Felix Zulauf Sees Another Market Selloff with Fed Rate Hike

Whether you chalk it up to luck or skill (or somewhere in between), Felix Zulauf, the Founder and President of Zulauf Asset Management in Switzerland, has certainly earned his right as a long-running member of the Barron's Roundtable.

In his August interview with Financial Sense, Felix explained to our audience why the mini-devaluation of the Chinese currency a week prior would likely spill over into other markets and raised the risk of a very sudden and sharp decline. Only a few days later, stocks around the globe fell by double digits.

In that same interview, Felix also predicted that stocks would likely bottom around October and then rally into December, which is exactly what they did. At that point, he told listeners, it will be necessary to re-evaluate market and economic conditions to determine whether the year-end rally will be sustained or not heading into 2016.

Before flying back to Switzerland, we caught up with Felix again in Florida to get an update on his current outlook.

Here's a portion of his recent interview with Financial Sense airing Friday for subscribers:

Felix, based on your reading of major events that took place this year, the forecast you gave on our show in August proved amazingly accurate. Where do things stand today?

"The world economy hasn't changed much. What we see is a world economy that is growing at a very slow speed and is actually rather slowing than accelerating. I think the US economy in particular is in the beginning of a slowing process that will surprise most and I think the Fed is probably making a policy mistake; they waited too long with a rate hike and now they will probably hike at the wrong point in the cycle...

I said last time that global equity markets as well as the US market peaked in spring of 2015 and they have declined (since). Then we had a rally from the September-October lows and that rally is well developed but it is lacking the favorable characteristics of a strong rally: it is weak in terms of breadth and high in terms of volume. You see a lot of stocks making new lows on certain days—more new lows than new highs—and this is a very weak rally in technical terms and that's no good..

I would give the market maybe another one or two months of churning a little bit higher into January, perhaps early February, and then I think we will see the second downleg in this bear market for most indices around the world, including the US indices. Even if the S&P, Nasdaq, and the Dow make minor new highs on this rally, this is a fake rally—it's a very weak rally—and I think it will be followed by another decline."

Explain why you think the Fed is making a policy mistake by raising rates next week, assuming they do so, and how this relates to your outlook for the broader market?

"If they hike the rate, the Fed has moved since the financial crisis from a precise Fed funds rate to a target range and the target range is presently between 0-25 basis points. If they hike to a 25-50 basis point range, they have to withdraw reserves on their balance sheet to move that rate up. They now have around $2.5 trillion reserves on their balance sheet and the Fed probably thinks that they can hike the rate by withdrawing maybe 300-400 billion dollars and I don't think that will do it.

I think they will need to drain at least $1 trillion—it could be a lot more than $1 trillion—and what this does is it will be a shrinkage of the Fed's balance sheet and it will also shrink liquidity and this will be quite negative for global liquidity in general. I think this will go into the history books as a major policy mistake. Though I am not an advocate or believer in zero interest rate policies and QE or whatever, I think we should save those policy steps for a deep crisis when the system is in trouble but really not fool around with them when the system is working properly. So I think that is the issue that I have with the market and I am rather bearish for 2016..."

Subscribers can listen to this full 30-minute podcast with Felix Zulauf airing Friday, December 11th by logging in and visting the Newshour page here. Subscribe to our weekly premium podcast by clicking here.

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