David Lin (Uncut) 12-14-2024

I expect a roller coaster year in the US I expect the top very soon, early in Q1 of 25 and then a sell off of a little bit over a thousand points in the S and P of 15 to 20% triggered by uncertainty about the Trump trade policy, the tariffs, a trading environment good for traders and hell for investors for buy hold investors.

Felix Zulauf returns to the show. He is a founder of Zulu Consulting. We’ll get his outlook on stocks, bond markets, monetary policy, the outlook for the economy and the biggest things that investors need to be paying attention to in 2025. Felix, always good to have you.

Welcome back to the show. Good to see you.

My pleasure. Thank you very much David for inviting me.

One of your recent reports is called the Trump Bubble. Many themes covered in that report and of course you write very frequently. We’ll talk about that report in some recent news. But what is a Trump bub you?

Well the Trump bubble is just Trump accelerated the uptrend and the euphoria in the marketplace. The bubble has been building for the last two years. It is driven by tremendous liquidity that the Fed injected via the back door via reverse repurchase agreements and things like that. And, and we are now at the level in terms of valuation that is the highest or second highest in the last 140 years.

And when you get to those levels as a long term investor, you know when valuation is high, your future return is low and vice versa. And bubbles, when you have parabolic markets, they do not correct by going sideways. So one extreme in one direction will eventually be corrected by going in the other direction and to another extreme again. So my point is that I would like to help people to get off the train before there is a train wreck.

American equities for 2025, is that still going to be the leader compared to European equities, Japanese and perhaps Chinese?

I think the markets will swing together in sync. China will underperform. Europe will underper. All the markets will underperform the US except when I’m right in the portfolio strategy.

I expect a roller coaster year in the US I expect the top very soon early in Q1 of 25 and then a sell off of maybe a little bit over a thousand points in the S and P or 15 to 20% in the major indices triggered by uncertainty about about the Trump trade policy, the tariffs and perhaps also the dochi cuts that people are talking about. And that could lead to an important low sometimes in the second quarter which I think will then be supported and helped by the Fed by easing. And then we go into another rally, most likely back to the highs or even a little bit higher than what we have seen, maybe to 7,000 or something like that on the S and P. And further out is unclear because it really depends on what sort of policies in detail are getting into place.

Because the policies that are being discussed in Washington are highly disruptive policies for the world economy and that will have an importance for the US Economy as well. You know the tariffs we are talking about, if Trump introduces those tariffs, it would be similar to the tariffs we had in place from 1900 to the end of World War II. And if he introduces only half of that, it would still be the tariffs from the beginning of World War I to the end of World War II. And you can go through the history books, those were not very good periods in terms of economic performance and in terms of investment markets, financial markets.

So I’m very concerned because a tariff means that the consumer either has to pay more than it would do otherwise or the producer selling earns less than it would do otherwise. So it is a major tax and the proportions of the tax are very high as I just introduced. And people should not forget that the intermediate term correction that started in 1929, October of 29 turned into a terrible mess. Global economic crisis, depression and the market meltdown.

Because In June of 1930 they introduced major tariffs with the Smooth Hawley Act. So I think what is planned is very disruptive if it is put in place. And some believe that Trump will only use it as a bargaining tool. That is possible.

But I have heard theories in Washington that they will remove the income tax and replace it by income from tariffs, etc. That is a non starter because if they do that it will disrupt trade to such an extent that everybody will suffer and dearly. So we have to watch very carefully what eventually comes out of Washington and we do not know the details yet. We have to wait and see.

And the sell off you think will be as a result of uncertainty around how some of these more I would say controversial policies will be implemented around Q1 during.

Yes, yes, I think it will be due to uncertainties. And on top of that you have another economic element. You know, if Musk and Rahman’s army are successful and cut out what they said, that would be dramatic. Even if they cut out only half of what they said it would be a trillion US dollars and a trillion US dollars is about three and a half percent of gdp.

And even if out only one quarter of what they said it would be close to 2% of GDP. So one guy’s expenditure is another guy’s income. And while I applaud that structurally for the long term, in the short term it would be very painful and there are a lot of open questions regarding all that. And as long as that is not clear, I remain on the cautious side because the markets are very overheated, very extended, and my technical tools are really sending warning flags.

And that’s why I’m expecting a medium term correction. It could be, of course, worse than that, but I’m going for the medium term correction for the time being. Sometime starting probably in January.

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Sometime something around 15, 20% like you said. But you also said that longer term, after this correction, you expect the S and P to go back to 7,000, despite the index already being very overvalued. Why 7,000? Are you assuming the economy will continue growing strong?

No, I’m assuming that if the market would sell off, as I expect, then I think central banks and fiscal authorities will come in and lend support immediately and that could give us another kick higher. The one thing is, you know, if this is a bubble, bubble can. Bubbles can break for several reasons. They can break due to any exogenous events.

And the way geopolitics and politics go these days, you know, there could be plenty of surprises, but we cannot forecast them. Then they can break due to economic reasons, as I just explained. And then, and most importantly probably is the liquidity issue. We have had tremendous liquidity injection into the system over the last two years due to the Treasury’s operation with the reverse repurchase agreement.

And I think that is drying up. We are down from almost 3 trillion down to 660 billion. And what I understand is most of that money is held by banks and not by the money market funds any longer. And that means that they will not go to zero or so.

So I think that source of liquidity is mostly spent. There is another 800 billion in the Treasury’s general account that could be injected into the financial market. But I think Scott Besant, the new treasurer, is very savvy in financial markets and he would not spend it without a major necessity. So therefore, I think the liquidity sources that we have seen driving liquidity in markets over the last two years are mostly spent for the time being.

The other liquidity source that is global in nature has been the funding via the Japanese yen. You know, everybody and his brother over the last 12, 13 years has used the Japanese yen to fund any projects or investments because you had virtually zero interest rates or almost negligible rate of interest to pay for, and you had a currency that was constantly debasing and devaluing the dollar. Yen has gone from below 80 to over 160 in the last 12 years or so. And at 160, the yen is vastly undervalued.

The purchasing power parity is about 88. And you can imagine what President Trump will tell the Japanese Prime Minister what he should do with the currency or getting punished via tariffs or things like that. So I think the Japanese people want to have higher interest rates. The Japanese central bank is the only one talking about hiking rates in a world where every other central bank is in a rate cutting mode and the trade situation is such that there is pressure to strengthen the yen.

If the yen begins to strengthen, the whole game changes. And that means people have to purchase the yen and sell dollars, etc. And that is a drain of liquidity that is coming to the market. You have seen that in the recent years, recent two years, the relationship between real Japanese interest rates and the NASDAQ earnings yield, or the reciprocal of the PE was the closest correlation you can get in financial markets.

So I think once you have a strengthening yen and higher Japanese interest rates, you are in for some liquidity withdrawal and hit to the financial markets and risky assets. And that I think could be the trigger to the sell off that I expect early in the year.

The next bank of Japan meeting is coming up, as you know. Let’s suppose we’re assumed that the bank of Japan will hike rates one more time. When that happened in August, first week of August, global markets sell off because of the reverse yen carry trade. As the Japanese interest rate rose, capital flowed out of US equities and risk assets into back into Japan.

Let’s examine that situation. Can that happen again in January?

I expect something along those lines. The dollar yen hit the high at 162 then sold off as you just explained to 140 and bounce back to 156. We are now trading at 151. We are bouncing back a little bit.

We could go to 155, 156 or even a little bit higher than that over the next two to three weeks or so. But after that I think dollar yen goes further down. And if we start as I expect the next medium term down leg in dollar yen we will most likely break 140. And that could trigger the sell off in the equity markets that I suggested.

Yes, and very interestingly I don’t know if this is just a coincidence because of a correlation, but if you take a look at the Japanese, the dollar yen pair, that’s the bar chart here and the purple line is the NASDAQ index. Ever since basically 2023 there’s been a good, good relationship, not perfect, but good relationship between currencies, the DXY and the nasdaq. Now this divergence is starting to show as the NASDAQ has been flat over the last couple weeks and like you just said, the dollar yen continues to move up towards 163. Can you explain this chart?

Well, as I just explained it and I think the divergence you see right now here in December is because everybody is addressing his own portfolio. Portfolio managers are doing that. They want to show low cash positions and high equity long positions and particularly in those entities and stocks and indices that have performed very well. And that’s why we had the biggest inflow into equity products in the last few weeks in many years.

And I think that is another extreme and that should shows you how vulnerable the market will be early in the year when the pressure to window dress for the end of the year will disappear.

I’d like to show you another chart, Felix. This is the M2 money supply from the Federal Reserve in 2020. Right before COVID it was at around $15 trillion. Over the next few months to a year it went up to 22 billion.

21 to 22 billion. That’s a six start trillion. Rather that’s a $6 trillion increase over the span of less than two years, which is roughly 40% of the entire money supply ever created in less than two years. If you take a look at how it was before.

So Felix, the inflation rate happened already. It spiked at 9%. But all this money created. Have we seen the last of inflation?

Well, we had one inflation cycle and inflation is coming down. Prices continue to go up, but at the lower rate. And that’s a problem for the average Joe, of course. And if I’m correct that we have a sell off and the Fed then leans against the wind and eases dramatically, then we will probably start the next wave of inflation from a low, sometimes in 25 and then rising through 26 and 27.

The Fed is cutting interest rates here in a situation where we have full employment, where the quality spreads are not existent, where the economy is growing according to the Atlanta Fed, now cast at 3.3% against the consensus expectation of 2% or so. Everything is perfect and the Fed is cutting rates. I do not understand it. I think it’s irresponsible.

They have been acting irresponsibly already in the last two years. They never squeezed out the inflation as they should have because the inflation rate is a product of primarily the industrial deflation or the deflation in the industrial goods sector in the world and that comes from China. The manufacturing situation in the world is not good. Manufacturing worldwide, including the US is so called in recession and you feel it in prices and prices are coming down.

However, prices and goods that are not traded and they cannot be exported like real estate or like a haircut or like a restaurant meal, etc. They are not coming down, they continue to go up. And the Fed and like all the other central banks are looking at the wrong data and pursuing a policy based on wrong data. I give you an example.

I come to the US for 50 years and it’s the first time in 50 years that a meal, comparable meal in a comparable restaurant in the US is more expensive than in Switzerland. First time in 50 years. And that tells you that the US really has a deep rooted inflationary problem.

If you take a look at my screen one more time, I’ll show you a chart of the US 10 year treasury yield. This is from. Let me just remove this line here. This is from.

Let’s just take a year to date. So we’re currently at 4.2% and as you can see here that the 10 year spiked at around 5% in October 2023. And it’s been on this downward trajectory of lower lows and lower highs ever since. Felix, you told me last year on the show and people can check out that last interview from last that should inflation return, we can potentially see the interest rate spike up to somewhere around 8%.

Can you elaborate on that? Do you still hold that view?

Yes. You have to put it into a longer term context. I wrote an article and gave a speech actually with the title the Buy of a generation in 1981 for bonds. And in June of 2020 when it was trading, when the 10 year was trading at at half a percent in 81 it was 15%.

At half a percent. I titled a report the Sell of a Generation. The Sale of a Generation and I said you should sell all your bonds. We went to 5%.

And that was the first upcycle in a new secular uptrend for inflation and interest rates since 5%. You can see it here on the chart. We have seen two big declines down to 360 in the second decline. And now we have bounced back to 4.5%.

We are now at 423 what I see on the screen. And we may bounce a little bit more to make a top around the 444.50 area. And then we have the final and third medium term decline in this down cycle. Probably a backtesting from the breakout point of the downtrend line from 1919 81, which comes through around 3% or so.

I’m not sure whether we go that low, but that’s the final down leg. That down leg should end sometimes before mid 25. So probably in the second quarter, once that is over, that will be the correction to the first up cycle in a new secular uptrend. And then comes the next, the second up cycle in a new secular uptrend.

And if I’m right and the policies remain as irresponsible as they have been, you know, all our policymakers do is they usually throw money at the problem. And there is a problem in the economy and the world economy is not doing well. So they are throwing money at the problem. And when that comes through, we will see inflation rising again.

And then we have trade wars, we have wars which are all very inflationary. So it doesn’t mean that inflation goes up because the economy will prosper and will be very strong. It will go up for many other reasons. And I think as a bond investor you have a last chance probably in the second quarter to get out.

As a trader you can probably establish a long position sometimes in early January or so for a downtrend from 440 or whatever it is, then to maybe three and a half percent or whatever it is. That is a trade and it is a risky trade because it is the last medium term decline venture.

Powell was asked if he’s looking at the 10 year yield rising as a troubling indicator and he said he’s looking at it. However, they’re not really making policy around this yet. At what point do you think a rise in the 10 year, at what level or at what approximation would you think that is it will start affecting Fed policy? In other words, they would take a look at that and perhaps slow down the race, the pace of rate cuts.

Well, I do not believe that they are really interested in squeezing out the inflation because they are not prepared politically not prepared to risk a recession. And you cannot squeeze inflation out of the system without risking a recession as Paul Walker in the late 70s and early 80s. So I think the Fed will come in based on what the stock market does. If the stock market sells off, they will come in because they fear the stock market is forecasting a recession or whatever.

And I think they will come in on the upside. Once in the next cycle we begin to break through 5%. I think the Fed will try to keep 10 year governments at 5% or below and then switch to yield curve control. And that is really a next chapter, a next Pandora box reopen.

Because that will be very bearish for the US dollar and it will be bullish for asset prices in a declining expressed in a declining US dollar because that will be very inflationary.

As a policy we have to consider international markets as well if investors are interested in investing all over the world. Can we compare the state of the US markets and the US economy to that of Europe, for example? You wrote about Europe extensively in your last report.

Well, the Europe economy is not as strong as the U.S. you know, the U.S. has one unique thing that has never shown up before in the US economy and not in any other economy. And that is for the first time in history, in modern history, you have a labor supply breaking below labor demand.

So the supply of labor is below the demand for labor. And that has really guaranteed a full employment situation. And the full employment situation has guaranteed a relatively good income situation for the majority of the people. And that’s why we have not seen the recession many other indicators have pointed to.

And as long as that is the case, we won’t have a recession except if tariffs or some other disruptive policy steps would bring it on. That’s important to understand. Europe is very different we have rising unemployment rates. We have a stagnating European economy.

Europe has priced itself out of the world economy in terms of competitiveness because we have much more expensive energy due to the war in Ukraine and the sanctions of Russia, we are still buying Russian oil and gas. But why are India and other countries at a much higher price? So. So economic activity is really energy transformed into goods and services.

And when that price is too high, you price yourself out. And then the European Union is the world champion in regulation. So instead of further regulation, they should start a major attempt to deregulate. And that is not occurring.

And as long as energy prices are the way they are, are relative to others, and the regulation environment is as they are, Europe will remain the underperformer in the world economy.

Earlier this year, the Italian Prime Minister met with Xi Jinping. Now I’m talking about the relationship between Europe and China evolving over the next year or a couple of years as the trade wars between the US and China intensify and escalate. China, for example, just last week banned the export of critical minerals, several critical minerals to the US Important for ammunition. Do you think that Chinese European relations will develop more closely in light of this?

I think the relationship will improve for the US Would love to have Europe being as tough with China as the US is and will be. But you know, the export in percentage of GDP for the US is 10% in total and exports to China is relatively minimal. European exports are 50% of GDP and exports to China are important. Exports from Germany to China has been higher than to the US recently.

And therefore what the us the harsher the US gets with China and Europe, the more friendly the relationship will become between China and Europe because they need each other.

Do you think then that perhaps there will be more isolation between Europe and US down the line or more separation? Not isolation, but more separation from geopolitical, political and economic trade matters.

It’s a difficult question because I think we are in the process where the US goes more insular and where the Europeans still consider the US the closest ally and friend, but are becoming, or they will soon wake up to the point that the policies they are pursuing recommended by the US relative to Ukraine and relative to Russia is not in the interest of the European economy and the European people. People. And once they realize that there should be a realignment of policies, we should be friends and friendly with each other, but we should not be as dependent on the US in terms of defense, etc. And I think it will probably.

But that’s a process. I think the relationship between Europe and the US Will change. I don’t think it will deteriorate, but it will be less close than it used to be, particularly if Trump plays hardball on tariffs.

Recent news coming out of geopolitical matters. Zelensky met with Trump and Macron now this past week. So the objective, or one of the major first foreign policy objectives of Trump, he said this in the campaign trail, is to end the Ukraine war. Now, they’re already in talks, so we can assume some sort of, I hope, some sort of resolution soon.

Where do you see this headed by Q1, Q2 next year?

Well, I think Trump is interested to stop the war, but that will be very tricky. The Russians do feel betrayed by the US not by Trump, but by many of the US Administrations before, since actually the Wall came down in Berlin. And I think the Russians want guarantees. They have a certain security request for their borders and the room, the geographic territory in front of their borders.

They want to feel secure. They feel threatened. And I think all, all Trump has to do is he has to give guarantees to Russia that Ukraine will never join NATO and that Georgia will not join NATO and that what’s the other one, Moldavia will not join NATO, et cetera, et cetera. When the US can give good guarantees that they are not going to expand NATO and military bases and missile bases ever closer to the Russian border, then there is peace.

But that’s a big if. And how do you do that? Because Trump may mean it, but what’s the next guy going to do? You know, it’s a very tricky question.

And the Russians will not cave in so quickly and agree to a peace fire and things like that, that I think they want to have good and solid guarantees regarding their security requests.

Yes. Putin has not been. Yeah, you’re right. He has not been very open to settling a peace negotiation right away.

However, if we do see some sort of settlement, what does that mean for markets?

Well, if we do see a settlement, it would be very good news, very good news for all those involved in the war, because the killing would end, of course, and it would remove certain uncertainties. And when you remove uncertainties, it is always a bullish factor in the marketplace. I do not believe that alone will make a bear market, turn it into a bull market, but it may open the, the door towards more investments that would not, you know, take place or materialize otherwise. So I would take it as a, as a bullish view, but you cannot take that factor alone.

But it would be a bullish ingredient to the whole equation, Would it affect.

The dollar at all? Or perhaps gold?

You know, gold is overboard. The main buyers have been BRICs, central banks, the western invest and speculators came in relatively late to the party. I think they will be shaken out. The way it looks is that gold has not really reacted much to the Middle east wars and what happened in Syria, etc.

And not much to the Ukraine war. And therefore I think gold is in a corrective process. Maybe the downside risk to $2,400 but the long term bull market remains because we but in a fiat currency system. And you know, when there are problems, what happens in the fiat currency system?

Absolutely. So finally then asset allocation, we talked about stock markets correcting perhaps in Q1 we talked about getting out of the bond market. What do you like then for 2025?

Well, I think 25 is a roller coaster year. The mini version of what I see in the big version over the full decade where I see big ups and big downs. I see it in a mini version in 25, first into the second quarter down and then a recovery with the potential to go to new highs and then likely down again. But that will depend what the policy setting will look like as we go further deeper into 25.

A trading environment good for traders and help for investors for buy hold investors.

Are you staying defensively right now in your portfolio? Are you staying on cap cash a lot? Are you selling some of your holdings or are you getting.

My equity position is very low, very low long and I’m looking to go net short very soon.

We haven’t talked about energy. Are you putting any positions in energy now that Trump is in office?

The shale market is sort of weak because the price of oil is too low for shale Baby drill. Baby drill is not going to happen with current oil prices. I think the oil market has been surprisingly soft in view of what was going on in the Middle East. And it tells me that the physical market is well supplied.

And my technical stuff suggests that we could have maybe the low to mid-60s on the downside and maybe 90 or so on the upside when there is some geopolitical event or so which we cannot exclude because the Middle east is not at peace. That chapter, you know, one chapter is closed. Syria, it’s a new chapter. But the war between Iran and Israel is still out in limbo and we do not know what that will trigger.

So I would say crude oil for 25, low 60s to the low 90s for West Texas Intermediate.

Finally Bitcoin reached 100,000 I wonder if this signals for the first time, by the way, I wonder if this signals a return of animal spirits. Do you look at that number where that trend, this big spike and say, well, risk appetite is back. There’s going to be a lot of momentum for risk assets. It’s not just bitcoin, but perhaps tech stocks or high beta equities.

Do you see that as a momentum play? Where do you think, okay, this is the top everyone’s getting in now?

I see it as a risk indicator or risk appetite indicator. I think it is. I cannot value bitcoins. I do not know what the proper value is.

With gold, you know, over a lengthy period, over a thousand years, it resembles an expensive suit about the price. And with bitcoin we do not, no, we have no clue. Is 100 too cheap or too expensive? Is 20,000 right, or whatever?

I think it is a asset that is a trading asset that is moving up and down depending on the liquidity cycle. And the liquidity also drives equity. So I think bitcoin moves more with equities than with gold. And if I’m right on liquidity in 25, then I think bitcoin will also have a big shakeout.

What I see at the present time, I use a lot of technical tools to get an understanding of where we could be in the cycle. And I see that the difference of two moving averages short and the longer one is such that we could have, we could be right now at the momentum peak. Momentum precedes price, which means we can go higher in bitcoin. And the Fibonacci numbers on the upside are anywhere between 115 and 130.

So we could see that early in the year, in the next few weeks. But after that I think there is a shakeout. And when I’m right, then the recent rally from 50,000 is a fifth wave in Elliott wave terms and it is the fifth of another five wave sequence. That means we then go into one of those major corrections that bitcoin has gone through and usually they go up between 50 and 80% down in price.

So I think when you go up to the 120, 115, 130 level, be prepared for a big shakeout in bitcoin.

This is what Jerome Powell said about bitcoin. Just take a listen.

Dollar war in the Federal Reserve itself.

In terms of the system. What do you think of that idea?

I don’t think that’s how people think about it. I mean, it’s, it’s so, you know, people use Bitcoin as a speculative asset, right. It’s like gold. It’s just like gold, only it’s virtual, it’s digital.

People are not using it as a form of payment or as a store of value. It’s highly volatile. It’s not a competitor for the dollar. It’s really a competitor for gold.

You know, it’s. That’s really how I think of it.

Competitor for gold. Do you agree?

Yes, to some degree, yes. It is an asset that is limited in supply, like gold. Gold. It is an asset that people have trust in because it is limited in supply, unlike fiat currencies.

But it is much more speculative, much more volatile than gold. We do not know what happens with bitcoin in the future. We have an experience over a thousand years or more with gold. So I have.

I have more trust in gold, even if it doesn’t swing as nicely as bitcoin on the way up. When we get bullish. I’m probably too old to be bitcoin aficionado to speak.

Very good, Felix. I appreciate your insights. Where can we learn more from you?

You can reach me at the homepage felixzoulauf.com it’s one word.

Felixzulau.common it’s interesting how you said that gold over a thousand years has resembled something like a. Or at least the last hundred years has resembled a expensive suit. I’ve heard that before. It’s more than kept up with the inflation of the average everyday good.

I think the other way to look at it is if you’re spending more than $2,000 on a suit, it’s probably overvalued. But either way it’s good to know.

I’m not sure that Jay Powell suit cost only 200 or 300 bucks. I think that was more expensive.

Yeah. Yeah, absolutely. Well, thank you very much, Felix. We’ll put the links to your website down below, so make sure to follow Zulof consulting there and we’ll speak again soon next year.

Happy New Year to you.

Great. Thank you very much for having me. And Happy New Year to you. All the best.

Thank you.

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