Don't be Fooled by the Market

Peter Schiff, President and Chief Global Strategist

With the dollar rallying, foreign stocks swooning, and commodity prices plummeting, many have concluded that the trends that I have been championing over the past decade have reversed. However, as is often the case over the short term, market behavior can easily fool the majority of investors. I am convinced that this is just one of those occasions.

For most of this decade, while my investment recommendations were benefitting from the trends I had forecast, critics erroneously suggested that my dire view of the U.S. economy was costing my clients money. More recently, as the U.S. economy has begun to collapse like the house of cards that I always said it was, my investment thesis has not performed as I would have expected. The panic unleashed by the magnitude of America's troubles has caused global stock and currency markets to behave senselessly. For the moment, fundamentals are not driving valuations.

I must confess that when many of the bulls I had been debating for years finally adopted my investment strategy, I was a bit worried that the trades were getting crowed. In hindsight, one can argue that I should have been more concerned that the accelerated fall in the dollar and the rise in commodities in late 2007 and early 2008 had brought in so many short term speculators that reversals were likely. But the fundamentals for the dollar remained so horrendous to me that those concerns could never gain the upper hand.

But with so many dilettante investors (who had jumped belatedly onto the foreign stock and commodity bandwagon in 2006 and 2007) now flushed from the market, the stage is set for huge rallies in both sectors. Since many of these investors were chasing trends they never really understood, they have fled at the first sign of trouble. This is par for the course in bull markets, as corrections are designed to shake loose the weakest players. This particularly includes leveraged speculators, who typically over-extend themselves on the rallies.

Just as they dismissed my economic forecasts for years, my critics are now making the same mistakes with respect to my investment strategy. Their justifications are recycled. Most investment analysts can only see what is happening in the present. As a result, they draw long-term conclusions from short-run events.

However, it should be obvious by now that doing the right thing often means going against the crowd. As this massive recession gets underway it's important to recall just how many people allowed this elephant to sneak up on them. The delusion was shocking, and it still is. What are the chances that these visionaries finally have it right?

There were also those who joined me in warning of a pending economic collapse, but advised investors to remain in cash (usually defined as U.S. dollars). For years, while the dollar tanked and foreign markets soared, these individuals appeared wrong on the economy and wrong on investments. While at the moment they can now claim complete vindication, if they stay in dollars too long, their victory will be hollow. While U.S. Treasuries are set to win the gold, silver and bronze in the 2008 investment Olympics, I do not expect a repeat performance in 2009. This is just another example of short-term movements incorrectly being given long-term significance.

However, most who saw this disaster coming now foresee a deflationary spiral, where the world economy crumbles, commodity and consumer goods prices collapse, and the dollar reigns supreme. This group is just as wrong now as was the Goldilocks crowd with respect to the U.S. economy a few years ago.

Based on the recent poor performance of my investment recommendations, many claim that I had been blinded by arrogance. They said the same in years past about my views on internet stocks, housing, and the U.S. economy. The fact that my conviction has not been shaken by short-term market action or popular sentiment is not a sin of arrogance but of confidence. The difference is crucial. Arrogance is confidence without knowledge. But if you know the facts, and understand the dynamics, then knowledge justifies confidence.

Now, I certainly admit that with the benefit of hindsight, it would have been better to have sold our foreign stocks and sidestepped this correction. However, I do not accept that my failure to do so invalidates my strategy. While I certainly warned that both foreign stocks and commodity prices could correct as the severity of America's economic problems became more evident (and I clearly advised that investors hold some cash reserves and physical gold to profit from such a correction), the only thing I truly missed was the sharp bear market rally in the dollar. This has made the short-term correction in foreign stocks much more severe then I had anticipated.

My take was that U.S. government's response to the crises would be so inflationary and so detrimental to the long-term health of our economy, that it would overwhelm any temporary boost the dollar would get from deleveraging. Here my error was my overestimation of the market's ability to comprehend the long term inflationary effects of a massive expansion of money supply. The irony here is that while the government is acting even more irresponsibly than I had forecast, the dollar has managed to rally in the face of it!

However, the case for foreign stocks has never been better. Not only are valuations at historic lows, but given the recent fall in global interest rates, relative values are more compelling than ever. In the final analysis only time will tell if I am correct, and investors need to study the facts and draw their own conclusions on the best way to apply them. Both the good and the bad news is that I do not believe we will be waiting too much longer for the answer.