Felix Zulauf: A New Multipolar World Order is Here

0:00Hi, on the 5th and 6th of June 2024, I'll be speaking at the largest AI event in Asia, Super AI in Singapore at the iconic Marina Bay Sands. Alongside brilliant minds like Edward Snowden, Benedict Devin and Balaji Srinivasan, I'll be on a stage exploring the extraordinary potential of AI and the profound change it represents, not just for financial markets, but also for the world as we know it. With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd and 9th of June. Visit superai.com to register and join me with 20 % off tickets using the code realvision.

0:44Use the link in the description and I'll see you there. It's going to be incredible. Hi, I'm Raoul Pal and welcome to my show, The Journeyman, where every week I take you on that journey into the very nexus of the worlds of macro, crypto, and the exponential age of technology. Now, as a macro investor, one of the most important things you can do, in fact, you must do, it's an imperative, is to hold alternative views in your head and assess probabilities. I see on Twitter people who are insecure in their views fighting with people who have alternative views. You shouldn't do that. Of course, you should be insecure with your views because you should listen to other people's views.

1:30And so you can adjust accordingly. And that's incredibly important to do. And you should do it from trusted sources, people who challenge your thought process. So for me, an old friend of mine, I really respect that I've followed since the early 90s, when he was on the Barron's Roundtable, and he was like amazing him and Jimmy Rogers and a whole thinker, independent thinker, and somebody I really, really respect. But he has a similar assessment of me of how broken the system is, but he sees different outcomes than I do. And I think that's really important because I need to attach probabilities to these outcomes.

2:18And so I want to dig in with Felix about where this could all be going. Where is my ideas wrong? My job is not to create a debate show. My job is to listen. The more we all listen, the better we'll be. The more we take notes and add them to our frameworks and to say, well, here's the opposing view. I attach this probability. In your trade ideas, you should be thinking like that. So your trade idea, you lay out your own ideas, but then you add in counter evidence and you kind of weight it and you keep going back to these things and saying, could this be right? Could this be wrong? The hard part is not to get overly confused because there's two diametrically opposed views.

3:10That's normal. You just have to learn what confidence do I have in my own view? If you don't have confidence, then you shouldn't be investing in that particular opportunity set or you wait for clarification. But obviously waiting for clarification can often be too late because then the opportunity is played out. Because it's usually when people don't see the opportunity when the opportunity really arises. Anyway, let's have a conversation with Felix Zuloff. Join me, Raoul Powell, as I go on a journey of discovery through the macro, crypto and exponential age landscapes. In The Journeyman, I talk to the smartest people in the world so we can all become smarter together.

3:54Felix, fabulous to see you back on Real Vision. My pleasure, Raoul. It's great to be back. Yeah, it's always great to talk to you. We've talked a lot over the years, and it's always a fascinating conversation, so I can't wait to dig in. We'll find out. We'll find out. So I always like to start, well, first just give people, I mean, a lot of people know who you are, but just to give people a bit of background, what you're doing, Zulaf Consulting, that kind of stuff as well. And then we'll dig into some really big picture views to start with. Like you, I used to be a money manager and had my own company and hedge funds.

4:30And I sold the business and I'm only managing my own capital. And I also publish for clients throughout the world on macro stuff from geopolitics down to interest rates, the business cycle, interest rates, currencies, stock market sectors and commodities, of course. And I publish about every two weeks and I hold several webinars during the year to keep my subscribers on track of what's going on. I tell you, you've got a huge fan in Arthur Hayes. I realize that he calls me daddy. That's right. Well, anyway. He's like your single best promoter, Felix. He's always out there talking about your work.

5:22Okay, okay. He's an expert on the crypto side, which I'm not. I'm not deep into that, but I know you are. Yeah, and Arthur's also, you know, he's a traditional finance guy as well. So he's a macro guy at heart, as we all are. So let's talk about your bigger picture views before we drill into where we are. Just to level set people's understanding how you see the world we're living in now, because there's a lot of complexity. And I think people really appreciate hearing. I have to start with the geopolitical setup because geopolitical world order has changed for many decades. actually since World War II, we had a unipolar world in the Western world, unipolar system that was very US-centric.

6:14And the US was a hegemon and the US could really move and shake the world the way they liked. And when the wolf came down and we globalized, it was a US-centric unipolar world order. And I think the Americans and the Europeans are the only ones who haven't caught it that it's over. That game is over. We are now in a disorder trying to look for a new multipolar world order because there are challenges coming up. China is challenging and rivaling the U.S. And there is a conflict of interests and it's about power and influence and rivalry. And I started to write about the coming wars in 2018 and people laughed at me.

7:10And here we are. And I think we will see more of the wars because the world policeman is considered weak. And when the US foreign minister is kept waiting in front of MBS in Saudi Arabia, the mover and shaker there, he tells you that the respect has gone down. And when Blinken travels to Turkey and he's not received by Erdogan, he's not received by the prime minister, not by the foreign minister, and eventually he's received by the deputy mayor of Istanbul, that tells you what's going on in the world. And I think the Americans are not aware of this, and the Europeans are also not aware of this.

8:02They just hide behind the big friend overseas, and that's what it is. This all means that everybody is trying to reposition itself in an upcoming new world order. And that new world order will be found by going through a lot of stressful moments. And it could be sorted out in diplomacy. But if it's not sorted out in diplomacy, then it's sorted out in wars. And I recently talked to Neil Ferguson, who now has a very similar view than I have on the world. And he was much more moderate a year ago. and he said when I asked him where are those diplomats he said there aren't any we don't have them so therefore the risk of war of continued war and intensifying war and conflict is very high you also have to understand that if that is the situation as I describe it then all the underlying conflicts that were underneath the surface so far, like in Azerbaijan and Armenia or in Guyana or in Serbia or what have you, will eventually come to the surface because they do not respect the former leader anymore and they feel they can act as they like.

9:36Yeah, because it feels like the policeman is not on his beat anymore. The policeman is gone. The big gorilla around the block is very weak. And therefore, it's a different world. It's a very volatile and unstable world in geopolitical terms. And geopolitics for the financial markets usually is not of great importance. When you have an event, it's for one day or two days or so, and then it is back to normal. But this time, I think it really begins to impact the longer term structural setup of the world economy. And that means the intensifying rivalry will lead to more sanctions, more protectionism, more nationalism and things like that.

10:20And that is going to make business much more difficult for multinational companies operating throughout the world. And I think the market is not discounting that yet. And when you look at it historically, the market only priced that in with a time lag. It is not a leading factor in structural shifts. It is a leading factor in cyclical shifts, but not in structural shifts. And I think investors should be aware of that because at some point of time that will get priced into the markets and will lead to higher inflation and lower valuation, higher interest rates and things like that. That's the world we operate in.

11:08And in that world, we have a business cycle and that business cycle has been highly distorted by the pandemic. And we are still trying to sort things out. and the market is now celebrating a more dovish Fed. I think the market doesn't understand yet that interest rates can decline and so can stock prices together with interest rates. So if we have a soft landing next year, then declining interest rates are very bullish for the markets. If we have a recession next year, then we have declining interest rates and declining stock prices at some point of time. And when you look at it historically, soft landings are very rare.

12:01And soft landing for next year is a major consensus. So when I look at what the global fund managers are saying and what the major consensus is and how money is positioned, it is very long bonds, very aggressive in declining interest rates and very bullish stocks and soft landing. That's the big picture and that's how the world is positioned. I think over the year end, you see from the late October lows, you see a medium term upleg. I think it's the third medium term upleg. And the normal bull cycle has three uplegs. Disbelief, belief, overbelief. And I think we are going or we are now in the getting the overbelief phase that will probably peak sometimes in the first quarter.

12:57I cannot say early or late first quarter. I'm leaning to late first quarter because the momentum is quite good. And your favorite neighborhood spot grows with Square. Indeed, my favorite neighborhood spot has quickly become Todd Snyder in Williamsburg. Williamsburg. Todd Snyder is one of my favorite menswear shops and has supplied me with all the clothes I have needed this quite hot summer. Every business has different goals, but Square is the business platform that supports them all, from opening a new location, selling something new, or just expanding their reach. Indeed, I've seen it with Todd Snyder.

13:37In Square also, you can get real-time insights so don't wait for end-of-day reports. Go to square.com forward slash go forward slash real vision to learn more about how your business can grow with Square. That's sq u a r e dot com slash g o slash r e a l v i s i o n. The liquidity situation over year-end is relatively generous. The Fed probably underestimated bank reserves, and they didn't want to run into a tightness problem over year-end. And therefore, like in Y2K in 2000, 99-2000, they are providing liquidity generously, and the decline in reverse repos is adding, etc. And this creates the ammunition of markets going higher.

14:36If we extrapolate the decline in reverse repos, which has been the major contributor to liquidity growth for financial markets, then the decline should be over by late first quarter, early second quarter. So I think coming to late first quarter or so, So the markets will peak, top out at new highs in most cases in Europe, as well as in the US, maybe also Japan, not in the emerging markets except for India and Brazil. And then I think we are in for surprisingly weak business numbers. I see the first, let's say, four months of the economy rather surprising on the upside and the rest of the year surprising on the downside.

15:30I think we will have two different periods. So usually when you have such a strong consensus of a soft landing, it's like when all the forecasts and experts agree something else is going to happen. And I think in the first part, we will see a stronger economy than expected. And in the second part, a weaker economy than is expected. And a weaker economy, you have now an underlying slowing, you know, a smooth trend is slowing. And that leads to lower inflation rates and the market takes it as very bullish. But with declining inflation rates and softer pricing, you also will get softer volume. And that will hurt earnings.

16:18Normally in a recession, earnings decline 25%. I wouldn't go that far. It could be less than that. It could be 10%. But if you take out, let's say, 10 % decline and the 16 times PE on the market, you come up with 3 ,500. And I think what is very unique about this market is the excessive concentration. We have several times in the history of the stock markets, we have had a large concentration in a few stocks. But the nifty 50 were 50 stocks. You know, the magnificent seven are seven stocks. And in the TMT craziness and bubble, there were probably about 50 to 70 stocks altogether. And most of them declined between 50 and 90 percent thereafter.

17:13And so did the nifty 50s. And I think, you know, the great Magnificent Seven are wonderful companies, but they are wonderful companies at half the valuation. There's nothing wrong with that. The problem people do not understand is that the market today does not relate so much to the underlying economy as it relates to liquidity. And when liquidity changes, which I do expect from late first quarter on, if not sooner, then I think what went up so much will go down as much. Because if you wanted to perform in line with the market, you had to own those stocks. When you look at the world index and today's markets as they work is the individual doesn't manage the money himself.

18:14He gives the money as a majority of individuals gives the money. He mandates a money manager and the money manager either indexes or he is a closet indexer. You know, that means that 80 percent of the money managed today is benchmark oriented, I would say. Now, if somewhere in the world somebody mandates someone and says, you know, index World Equity Fund, then almost two thirds of that money goes to the US. And out of that money, one third goes into seven stocks. So we have such an extreme concentration that once the market turns down and money managers have to sell because they have redemptions, they have to finance redemptions or they have to raise cash, there is no other way than to sell those stocks.

19:12And that could exaggerate the decline on the downside. That has nothing to do with the real economy, just with the technical setup of the market. I think investors should be aware of that. So I guess that from a high in the early part of the year, we will then have a nasty decline. I do not know when it ends, maybe in the third quarter or whatever. And we will have a year that is one of the few years in the history where we have an important new high and an important low. That is rare. It has only occurred more often in recent years. We had one in 22, we had one in 20, we had one in 18. Then you have to go further back to 87 and even further back to 62.

20:06And then I think 37 was another one. And this is very rare and And it speaks of high volatility and that we had it in recent years really alludes to what I said at the beginning of this decade, that this decade will be a roller coaster for the markets. And investors have to try to time the markets to some degree, the mini cycles, because if you can cut out 50 percent of the downside, you are a hero. you see uh and and that's what i'm trying that's what i'm trying to do for my subscribers a whole bunch of questions thank you for that how different is the magnificent seven i've been thinking through this as well to the fang stocks so we had a kind of very similar thing through that kind of 2012 to 2020 period where it was a very small group of companies that kind of attracted all of the capital.

21:06Does this feel similar to that? It is similar to that. But I think the weighting of the FAANG stocks was much less. We have a much higher weighting of the Magnificent Seven than we had in the FAANG stocks. Much higher today. I guess because Microsoft is in some really giant companies, I guess. Sure. And it's a great company. No question. Let's talk through the liquidity scenario, the liquidity change end of Q1 or wherever that happens. So let's assume that the Fed have drained the reverse repo. Now, ordinarily, if that stops, then they're still doing QT, so liquidity conditions tighten. Is there a chance, A, that they stop doing QT when that happens?

21:51And B, is there a chance the Treasury drains the general account all the way through election year to buy votes? You know, the general account is an option, of course. They have done it before. And they have done it when financing the government deficit became a problem. So they have withdrawn liquidity from that side. That could happen again. They are slightly below target right now. I think they are in the upper 600 billion and the target is about 750 billion. That's where they should be according to the formula they are using. The reverse repos is a different story. The reverse repos was really built up because money market funds had such a tremendous inflow of money because the banks did not have competitive deposit rates.

22:49And therefore, bank clients shifted money from bank deposits into the money markets to get a higher rate in the money market. And there were not enough treasury bills outstanding they could buy. And then they turned to the Fed. And what the Fed did is they created artificial treasury bills, which are reverse repos. And then when the Treasury had to fund the large deficit and they didn't do it at the long end because the long end was rising so dramatically and they feared to lock in at the wrong rate, they turned to bills. And they issued virtually primarily bills. They issued debt primarily at the short end.

23:45And that made more bills available to the money market funds. And the money market funds started to sell their repos. And that was the decline of the repos. It was not Fed induced. It was due to the money market funds. Now, the money market funds last month, I think, or the last few weeks for the first time had withdrawals, redemptions. And that is interesting because that could mean that the decline in reverse repos could be over already. And if it would be, it would stop the inflow of liquidity into the financial system. So we have to watch that very carefully. Now, what about the situation with rates?

24:32So we saw, you know, go back, what, I guess, October, August, September, October, we saw that when the Treasury were building the general account, and they had to finance the deficit, the bond market hated it. And so then suddenly that the Treasury slowed down, they started issuing bills and being really careful about it. And then the reverse repo started draining. they've got a massive amount of debt to roll and deficit to finance going forwards for the next 24 months how do they do this without forcing rates lower and using the balance sheet well they are they should actually do it now when the appetite for bonds is so high you know the bond trade but they can't afford to do it at five percent you know that's the issue We are down at four now, intense.

25:27And, you know, it won't get, I do not know, but I assume that the Fed is having the idea in mind that eventually they have to go to yield curve control and 5 % is about the upper limit. And therefore, I think they are more relaxed now at 4%. At 5%, they were very, very nervous about the whole situation. And that's why they also help with some maneuvering in the balance sheet and with the help of the Treasury also. Of course, there will be a number of new bond issuance coming. And in a recession, it's usually not the problem to finance. Structurally, the buyers are changing. The buyers of the bond markets, you know, the foreigners have been decimated.

26:18The BRICS countries will not buy new treasury bonds, a new U.S. dollar denominated debt, because they saw what happened with the Russian assets. And the dollar being used as a weapon against those who do not behave as the U.S. likes creates a lot of problems. And the Chinese and the Saudis and the Russians have started to work on the creation of a competitive system already that will eventually be launched, but they will not buy into treasury bonds. And that's why they are buying much more gold these days. You know, they are using gold and they may use, eventually may use other commodities as well for their reserves instead of treasury bonds.

27:06So that creates a problem for the U.S. And it really means that the old currency system as it worked is not the same anymore. It's different. At least half of the world will not participate in the dollar as they did in the past. And that will become a financing problem for the U.S., particularly when you see how structurally offside they are in fiscal policy. Of course, there are domestic institutions and of course, there could always be a legislation that certain domestic institutions, pension funds, insurance companies, banks, what have you, have to buy a higher percentage of treasuries than at the current level.

27:55than at the current level. So they can legislate their potential domestic buyers if they have to, and they will do it. I have no doubt that they will do it if necessary. Hey, everyone. We're going to take a quick pause and hear a word from our partners. We'll be right back. Hi. On the 5th and 6th of June, 2024, I'll be speaking at the largest AI event in Asia, Super AI in Singapore, at the iconic Marina Bay Sands. Alongside brilliant minds like Edward Snowden, Benedict Devon and Balaji Srinivasan, I'll be on a stage exploring the extraordinary potential of AI and the profound change it represents, not just for financial markets, but also for the world as we know it.

28:40With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd and 9th of June. Visit superai.com to register and join me with 20 % off tickets using the code realvision. Use the link in the description and I'll see you there. It's going to be incredible. And that's a form of yield curve control as well. I mean, Switzerland did this two decades ago. They kind of forced the pension system into Swiss government bonds. And what you do is you cap yields. Yes, but the capping of the yields was not due to that. The capping of the yields was due to the fact that in the old days, the Swiss franc was a very strong currency, and it could follow a hard currency policy, the guys at the Swiss National Bank, because the biggest trading partner, Germany, followed a hard currency policy.

29:41That is gone. And therefore, Switzerland cannot follow as hard a currency policy as they used to in the past. And therefore, the Swiss franc is also not the Swiss franc of the old days anymore. You know, it's a weaker currency. It's still a strong currency due to the external accounts with the chronic current account surplus, etc. But it is not the strong currency that it used to be in the 1970s. Let's talk about the course of rates over this cycle. So you've talked about the issue with liquidity, the issue with equity markets that could have end of Q1, Q2, Q3 maybe. What do rates do? Do rates continue to fall over the cycle because economic growth is slow?

30:31Or does this issuance create more spasms in the bond market? How are you thinking through rates? If all the tightening that has been going on over the last year and a half or so works similarly to the past, then we will have an economic problem, a recession. I don't think it will be a very deep recession, but it could be a mild and long-lasting recession. And because we do not have the excesses in inventories and in some of the financing segments as we had in previous cycles. So a mild recession. In a recession, whether it's mild or not, rates come down. So I expect rates to decline next year through next year.

31:21Usually in a recession, the central banks try to reliquify the system because the higher the leverage is in the system, and it is higher in every cycle than the previous one, you have to reliquify. you have to do more to reliquify the system. And therefore, the injection of liquidity that I expect will have very positive effects, sometimes from a lower level in 2024 through 2025 and maybe into 2026. And that will be a great run for equities. And it will be a great run for commodities. It will not be very good for the US dollar because when the world eases, the dollar goes down. When the world tightens, the dollar goes up in simple terms.

32:12And in that sense, I think we will have a very cyclical environment over the next few years and very attractive. Bond yields, that's the other thing. You know, bond yields could hit the low sometimes in the second half of this year. And the breakout point in the long term decline on a log scale chart in 10 year treasuries was three and a quarter. So I think we could go down to three, maybe even slightly below that 275. That would be the maximum I could see on the cycle. This will be a higher high than the previous low, which was a secular low at half a percent. And from there, we go up again together with commodities.

33:05If commodities rally the way I think they will. And, you know, three quarters of the world's commodities are controlled by the BRICs. And in the conflict-led world that I described at the beginning, they will use that at times as a weapon against the Western world. And that means that supply could become scarcer than many believe. It's not so much a demand push, it's much more a supply constraint. and then prices go up and the oil could easily go up to$200 in 26 or so. And if that happens, the CPI will not be at 3%, certainly not at 2%. It will go over 10%. And then we have a problem in the bond market because then treasury bonds will go much higher than they have been at 5%.

34:03Because what we learned in the 70s, it is the second upcycle where the bonds really get crucified. The first cycle, the market looks back and values against the past. In the next cycle, in the second cycle, it goes back to the previous cycle that was inflationary and says, oh, we need to have a higher real rate of return. And therefore, in theoretical terms, it could go to 8 % or 9 % or something like that if the CPI goes to 15%, let's say. Now, if that would happen, our system has a problem. Then our system will enter a deep crisis and it will probably be needed that we have a deep crisis, because otherwise you can never restructure government expenditures and income and the fiscal side of it.