Friday, April 10, 2009

Peter Schiff: The Little Book of Bull Moves in Bear Markets


Peter Schiff, the well known market pundit and "perma-bear", released his second book, The Little Book of Bull Moves in Bear Markets, in October. At first glance this seems like brilliant timing. Markets worldwide have been in free fall since the release of his book and what all investors are looking for is a way to make some positive returns in this massive bear market. As it turns out, this book contains a lot of advice that would have failed to protect investors from recent market turmoil.

Let me state this up front: I neither hate Peter Schiff nor dislike him. I am familiar with his investment theories through his writings and numerous media appearances. I happen to agree with many of his views and he has proven to be correct in many of his prognostications. With that being said, he has not been right about everything.

Now that I have that out of the way, let me state outright that The Little Book of Bull Moves in Bear Markets is a bad book. It is not necessarily that I disagree with the arguments that Schiff makes, it is that I disagree with the way Schiff makes his arguments. This book contains some dangerous investment advice and is borderline disingenuous at times. On top of that, the book is surprisingly short on details and reads more like a sales brochure than a serious investment book. Let us tackle a few of my issues with this book:

Inflation

On pages 28-29, Schiff raises issues with the way the Consumer Price Index (CPI) is measured:

For Example, the inflated price of residential housing was never reflected in the CPI because instead of using home sales figures, the Department of Labor substitutes a figure they call "owner equivalent rent." With all the shenanigans used to turn renters into buyers during the recent bubble, the rental market went into a slump for lack of takers. Since owner equivalent rent was used to represent residential real estate prices in the CPI, the index significantly understated the rate at which real estate prices were actually rising.

Schiff mentions several times in the book that the real inflation rate is closer to 8-10% instead of the 2-5% typically measured by the CPI. What he is arguing is that we should measure housing prices as part of the inflation rate. Great - the only problem is that, using his own arguments, now that housing prices are crashing that also means that the "true" inflation rate has crashed as well. If we use the Case-Shiller Composite-20 housing index, which is generally considered the most accurate metric, housing prices are off 29.1% from the peak in Summer 2006. If housing prices represented 40% of the CPI, as they once did, the CPI would be deeply negative right now. Has Schiff since changed his stance and argued that deflation is occurring? Nope. Watch any of his media appearances readily available on YouTube - he hasn't budged one bit.

Decoupling

Decoupling is briefly defined as the idea that the US economy could fall apart but the rest of the world would manage solid economic growth - in other words the US would decouple from the rest of the world. On page 134 Schiff asserts:

Were the entire global economy to go down the tubes, there would be little point in investing anywhere. But that's not going to happen, which again brings me to the issue of decoupling.

I would argue that this is precisely what is happening right now - the entire world economy has already entered a synchronized recession that is rapidly turning into a depression. I won't rail on Schiff for incorrectly predicting this event, as most experts did as well, but at least most of those experts have the excuse that they did not see the US entering such a tough economic period. Schiff predicted that the US economy would fall apart, yet still held on to the notion that the world economy would be smooth sailing. How intelligent is that? This notion of decoupling has proven itself to be completely wrong as this crisis has unfolded. More on decoupling on page 212:

In the 1930s, the Great Depression affected not only the United States but nearly every nation on earth, so hard times here were matches by hard times elsewhere. This time it will be different. Even the most uninformed U.S. citizens will be forced to notice that other nations' living standards are on the rise, just as ours is on the decline

With the US GDP making up just over 25% of the world's GDP, what are the chances that a serious economic crisis in the United States would not drastically affect the rest of the world? As long as international markets are highly intertwined and the US makes up a large percentage of the world's economy, the decoupling thesis makes no sense in theory and current events backs up this commonsensical view.

Falling more under the category of general inconsistency but still based on his decoupling theory, on page 161, Schiff begins to go through the countries that he rates highly for investment purposes. He notes that Australia exports 60% of its products to China and thus is immune to a US slowdown. On the very next page he recommends Canada despite that fact that 80% of its exports go to the US! You can't have it both ways.

The Dollar

Schiff's entire investment thesis rests on one single premise of which he is so absolutely certain - the dollar will crash. He uses this assumption to suggest investing in everything from gold, energy and foreign currencies. On page 133:

The one risk of foreign investing that exists regardless of the merits of the investment is currency exchange risk - the risk that when we convert income or sales proceeds from a foreign currency to the dollar, we will experience a loss because the dollar has become stronger. That, of course, will be the least of our worries looking ahead.

Now, to be fair, Schiff admits that counter-trend rallies are always a threat, but for the last year Schiff has been dead wrong about the dollar. When you rest your entire investing thesis on one central tenant, you are taking big risks no matter what minor diversification among specific investments you choose.

On page 160, Schiff notes the currency gains against the dollar that he predicted in the last year:

Here is a breakdown of the basket of currencies I invest in for the bulk of my clients and how each fared against the U.S. dollar in the 52-week period ended April 30, 2008: Australian Dollar +19.41% Norwegian Krone +18.70% Euro +18.35% Swiss Franc +15.07%...

Schiff goes on to mention other currencies as well. Here is a multi-year chart pricing the dollar against a basket of currencies. Note how the dollar has performed since April 30, 2008:


Here is a media appearance of Peter Schiff on Kudlow and Company on February 18, 2009. When Schiff is confronted with the fact that the dollar has since risen against almost all currencies in the past year, he responds by saying that his predictions are long term and that he looks years and years out. At the same time, in his book here he is patting himself on the back based on a 12 month move in currency rates. As I said before - you can't have it both ways:





Dangerous Advice

Later in the book, Schiff goes way too far with some wacky investment advice. On pages 219-220 Schiff recommends, under certain conditions, borrowing against the equity of your house to invest. "Since you're paying your loan in dollars, if you invest abroad and the dollar continues to fall, that difference will grow into quite a today sum that you can collect on a monthly or quarterly basis." What absolutely terrible advice. I don't think anyone should ever gamble with their home equity under any circumstances - period! Why take a chance, even a tiny chance, and risk losing you and your family's place to live? No investment adviser should ever suggest such rubbish.

Accurate Forecasts

To be fair to Mr. Schiff he doesn't have it all wrong. He accurately called the housing crash and has been bullish on gold for many years. Let's examine a few other areas where Schiff nailed it:

Chapter ten is titled "To Infinity and Beyond - Secure Employment for the Future." In it, Schiff notes that at the time of publication (Summer 2008) the unemployment rate was 5.5% and would climb much higher. Today it stands at 8.5% and shows no sign of abatement.

On page 230, Schiff says that the government "will keep spending, printing and borrowing from abroad to try to preserve a lifestyle that our country can no longer afford. This will only ensure that the crisis will be deeper and be more painful than it needs to be, requiring 10 or even 20 years before it is resolved." This is exactly what has been happening and I completely agree that we are now looking at a 10 to 20 year period of weak economic growth because of these governmental policies.

Conclusions

In the end, here is Schiff's problem. He recognizes all of the risks inherit in the dollar and the US economy but ignores all the issues present in foreign economies and their currencies. In this way, he is political. It is akin to a Republican supporter who recognizes the flawed arguments of Democrats while ignoring his own parties hypocrisies. The absolute last person you want to listen to for investment advice is someone who is biased in any way. You want to invest with someone who is able to change their mind when the facts change at a moment's notice. Schiff fails this test.

If you think Schiff is mostly right about the US economy and the dollar, here is some free investment advice. Stay out of the US stock market, stay out of US dollar denominated bonds (especially long term government debt), buy some gold just in case and take some long term positions in other commodities such as agriculture and energy. Any other advice Schiff mentions tends to be speculative and may end up in investment losses even if his central thesis proves correct.

4 comments:

Tyrone said...

Well balanced conclusions. I am, however, biased, in that those are the steps I've been taking to mitigate financial risk.

SoYouThinkYouCanInvest said...

Thanks Tyrone. I think it is important to hold those accountable for their predictions. As an example, I myself was bearish on the economy for many years and saw the housing collapse coming but never dreamed the crisis would spread so far and wide. I also did not envision that commodities would take the hit that they did. Since then I have begun to learn more about leverage and debt and so the events of the last year now make more sense.

Yakov said...

On decoupling... I think you are ignoring an aspect of Schiff's argument here.

In Crash Proof, he makes your point that there will be a negative impact for the world if the US economy crashes. But, his larger point is that their production-capable economies will recover more easily.

On the dollar...

I agree that Schiff is clearly sloppy in using the 12-month data to support his theory, and then claiming it's insufficient data when shown the graph on TV.

But -- whether you agree or not -- his overarching point on the inflation of the dollar seems to be nuanced with the admission that other countries are working very hard to support our dollar. I think his assertion would (probably?) be that when foreign willingness to prop up the dollar fades, the "inevitable" inflation will resume. An additional corollary would be that further effort to forestall this collapse only stores up more pain for everyone in the future.

I think you bring up some valid points about some sloppiness from one book to another or between interviews, etc. Yet, I think if you take his contributions as a whole, they are not trivially falsifiable.

Anonymous said...

"Schiff goes on to mention other currencies as well. Here is a multi-year chart pricing the dollar against a basket of currencies. Note how the dollar has performed since April 30, 2008:""

Yeah, the dollar is on a tear. Er, wait, that April 30 thing didn't really work out now did it?