will probably bring on much more volatility than in the past.

Grant Williams:

Yeah, I think volatility is perhaps the one thing that we can count on. There’s one more thing I’d love to ask you about while we still got you, I’m conscious of your time. But when you look at the disconnect between what the stock market is doing and what the real economy is doing, me, I struggle with it every day, it’s just almost unfathomable how the two can coexist. Are the central banks and the amount of fiscal stimulus they’re going to throw there, are they big enough to justify the stock market position or is there a day of reckoning coming when suddenly the state of the real economy is going to matter to equity indices?

Felix Zulauf:

I don’t see that big of a disconnect.

Grant Williams:

Really, well that’s interesting.

Felix Zulauf:

No, because look at the structural windows and beneficiaries of what has happened in the last six or seven months or so. They are beat up big time and so the capital flows to the big winners. This is economically logical and the value and more cyclical stocks have been underperformers. Of course they have bounced and lifted by the sea of liquidity, and that’s probably what you refer to, because the economy is not back to where it was. But most value and cyclical stocks are not back to the highs, and they reflect the more difficult, the more retarding economy, and the economic sectors that are not beneficiaries of the structural change. But some are very big losers of this change and they have been going down.

Felix Zulauf:

So there is a logic to it. I’m not saying the valuation is right, but there is a logic to it. And the valuation is a reflection of the excess capital that has been pumped into the banking system, which the real economy cannot take up in a productive way. So there is a logic to it, I’m not saying this is a sound situation, it is not, but there is a logic to it. Sometimes I also understand it only after but not before, it’s difficult. Because the rally has been much more powerful than I expected, I did not expect the rally to be so powerful when it came. I saw a good low on March 23rd, I even wrote the report, “This is a very good short term low.” But I thought we run up and then we come back down again. So the first part was right but the second part was wrong.

Bill Fleckenstein:

I think a lot of what may fooled last week myself and some other people I’ve talked to is perhaps the point that Mike Green has made about the dominance of the passive investment flows which didn’t get turned off during the train wreck that we had in March. Have you looked at this phenomenon much, Felix? And if you have, do you have an opinion about it?

Felix Zulauf:

Well, it’s an investment fiat and it is very powerful towards the end of a cycle of a theme cycle, it’s ever more powerful until you peak. And then when you turn around, it is very powerful on the other side. So I think this is just another leverage built into the markets, the passive investor. The passive investment is just another level on the markets and I underestimated this myself I must say because I’m a dinosaur. I come out of a time where we valued stocks and companies and [crosstalk 00:58:06].

Felix Zulauf:

Yeah, and today it’s very different. What we should learn is that when you have a deflationary problem in the system, then the central banks come in and it’s not the smoothest thing, then it’s just one way to go. It’s just one way because they are so afraid that the system falls apart that they over do it every time big time, they have to. And that’s actually those who understand that make the big money in those runs. I’m sure we will have another deflationary episode at some point in the next few years, and when it happens and it turns, go for it.

Grant Williams:

Felix, it’s been an unbelievably confusing and fascinating discussion. I’m going to have to go and sit in a dark room and think about all this now because it really has just been extraordinary. I can’t thank you enough for taking the time. I’m only sorry that we won’t get a chance to play golf this year you and I, don’t think that’s not for 2021 I suspect.

Felix Zulauf:

We’ll do it next time. Okay, it was a pleasure. Thank you very much Grand and Bill.

Grant Williams:

Felix, thank you.

Felix Zulauf:

Thank you very much.

Bill Fleckenstein:

Thank you, Felix.

Felix Zulauf:

I hope to see you sometimes next year.

Grant Williams:

Likewise. Take care and stay safe in Switzerland.

Felix Zulauf:

Thank you, same to you. Bye-bye.

Grant Williams:

Cheers. Bye-bye. Okay, well-

Bill Fleckenstein:

What intelligent quasi summations can one come up with after that? It’s so weird but it’s so fortunate to be able to catch these thoughtful and successful investors/thinkers and catch them on a good day when… You know how it is for these conversations, you get off on a tangent and it never quite gets going. And while we were listening to this, I kept thinking, “I can’t wait to listen to this again.”

Grant Williams:

No, it’s exactly right. And this is exactly why when you and I sat down and started talking about this, Felix is one of the first names on my list. I was hoping he would do this for us because he doesn’t do much of this stuff, which is a great shame for people because as you’ve just seen, the quality of his thinking and the breadth of his thinking and the depth of his thinking are just remarkable. I’ve been fortunate to sit and chat with Felix on a number of occasions. And every time I walk away feeling exactly like I do right now, it’s like there’s so much to think about there. And he just pulls it all together so beautifully.

Bill Fleckenstein:

Yes. But there’s no way anyone would be able to extract the amount of usefulness, so to speak, that there if you didn’t have a format like we did, right?

Grant Williams:

Yes.

Bill Fleckenstein:

So sometimes there aren’t any cliff notes, you have to read the whole book, right?

Grant Williams:

That’s a great point.

Bill Fleckenstein:

And it’s really interesting to have his perspective right after we had Mark’s perspective because they both come at the world from a similar vantage point, and they’re both Swiss ironically.

Grant Williams:

Yeah, no, it is. Felix has this ability to hold so many different thoughts in his head and to see ways in which they mesh into each other in a way that most people I’ve encountered just don’t have that ability. He’s an extraordinary individual and he’s a good friend and a remarkable man, I have to say.

Bill Fleckenstein:

Well, that was wonderful, I really enjoyed it.

Grant Williams:

Well, I guess all that remains bill is to firstly thank our guess, the great Felix Zulauf. For those of you who weren’t familiar with Felix before today, I suspect it’s been quite the wake up call for you. If you want to find out more, you should go to his website Zulauf Consulting, which you’ll find felixzulauf.com. Funnily enough, I looked for Felix, he is on Twitter, he has 952 followers and I don’t think he’s tweeted yet. So there’s almost 1,000 people out there almost like Life of Brian, everybody waiting to hear what Brian has to say. So hopefully Felix may just send one tweet out from the mountain top and keep the people happy. But do check out felixzulauf.com. Felix is writing over the years and you’ll find it in various places on the internet. Whatever he writes is worth reading no matter how old it is, still there’s lessons you can take from it.

Grant Williams:

Thank you to you for listening to us. Thank you for continuing to support and follow us for rating reviewers on the iTunes store, as I say every week, it really does help us. As always, my thanks to you, Mr. Fleckenstein for doing this with me, it’s been a real thrill to do these and I feel incredibly privileged.

Bill Fleckenstein:

I feel the same way. And yes, it’s been incredibly educational.

Grant Williams:

Alright. So please follow us on Twitter. You’ll find me @TTMYGH.

Bill Fleckenstein:

And I am @fleckcap.

Grant Williams:

Yes, he is. And we’ll be back with more of these conversations when our brains calm down. Thanks for listening. Well, that’s it. So all that’s left is the WeTransfer and we’re in business.

Bill Fleckenstein:

I think I can handle it.

Grant Williams:

You got to.

Bill Fleckenstein:

I’m getting better at this.

Grant Williams:

You are. Plus it fills all in for you.

Bill Fleckenstein:

Yeah. Right now, basically the stock market is essentially uninvestible right. We can vote against the policies by owning gold or miners or whatever, you can have your macro stuff, but you can’t really make this work. I did think it was interesting that he called the fadness of the passive because I certainly can see that. But it’s hard to see how it breaks. I think if we asked Mike, Mike would say, “Well, it can’t break, it just has to just go to the go.” I always think that at some point they can push things to a place where even what’s going on can’t quite hold it and then it escapes to the downside and it feeds on itself, but who knows.

Grant Williams:

Well, that’s why I look at this, the number of people losing their jobs, how many of those are going to want to tap their 401ks?

Bill Fleckenstein:

Yeah.

Grant Williams:

That stuff that comes out of nowhere and it’s like, “I need money and I’ve got all this-”

Bill Fleckenstein:

Right. But I think what we need is something has to happen from a corporate America unemployment standpoint to stop the 401k flows. Probably it might need to happen in the tech sector because that’s where probably more of the younger bodies are going, and the younger bodies that are all going target date and all this stuff. Of course the passive guys keep getting the laws changed to advantage them vis-a-vis everyone else. So it’s a pernicious problem. I don’t think it’s permanent, but seeing how it ends. I know it will end, I know it’s insane, what ends that would have to be some combination of, I would think a big unemployment problem in corporate America. But all right, my file is done, as long as I got you, I’m going to transfer my file.

Grant Williams:

Deal.

Bill Fleckenstein:

It is in the process of transferring.

Grant Williams:

Nothing we discussed during The End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets.

Read More