FELIX ZULAUF: THE MARCH 2009 LOW WON’T HOLD

This weekend’s Barron’s Roundtable had an excellent update on several of our favorite market pundits.  Felix Zulauf is  a notable standout who has called the last few years with uncanny accuracy (see his full interview on King World News here). Zulauf is terribly bearish and believes the debt deflation environment is far from running its course.  He believes we are currently at a major turning point in the markets where investors are beginning to realize that government spending is not the solution to all our problems.  He says the fiscal austerity measures will only increase deflationary pressures and that the pain is inevitable and unavoidable:

“The world is at a major crossroads. Some countries are at the end of a dead-end street. Greece has hit the wall. Spain and Hungary probably will be next. The Greek debt crisis was the beginning of markets refusing to finance irresponsible public-sector indebtedness. It will travel from the periphery to the center in coming years. The common denominator in the housing crisis, the euro crisis and the banking crisis is that industrialized economies carry too much debt. These crises show that we have to rewrite our system. We have been living a fiction for the past 20 years in order to enjoy a greater standard of living. Hard times are ahead, and the steps that Europe has announced to contain its crisis are only the beginning. Governments must cut spending and promises, such as entitlement programs, and raise taxes. At best this means stagnation for some years, but it could be much worse. Deflationary pressures will increase.”

Zulauf says the markets have misinterpreted the government stimulus as a sustainable recovery.  At the beginning of the year he was bullish on the markets and said the S&P could run as high as 1,200.  But he said to sell any move higher.  He missed the peak by 19 points.  He currently believes the markets are beginning their next big down leg:

“The market is naïve in assuming the earnings models of the past 20 or 30 years can be extrapolated out to the next five years. The market will hit a lower low than it did in March 2009. What was missing last year was the complete desperation and turning away from equities as an asset class that marks the end of a secular bear market. That will come. European and U.S. policymakers believe China eventually will bail us out, but China is tightening. Its real-estate sector will get hit badly. All the leading indicators are topping around the world.”

Zulauf doesn’t think the market will fall in a straight line, however.  He says stocks are susceptible to a 20% decline from here, but that a panic low could be supported by more government intervention:

“Commodity prices are heading lower. The stock market probably will make its low for the year in late summer or fall. The upside is probably 5%, the downside 20%. If there is a big break in the fall and the Federal Reserve starts printing money again, stocks could rally. I would be willing to buy if the markets are oversold enough and my indicators turn bullish medium-term. That likely would mean stocks go up through year end, though they could rise more if the crisis triggers another major stimulus by the authorities. The market’s move would be temporary, however.”

Ultimately, however, Zulauf says we are going much lower.  He believes the S&P will fall to book value which is right around 500 – a more than 50% decline:

“Secular bear markets usually bottom slightly below book value. Book value on the S&P 500 is around $500, a far cry from last week’s $1,064. In the 1930s, the market was trading at half of book.”

His outlook for the endgame in Europe is equally dismal.  Zulauf has proven quite prescient here as well.  In the late 90’s he said the Euro was destined for failure and gave it 10 years to survive.  He says the currency is structurally flawed and will can no longer be trusted:

“People are losing faith in the central bank and currency. When the euro was introduced in 1999, I predicted that if the European Union stuck to the rules it established, it would be the shortest monetary union in history. I gave it 10 years. After about three years, they broke the rules, which stipulated government deficits couldn’t go above 3% of gross domestic product; no member country could help another financially amid a crisis, and the European Central Bank couldn’t buy the government bonds of any EU nation. Now they have broken them again. How can one trust the currency when the authorities keep breaking the rules?

Like myself, Zulauf believes the EU would be better off without the smaller, weaker nations.  He believes the problems will persist until some sort of major structural change is implemented.  The endgame here is a break up:

“It would be best if the weaker members left the EU. If they don’t leave, the devaluation of the euro will continue. Eventually it will have to decline to a level at which even the weakest member can compete in the world economy. At the end of the day, the EU will break up, because its other members are using Germany as the payer of last resort for their sins. German citizens will revolt and vote in a new government with a different attitude.”

Now there’s a bear case for you….Unfortunately, Zulauf hasn’t been wrong about much over the last few years.

Source: Barrons