Felix Zulauf: Here Comes the Buying Climax

Regular readers know I’m a huge fan of Felix Zulauf‘s career as a macro investor as well as his ongoing commentary. I always look forward to his remarks in the Barron’s Roundtables and in his regular notes. 

Felix has been bearish for years now but opportunistic in some regards. He now believes that equities are advancing toward some sort of “buying climax” to end the rally, rather than a rolling over. Both end badly in his view absent a fundamental economic improvement, from what I can surmise.

The below comes from his larger May note…


Entering Euphoria in Equity Markets

The problem with currently rising equity markets is not rising prices but the lack of fundamental improvement. Stock prices are driven primarily by this lack of alternative investment opportunities and the growing belief that central banks’ money printing can and will generate attractive investment returns for equity investors for a long time despite the lack of supporting fundamentals in the real economy. That is a risky assumption, but as long as rising trends remain intact, nobody worries. In fact, the momentum of the leading equity market indices (Japan, the U.S., Germany and Switzerland to name some) is very powerful and has the potential to carry further, potentially even into a buying climax. Similarities to the gold price in spring 2011 come to mind. At that time, the conviction that gold could only go one way because inflation will eventually rise was as extreme as is now the case for equities.

Once equity markets discover the emperor has no clothes, they could face a quick and painful adjustment to bring markets in line again with fundamentals. For the gold market it was when investors realized there was no rise in CPI inflation or the assumption that systemic risks are declining. It is true that equities look attractive relative to fixed-income alternatives from a valuation point of view, when depressed fixed-income yields are compared to dividend yields or earnings yields (reciprocal of P/E ratios). Those comparisons are all fine as long as economies do not fall back into a recession and earnings stay at least stable. As investors are not expecting a recession, they still believe equities are by far the best place to be, and they act accordingly. That’s why we might see an end to this cycle with a bang (buying climax) and not a whimper (conventional broadening cycle top).

Currency manipulation is the game of the day for central banks, although they deny it. Several central banks have cut their rate recently, with Korea being the latest. Sweden will most likely be next. With central banks in the U.S. and Japan extremely expansive and the ECB most likely joining soon to “help the economy,” there is plenty of liquidity in the system to nourish a continuation of the stock market rally. Moreover, with the world economy sloppy and CPI-inflation rather soft, there is still more room for central banks around the world to further loosen monetary policy.

While global equity markets show some minor divergences here, they are not serious yet and are counterbalanced by important positive confirmations in the technical picture of the market. Usually we see the deterioration and non-confirmations with a lead of a few months before markets begin a bear cycle in earnest. Those signs are not yet present, today. But this is not a cycle that can be compared with previous ones, and therefore we have to monitor the health of the market very closely for any sign of trend deterioration to avoid a more serious and painful downside adjustment.



Global Connections (Itau BBA)


I should also mention that Ed Yardeni is out with a new post tonight, he sees the melt-up as having become more likely as well, noting some comments Bernanke made at a commencement speech this weekend, link below:

Bernanke’s Melt-Up (Dr Ed’s Blog)

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