Felix Zulauf, head of Zulauf Consulting, recently discussed his short- and long-term outlook for the markets, the global economy, commodities, and much more in an interview on our weekday podcast. In the short-term, Zulauf forecasted that we are likely in the "later stages of this bear cycle...[but] I do believe that we have one more leg down into the first quarter of 2023."
Here's what he had to say in a recent interview on FS Insider (see Felix Zulauf Discusses the 'Decade of Rollercoasters', Beginning of New Bull Cycle, and More for audio).
Zulauf attributed this forecast to the widespread tightening of monetary policy by central banks around the world, stating, "The Fed continues to tighten, and central banks around the world have tightened. And I think what we will see then, is the fallout of this tightening process." As a result, Zulauf expects to see a weak global economy in the first half of 2023. "The important thing for an investor is to see bad news coming in, and that companies begin to guide earnings down. And maybe there is going to be a credit event," he said.
Too Many Inventories
Despite the relative strength of the US economy due to stimulus provided during the pandemic, Zulauf believes that the pool of savings is dwindling and that involuntary accumulated inventories in Asia, Europe, and the US will continue to grow. "I do believe that the involuntarily accumulated inventories in Asia, in Europe, and also now in the US and North America... will probably go up even more when sales disappoint in the next few months," Zulauf said. This could lead to price cutting in an effort to get rid of excess inventory, resulting in a decline in inflation. Zulauf also predicts that China will experience deflation, which will further contribute to a decline in inflation for traded goods coming out of Asia.
Potential Fed Pivot
Zulauf believes that a market downturn of 30% or more in 2023 could lead to a pivot by the Federal Reserve and an improvement in liquidity, resulting in a bond rally. "I think we get to the point where the Fed believes it's time to change, and it's time to ease up," he said. "So I do expect a Fed pivot sometime in the first half, it could be even late first quarter where the Fed swings around." He predicts that short-term interest rates will peak soon, while long-term rates may have already peaked or are in the process of topping out for a cyclical decline lasting six to nine months. This bond rally could result in a decline of 150-200 basis points for 10 and 30-year rates.
Outlook for Commodities
Looking ahead to the second half of 2023, Zulauf believes that the commodity complex will begin to find a bottom and rise again. "And because the liquidity will be better, I think the world economy will begin to recover, especially the US economy," he said. "I think the US will recover faster than the rest of the world because the US has the most flexible economy, the most flexible financial system, and the most flexible labor market." Zulauf advised investors to remain cautious in the short term, but to be ready to take advantage of opportunities as they arise in the second half of the year.
Lost Decade and Return of Active Management
Felix also spoke about the potential for stagnant returns in the coming years. According to Zulauf, passive index-type portfolios are likely to deliver poor returns over the next decade, with returns potentially hovering around zero. He also believes that this decade will be marked by significant volatility, with "dramatic moves up and down and in different segments." In order to achieve higher returns, Zulauf advises investors to be able to time these cyclical swings and select the dominant themes. He notes that the current generation of investors has become accustomed to achieving decent returns through passive indexing, but that this may not be the case going forward.
Deleveraging in China
Zulauf also discussed the importance of China in the global economy, stating that in most countries, China is a more important trading partner than the US. He compared the current situation in China to Japan in the early 90s, when Japan experienced a credit and real estate boom followed by a weak banking industry and rising non-performing loans. Zulauf believes that China is experiencing a similar situation, with undercapitalized banks and rising non-performing loans, as well as an excess of infrastructure and real estate. He expects to see a "massive deleveraging" in China in the coming years, which will have global implications due to the country's central role in the supply chain.
The following was just a brief portion of the material covered in our recent conversation with Felix Zulauf. To listen to this full audio interview, see Felix Zulauf Discusses the 'Decade of Rollercoasters', Beginning of New Bull Cycle, and More or, if you’re not already a subscriber to our FS Insider podcast, click here to subscribe.
Also, don’t forget to follow more of Felix's work and sign up for his newsletter by going to www.felixzulauf.com.