The End Game Ep. 9 — Felix Zulauf
This is a Williams and Fleck Podcast.
Together with Bill Fleckenstein, Grant Williams is interviewing Felix Zulauf.
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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…
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The audio version of the podcast you can find on Grant Williams website — “Things That Make you Go Hmmm…” website, Podbean or on Itunes and any other podcast app.
For everybody who would like to read the kindle version — You can find it HERE on Amazon.
Let’s start the Interview!
Grant Williams 0:00
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.
Welcome everybody to another episode of the End Game.
Joining me, as always, my partner in crime, Bill Fleckenstein.
Bill Fleckenstein 0:44
Hello, mate.
Happy to be here with you today and hopefully this will be an interesting conversation we are about to have.
Grant Williams 0:49
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 wouldn’t because you would have seen it on the title of the podcast. 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. He’s been around for a long time, he was a member of the Barron’s Roundtable. He has his own consulting firm out of Switzerland and if you haven’t checked this work out, please, please do so.
www.FelixZulauf.com
Bill, 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 1:35
Me too.
Grant Williams 1:36
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 1:45
My pleasure. Thank you very much for having me on your podcast.
Grant Williams 1:48
It’s a very different world to 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 finances is very, very different, in many ways, the world inside finance is boringly the same, more stimulus, more government programs, more checks, more debt and we’re just trying to get a sense of what comes next?
How do we transition from here to there and what does it look like?
You’ve been someone who has been exceptionally appreciate in calling big secular turns and so I just wanted to ask if you feel as though we’re approaching any of those in any particular places and what would you look at?
If so, what is on your radar?
Felix Zulauf 2:36
Well, I do not know the future, of course.
I think about it and I do believe we are trapped. 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 5 to 10 years or whatever. So something has to happen.
First, we have tried to devalue 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 sort of things.
Now, we bring on the fiscal side, I believe. So far, what we see on the fiscal side is gigantic but it’s not stimulus. It is 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. It’s not more than that. I think they have to do more than that.
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 is 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 dept explodes to an even higher level and not only government debt explodes but also the government share of our economies.
In the second quarter for the US economy, the government share of GDP, nominal GDP, jumped from the mid-20s to the upper 40%, the eurozone, on average, has a government share of about 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, 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 is government-led, it is government manipulated, it is government intervened, the free market is pushed out and the planning guys are running the show.
The fiscal authorities, the governments, as well as the central banks, work together and they are running the show. This is what it is. We lose our freedom because when they do that you get a lot of unpleasant surprises that come out of market mechanisms that are still working to some degree and of course those unpleasant surprises cannot be and therefore they manipulate and they intervene more, they regulate more, and they dictate more, etc, etc.
I think that’s the path we are usually going in a situation like this. When you go through history you usually end up in hyperinflation and then a monetary reform.
With the demographics we have, it is very difficult to create hyperinflation. They have tried for some years. Once we get up to 3/4/5 percent of inflation, if they can achieve that, then there is a chance that we could have much higher inflation. They could achieve higher inflation if the central banks begin to directly finance the governments. The Brits have announced they will do or they are doing it already, some others as well, Brazil is another one, the structurally weaker economies like Brazil and Turkey, they will most likely run into 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 a 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. I think there is no winner coming out of this.
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. There is no real winner coming out of this. All you can do is lose less than others. That’s how I see it over the long term and I think the situation is not just economic, it backfires into the social arena, it becomes very political because the policies that they are applying are creating a bigger and ever bigger rift between the haves and the have nots and this leads to ever more socialist policies and redistribution policies, etc, etc. 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 what the exact next steps will be, I mean, the next steps next year, I think, will be a lot more fiscal support. That’s what I expect. I think that monetary policy will remain easy for some years. That’s the combination for the next few years.
Then you have to mix it up on a geopolitical situation that is not very stable and is in flux and you have the fight between the Chinese and the US and potentially, if Trump gets reelected, he will take on Europe in the next term. It’s probably less dangerous if Biden gets elected because Biden will take the US to the European socialist model.
Then, the risk of tensions is probably less but I think there is a move away from the globalization trends that we have had. We have the movie running backwards. We have regionalization. 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. I think they are focusing on Asia for the short term, for the next few years, to strengthen their position in Asia, to make sure they can integrate Taiwan which could play havoc with the markets and geopolitics. They need the semiconductor industry that is located in Taiwan.
I think the US is also turning inwards.
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, even Biden, will not tolerate the trade surplus that Europe is running against the US. They will try to bring the dollar down to a level where the Euro gets higher and then the trade surplus disappears. If the trade surplus disappears, it is a deflationary shock to the European economies and then you have the risk whether they can stay together in that misconstructed EU and Euro, etc, etc. There are a lot of moving parts in this whole scenario.
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 about 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 sharp.
The problem with all of that is that you play that in markets that may not stay free markets anymore and 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. 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 14:16
Well, I think all that’s left is to say thank you and wrap that up because that was extraordinary, Felix.
What a fantastic backdrop for this discussion and there’s so much that I think we can we can dig into there.
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 going to try and go back to the beginning, work my way forwards, otherwise, we are going to get stuck on the dollar which is one of the last things you did and work it backwards, which could be tricky.
When you talk about the rules changing and you talk about how the free markets are under threat, I think anyone that has spent any time watching this can see that is now a very real threat.
How should investors think about that in terms of things they can do and signs they should be looking for, I mean, 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 15:17
It depends on 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.
If you want a certain return you have to move up the ladder of risk and 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. If you are in less liquid investments, those could get very illiquid, or totally liquid, and then you are stuck. That’s the worst thing that can happen to an investor or speculator.
I think you should stay with large-cap equities, with some of the commodities, 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. The commodity sector has been out of favour for virtually 10 years and I think it’s bottoming on a secular 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 warmer and that is not very good for harvest results and 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.
The next five years, I think, food commodities could be fantastic.
Bill Fleckenstein 18:29
Felix, if we see the governments do what you suggested, which seems like it’s an about as sure thing as we can guess that, I would think at some point, bond markets would start to get a bit concerned.
Obviously, you’re talking about more supply and of course, central banks will monetize some amounts 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?
How do you think that dynamic might play out?
Felix Zulauf 19:08
I have been a bond bull since 1981 and I wrote a piece in 1981 called “The buy of a generation”. About two or three months ago I wrote a piece called “The sale of a generation” — So I think the big bond bull 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 part, if not all, but the credit quality of the borrower goes down. Therefore you have to price it differently and therefore those who can move away will move away and therefore bond yields next year I see pointing up.
I do not know exactly how the next five years develop but I could see one or two cycles at relatively low yields, let’s say 10-year treasuries between zero and three per cent or three and a quarter, but at some point, we will break through on the upside. The generational cycle is turning. We are in a secular bottoming process now for some years. Bottoms in yields are a saucer type of bottoms whereas peaks are usually spike peaks and therefore I am very bearish on bonds long 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. 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 when you have rising bond yields usually stock prices for value stocks go up and the prices for growth stocks go down.
We now have this structural change, we have the big discussion, growth versus value, and I think what most people didn’t quite understand yet is that this lockdown, due to the pandemic, or what they call a pandemic, has really accelerated structural changes that have been in place before and we made a Quantum Leap towards more online retailing, less mall retail shopping, less commercial offices, more 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.
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 pick any P/E you like as long as the market believes it is 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 start repairing their balance sheets and that is an important item. 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 and 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 cost the marketing, they have to cut the advertising, they have to cut labour, they have to cut the inventories or whatever, they have to 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 and therefore I was talking about an economy that has first a hiccup, a bounce from the low, and then it keeps retarding because the corporate sector must continuously cut costs, maybe for two years or whatever, and therefore the fiscal support must come in, in a bigger size, to push the economy further up and then you create supply problems in some areas because some of the suppliers are gone.
Then you may have some cyclical inflation.
If the China, which has always cut export prices, 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 this 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 the past periods, have a two year run in the end to the peak and, actually, it’s about two years by late this year and you can be off by six months or 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 1999 before the final run to the peak or it is already past the peak. I tend to the former. I think 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. When growth/value changes in favour of value, it’s the end of the outperformance by the US stock market because all the other indices in general, are more value-oriented. Maybe with the exception of Taiwan and Korea. Those indices are also very heavily weighted in growth and technology. 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. It will most likely happen in a down market and not in an up market. Most people miss it because they will be concerned and carried on by working on preventing losses with their baby darlings that are heavily represented in their portfolios. They will not focus on “What should I buy?”
Usually, leadership shifts take place during down markets. I think we could have quite a good down market, whether it is a short term occurrence, let’s say 30 to 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. 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 an index call on the S&P and NASDAQ. It’s all sorts of things coming together. It’s all the same trade.
Grant Williams 29:52
Is there a key to that? 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 30:06
I think it’s the bond markets. I think it’s the US bond market more than the other bond markets and 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 turn and that’s probably the trigger.
Grant Williams 30:32
Right.
Felix Zulauf 30:33
We have broken the 10 Year marginally and the 30 has not broken yet. It may break modularly and fall back into the range before it really breaks out, sometimes next year I believe. I believe is probably next year.
Grant Williams 30:52
There are a couple of things I want to wrap in if I can.
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 the 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 and at the same time, the longer this goes on the more debt there has to be issued. The central banks are going to struggle mightily to absorb all that. They have to find someone to take that dept on.
Do you think that we’re going to get into that fairly soon where governments start to say:
“Okay, there are levels you need to hold in your portfolios.”
Felix Zulauf 31:41
No, I think in the first step it’s all central banks. They take up the paper. I think in the next step, later on, you will get those mandates. Yes. That’s part of the new game, as we discussed before.
Bill Fleckenstein 32:00
When you describe the situation that could argue for structurally more unemployment and given the Federal Reserve’s new Jihad for targeting unemployment very aggressively and they are more willing to let inflation run hot, it seems to me that they are going to be required to be even more activist, especially when you layer in the fact that the government is going to issue more debt because it’s going to be bigger from a fiscal side.
It sounds to 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 that employment down if the bond market rates start to try to back up a little bit.
Does that seem logical to you?
Felix Zulauf 32:58
Sure, I would say that by the end of this decade the Fed’s balance sheet is probably at 40 or 50 trillion or something like that.
Bill Fleckenstein 33:08
Oh, my God.
Felix Zulauf 33:15
Grant, we talked about that at another instance 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 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 of it because they don’t have that much money and they are not that liquid, but the central bank can create the money. Most people think that when the central bank creates money and injects it to the banking system, that creates inflation, it does not. For inflation you have the banks to lend and the borrowers to borrow, to make a transaction in the real economy, and only then you can get inflation in a bigger way. Other than that, the money is stuck in the banking system 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 35:09
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 gonna be at 10 trillion by the end of the year.”
Now we’re talking about a world where at the end of the decade, possibly 40 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 the world look like? What does the dollar look like? What does gold look like? What does oil look like? Obviously, your commodities play should perform spectacularly well if we do end up in that place. But what are things like the dollar and gold look like in that world you just described?
Felix Zulauf 35:50
The dollar measured in its own way will decline, measured relative to other currencies, it’s another question. It always takes two to tango and 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 next year. That is possible. But the Euro is a misconstruction and if the Euro goes up to 130, then the trade surplus is cut in half, if not more, and then the European economies are going into a deflationary condition. When they have a deflationary condition 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. Therefore, there could always be big moves both sides, because there is no sound currency anymore.
In the past, we had a strong Deutsche Mark. Germany had its house in order. That’s not the case anymore. We had the strong Swiss franc because Switzerland has its house in order. The house is in order with the central bank 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, etc. 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. Before that, with the Dutch guilder. 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. The dollar is maybe overvalued by 10% and the Euro may be undervalued by 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 maybe money tries to flow out and it creates a balance of payment crisis and 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 and in that sense, the European situation is very interesting because the European stocks are all trading below book 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. That means they cannot issue new equities, they cannot raise capital, equity capital, it’s too expensive, it doesn’t make sense.
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. They cannot lower 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 was Draghi and his crew. 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.”
I’ve never seen any dumber thing than this but this shows how desperate the situation is and we will see many of those things.
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 flows away because there is a bail-in clause. That means that if you are a depositor with a bank in the Eurozone, and the banks could get in trouble, the bank could use your deposits and turn it into equity capital. When you see that risk going up, the capital runs away and therefore, at some point, we may see capital controls to prevent capital from moving out to save the banking system. In the end, within the next five years, the major European banks that are system relevant will be nationalized, there is no way out. There is no way out. When they nationalize the banks, they are usually not doing it at a much higher price but usually at a much lower price.
Bill Fleckenstein 42:26
All of that sounds like a bullish backdrop for the gold market.
Felix Zulauf 42:31
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, and we have a situation were real interest rates are negative and I think real interest rates will stay negative for years to come. They must stay negative! Otherwise, you cannot support the system. As a result, this is bullish for gold on a major trend basis. Of course, you can have shakeouts, temporary shakeouts from time to time. The big run in gold usually comes in the last two to three years of a secular bull market. It is usually because the investors buy gold not because central banks or the normal purchases by the Indian savers or the Chinese savers. It is when they begin to fear that the system could fall apart and they could get trapped and then they run to gold. Therefore, I’m very bullish on a major trend basis and I think gold mining stocks are options on the gold price because they have a lot of gold in the ground. At the height of the bull run, and near the peak, people will talk about how valuable those assets in the grounds are and therefore, on a major time basis, I’m quite bullish. Technical work is not so bullish for the medium term. It’s overbought. It’s momentum oscillators are wrongly positioned. I don’t like it for the next few months. But on a longer-term basis, you have to own it.
Bill Fleckenstein 44:49
Yes.
Grant Williams 44:50
You know, 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 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, to show just how fragile the system is.
One of the things that wasn’t necessarily a big problem at the beginning of this last decade but certainly since 2016 in America and maybe 2012 in Europe , a problem that has increased in its size and its importance, is geopolitical tensions and not just the international ones but interstate ones. And, obviously, we’re heading towards the US election in 26 day. Clearly, that has the potential for all kinds of deleterious effects in the aftermath of that. As you look forward to that, how are you thinking about this, both in terms of the overall outcome, without your need to make a prediction, none of us knows 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 46:16
I really don’t think it matters much who will be president in the next 4 years.
Grant Williams 46:23
You are probably right.
Felix Zulauf 46:27
I thought that after 2024, if Trump would get reelected, we would see a US president who is left from Bernie Sanders, that was my expectation, anyway.
The society is so divided. The rift between the haves and the have nots are more extreme than in Brazil. When you look at the statistics, the Gini 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 middle class and lower middle class, not among the very poor, but the lower middle class. If they do not get what he promised, they turn to the left. I recently saw a survey in the US among age groups and the age group from 18 to 29 years, they favour socialism more than capitalism. When you see things like that there is a big turn and the Zeitgeist, the pendulum, is swinging much more toward the left. Trump is not a right-wing person. Trump is a nationalist with some socialist things in his program, like spending like crazy, 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 before. They ruin the finances of the government in the long run. There is nothing new under the sun. It is a continuing trend and the trend is accelerating. 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. That’s the normal trend of a democracy or what they call a democracy, it’s not a real democracy, but that’s what they call a democracy.
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, Biden will even raise tax rates for the corporate sector. That may make a marginal difference. 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 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 up with the Chinese because nobody else did and it was about time. If somebody doesn’t behave well, you have to tell them that things have to change. Actually, every coming up nation, when you look historically, has behaved like China, even the US, at that stage of development. 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.”
I think Biden would probably be more pro-NATO and could probably work better with the European socialists because his team will probably also have some keen socialists as members. 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. Thucydides wrote that over 2000 years ago. There is also going to be further tensions between China and the US. What it all does is, economically, the movie of globalization is running backwards. We will have different supply chains. There will be a dual supply chains. One for China and Asia and one for the rest of the world. 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 throughout our societies is another question. The windfalls of globalization were not spread out evenly. The big winners were the upper 1% in the western world and the new middle class in the emerging world. 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. If they do not become big winners, then you will have revolutionary type of attempts. These attempts may lead to cessations. I would think that 20 years from now we will probably have more nations in the world because some nations will split apart. Some regions will go away. It’s not even sure whether California is a US state. It could easily move away. It’s probably the seventh or sixth-largest economy in the world. It could do 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 this 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 53:54
Yeah, I think volatility is perhaps the one thing that we can count on.
There is 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, for 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 gonna throw at it 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 54:32
I don’t see that big of a disconnect.
Grant Williams 54:35
Really? That is interesting.
Felix Zulauf 54:37
No. Look at the structural winners and beneficiaries of what has happened in the last six or seven months. They are beaten up big time. The capital flows to the big winners. This is economically logical. The value and more cyclical stocks have been underperformers. Of course, they have bounced and lifted by the sea of liquidity. That’s probably what you refer to. The economy is not back to where it was but most value and cyclical stocks are now back to the highs. They reflect the more difficult and 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. So there is a logic to it. I’m not saying the valuation is right, but there is a logic to it. 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 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 23. 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 and so the first part was right but the second part was wrong.
Bill Fleckenstein 56:45
I think a lot of what may have fooled me, I speak for 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 57:09
Well, it’s an investment fad and it is very powerful towards the end of a 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 investment fad 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.
Bill Fleckenstein 58:04
You mean — like a business?
Felix Zulauf 58:06
Yeah. 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 a smooth 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 overdo it every time, big time. They have to. Those who understand that make the big money in those runs and 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 58:56
Yeah. Felix, it’s been an unbelievably confusing and fascinating discussion. I’m gonna have to go and sit in a dark room and think about all this now because it really has been pretty 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, I think that’s one for 2021 I suspect.
Felix Zulauf 59:18
We will do it next time. Okay, it was a pleasure. Thank you very much, Grant. Thank you very much and hope to see you sometimes next year.
Grant Williams 59:27
Likewise, take care and stay safe in Switzerland. Thank you.
Felix Zulauf 59:31
Same to you. Bye-bye.
Grant Williams 59:32
Cheers. Bye-bye.
Wow. ok.
Bill Fleckenstein 59:42
What can one come up with after that? I mean, it’s so weird, we have been so fortunate to be able to catch these thoughtful and successful investors slash thinkers and catch them on a good day. You know how it is with these conversations, you get off on a tangent and it never quite gets going and while we were listening to this, I was thinking, I can’t wait to listen to it again.
Grant Williams 1:00:09
Yeah, it is exactly right. 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 always 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 have 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. Every time I walk away, feeling exactly like I do right now. There’s so much to think about there. He just pulls it all together so beautifully.
Bill Fleckenstein 1:00:43
Yes, but there’s no way anyone would be able to extract the amount of usefulness that is there if you didn’t have a format like we do. Sometimes there aren’t any Cliff Notes, you have to read the whole book.
Grant Williams 1:01:01
That’s a great point.
Bill Fleckenstein 1:01:02
It’s really interesting to have his perspective right after we had Marc’s perspective because they both come at the world from a similar vantage point and they’re both Swiss, ironically enough.
Grant Williams 1:01:14
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 the ability to. He’s an extraordinary individual and he is a good friend and a remarkable man, I have to say.
Bill Fleckenstein 1:01:39
Well, that was wonderful. I really enjoyed it.
Grant Williams 1:01:43
Well, I guess all that remains, Bill, is to firstly, thank the great Felix Zulauf. For those of you who weren’t familiar with Felix before today, I suspect it has 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 at www.FelixZulauf.com.
Funny enough, I looked for Felix, he’s on Twitter, he has 952 followers and I don’t think he has tweeted yet. So there are almost 1000 people out there — almost like the Life of Brian, everybody waiting to hear what Brian has to say. So hopefully, Felix may just send one tweet out from the mountaintop and keep the people happy, but do check out www.FelixZulauf.com.
Felix was writing over the years, you’ll find it in various places on the internet. Whatever he writes is worth reading, no matter how old it is, there are lessons you can take from it.
Thank you to you for listening to us.
Thank you for continuing to support and follow us, for rating and review us on the iTunes Store, as I said it every week, it really does help us.
And 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 1:02:51
I feel the same way and, yes, it’s been incredibly educational.
Grant Williams 1:02:56
All right, so please follow us on Twitter. You’ll find me @ttmygh.
Bill Fleckenstein 1:03:02
And I’m @fleckcap.
Grant Williams 1:03:03
Yes, he is and we’ll be back with more of these conversations when our brains calmed down. Thanks for listening.
That’s it. So all that is left is the WeTransfer and we are in business.
Bill Fleckenstein 1:03:14
I think I can handle that.
Grant Williams 1:03:16
You got it.
Bill Fleckenstein 1:03:17
I’m getting better at this, you know?
Grant Williams 1:03:19
You are and plus, it fills it all in for you.
Bill Fleckenstein 1:03:25
You know, right now, basically, the stock market is essentially uninvestable. 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 ask Mike, Mike would say:
“It can’t break.”
I always think that at some point they can push things to a place where even what’s going on can’t quite hold and then it escapes to the downside and it feeds on itself. But who knows?
Grant Williams 1:04:08
Well, that’s why I look at the number of people losing their jobs. How many of those want to tap their 401Ks? That kind of stuff comes out of nowhere and it’s like — I need money.
Bill Fleckenstein 1:04:23
I think what we need, 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 the younger bodies are going and the younger bodies are all going target date and all this stuff. And of course, the passive guys keep getting the laws changed to advantage them visa vie over everyone else. So it’s a pernicious problem. I don’t think it’s permanent, but seeing how it ends, I know it’ll end, I know it’s insane. It would have to be some combination of a big unemployment problem in corporate America.
All right, my file is done, I’m going to transfer my file. It is in the process of transferring.
Grant Williams 1:05:16
Beauty.
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.
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Transcribed by Felix Häffner
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