Interview with Felix Zulauf on China and Late-Stage Market Melt-Up

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FS Insider recently interviewed Felix Zulauf, a longtime member of Barron’s Roundtable and the head of Zulauf Consulting, to get an update on his market outlook. Here's what he had to say...

For audio, see Felix Zulauf on Market Melt-Up, China, and More

Late-Cycle Sentiment Emerging, Melt-Up Likely

“I really think that we are seeing the beginning signs of a melt-up in parts of the stock market,” he said. “Because it’s late-stage, I do not know how long the market will run. I think sometime in the first half [of 2018] we will see the peak.”

This cycle peak is difficult to judge, however, because conditions are so abnormal, Zulauf stated. In a normal cycle, the peak usually comes when inflation rates go up, central banks begin to tighten, the economy is running on all cylinders, and corporate profits are strong.

We see some of these signs now, but not all of them. Fed tightening is an exception among other central banks, Zulauf noted. And other risks appear to be rising, he added.

“Markets are not always a one-to-one reflection of economic reality,” he said. “There are many other factors. The cycle is very old, and there are a lot of geopolitical issues that are very fragile and could go in the wrong direction.”

Near-Term Conditions Deteriorating

The US consumer isn’t in great shape, Zulauf noted. We do see rising real income, but the savings rate has dropped to a multi-year low recently, he noted.

“That is not the precondition for a sustainable extension or advance of the economy,” he said. “I really think that the US economy is tired, and the tax stimulus, if it comes — and I think we will see something — may extend the expansion by another year or so. But I do expect that 2019 and 2020 will be a window for recession.”

Many economists and analysts have questioned this type of thinking, arguing that global growth is strong. Zulauf acknowledges that fact, but he added that the rest of the world is very highly dependent on China.

“As China goes, so goes the rest of the world, with the exception of the US,” he said.

The most important points in the future are 2021 when the Communist Party celebrates its one-hundredth anniversary, and in 2022, when the next National Congress is held to pick new leadership. He suspects President Xi wants to break tradition and attempt to hold a third term.

If that’s the case, he should look to slow China’s economy down in 2018 to be able to stimulate in 2021 and 2022, Zulauf stated. That would slow down the Chinese economy, and with it, the world economy, supporting his contention for a window of economic vulnerability starting in 2018 and developing in 2019 and 2020.

Buying Climax in FAANG Stocks?

This likely indicates that we’ll see a market high sometime within the next 6 months or so, he stated. The absence of a correction this fall suggests the potential for a market melt-up before that peak, he noted. The interesting thing is, this bull run has been carried by a few FAANG stocks.

This is the sort of thing we want to see to call a top, he noted. When we see an advancing index and lagging breadth and non-confirming breadth, we usually have a top thereafter, usually within 3 months of non-confirmation.

“I think sometime in the first quarter or spring of next year, that should be it,” he said. “It could be ending in a buying climax because historically bull markets have been dominated by one major theme. This bull market has been dominated by the FAANG stocks.”

This would be a good development from an investor’s point of view, he noted, because buying climaxes are easy to spot. Within a few days of the climax, Zulauf stated, it should be possible to identify from a technical point of view.

He admits he may be wrong, but he advises investors to listen to what markets are telling them.

“Go with the trends, because bull markets usually last longer than skeptics like me believe,” Zulauf said. “But once bear markets arrive, they can be vicious and destructive. They can destroy a lot of wealth and destroy families. … Risk management is the absolute key.”

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