Notes, Views, and the Occasional Provocation January / February 2009  

Many investors lament having failed to foresee the economic crash of 2008. But as the case of investment-guru Peter Schiff reveals, you can locate the right economic dock, but still miss the boat with your investment strategy.

We've updated our website at Please take a look. And please do forward this newsletter along to anyone who might be interested.

Warm regards,

Milo Benningfield

Right Forecast, Wrong Strategy
Investment guru Peter Schiff had near perfect economic foresight regarding the Crash of 2008. So why wasn't he able to profit from it with his investment strategy? more

From the BFA Blog
Several highlights from our blog at more

BFA Notes & Media Quotes
News at the firm and recent media quotes. more

Right Forecast, Wrong Strategy
Among the most tempting siren songs for otherwise disciplined long-term investors is the economic forecast. If you can predict what happens next in the economy, you can position your investments to reap the benefits. Or so it seems. The case of Peter Schiff, a.k.a. Dr. Doom, is instructive.

Author of Crash Proof: How to Profit From the Coming Economic Collapse in 2007, Mr. Schiff consistently and accurately called the Crash of 2008 two years before it happened. As he told anyone who would listen, the U.S. mortgage market was poised to crash and would bring down not only the housing sector, but the major financial companies and the entire U.S. economy.

Today Mr. Schiff is what Fortune calls a "cult hero and something of a minor celebrity."1 There is even a YouTube video that has been viewed more than a million times called "Peter Schiff Was Right."2 The video is smashing vindication for Mr. Schiff, who had to put up with outright ridicule by fellow financial pundits during 2006 and 2007 as he appeared on various news shows.

In one scene, two Fox News housing experts openly laugh at Mr. Schiff when he disputes their claim that housing would rise 10% in 2007. When he explains that housing prices were "completely unsustainable" and "bid up to artificial heights by . . . temporarily low adjustable rate mortgage payments, by a complete absence of any lending standards, and by speculative buying," one of them shouts, "So what?!"

On other CNBC and Fox News segments, panelists recommend purchasing a variety of now-defunct financial stocks – Washington Mutual, Bear Stearns, and others – and smirk when Mr. Schiff recommends avoiding U.S. stocks altogether. One after another, they call Mr. Schiff "off base," "flat out wrong," and wonder "where's he getting this stuff?" New York Times columnist Ben Stein argues Merrill Lynch (which no longer exists as an independent company) was "so cheap they should be putting the stock in cereal boxes and giving it away."

In the history of "I told you so's," it doesn’t get any better than this video. And if Mr. Schiff had stopped after making his forecast and taken a bow, he’d be eligible today for an honorary doctorate and perhaps Time Magazine's Person of the Year.

But he didn't.

Mr. Schiff is more than an author and economic prophet. He owns a broker-dealer Euro Pacific, whose clients open accounts to take advantage of his insights. And according to the Wall Street Journal, most of his clients

had one thing in common last year: heavy losses. A number of investors said their Euro Pacific portfolios lost 50% or more in 2008, worse than the 38% drop in the Standard & Poor's 500-stock index last year. People familiar with the firm say that hardly any securities recommended by Euro Pacific brokers gained ground in 2008.3

As one client put it, "His thesis of how things are going to collapse and crumble and fall apart isn't effectively executed in [my] account." Indeed, some Euro Pacific investors reportedly lost up to 70% of their accounts last year.4

So what happened? Here, at last, is someone who saw the economic tsunami coming and apparently even he couldn't profit from it.

It's a common pitfall: even a pinpoint-precise economic forecast won't tell you how the capital markets will respond. Yale Endowment's David Swensen observes, "success requires more than an accurate [macroeconomic] prediction. Problems remain in identifying the direction and magnitude of the macro insight's influence on market levels."5

As Mike Shedlock, who writes a respected financial blog, noted, Peter Schiff's investment thesis centered on several predictions, including:

  • U.S. equity markets will crash.
  • U.S. dollar will go to zero because of hyperinflation.
  • Foreign economies will "decouple" from the U.S. economy and thus be immune to a U.S. slowdown.
  • Thus, investors should buy foreign equities and commodities and hold them with no exit strategy.

Mr. Shedlock noted further:

Schiff was correct about point number 1 above. The U.S. equity markets crashed. That was a very good call. Unfortunately, his investment thesis centered on shorting the dollar in a hyperinflation bet, and buying foreign equities rather than shorting U.S. equities. Furthermore, Schiff made no allowances for being wrong and had no exit strategy whatsoever. What happened in 2008 was that foreign equities sold off much harder than U.S. equities, and a strengthening dollar compounded the situation. In other words, Schiff failed where it matters most: Peter Schiff did not protect his client's assets.6

A big part of Mr. Schiff's problem is that while the economy drives corporate profits and thus stock prices over the long term, in the short term they're not well correlated. Look at what happened with China: it was the strongest economy ever for the 10 years ending 2002. But during that time there was a negative ten-year return on Chinese stocks. It was only when the Chinese economy began slowing that China had a 300% return in its stock market.

One reason for this short-term disconnect between the economy and the markets is that investor perceptions vary even when they are staring at the same economic indicators. Thus, guessing which way the markets will move becomes an almost impossibly difficult game of estimating what other market participants will make of the same facts you see.

The economist John Maynard Keynes described this phenomenon in his famous beauty-contest metaphor. Imagine a fictional newspaper contest in which contestants are asked to choose the most beautiful woman's face from a set of six photographs. Pick the most popular face and you are eligible for a prize.

You might simply pick the face you find most beautiful and hope everyone else selects it as well. Or you might be more strategic and try to guess which face other people will decide is most beautiful. As Keynes noted, this process could extend some length:

[I]t is not the case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some who practice the fourth, fifth and higher degrees.7

To Peter Schiff and many other investors in the years leading up to 2008, it seemed obvious that mortgage lending was out of hand, consumers were overspending, and soon the whole U.S. economic house of cards was bound to come crashing down, especially when foreign investors in U.S. assets realized they might not be repaid.

To capitalize on the situation, Mr. Schiff advised his clients to invest in such companies as Canadian Oil Sands Trust, which focused on crude-oil projects in Canada, and the India Capital Growth Fund, which invested in companies that do business in India. He also advised clients to avoid U.S. stocks, hold foreign currencies, and invest in "gold, mining and infrastructure stocks from Canada to Australia."8

But as bad as things got for the U.S. last year, they were worse everywhere else. Other countries had their own housing booms and busts, their own shaky financial institutions, and their own inept monetary responses. In that context, the U.S. dollar represented safety and strengthened against every foreign currency except the yen, dealing a death blow to Mr. Schiff's investment strategy.

In response to recent criticism, Mr. Schiff acknowledges that his investment forecast "didn't materialize in 2008." But he says he is still right, just a little early, and his strategy will still pay off over time.9

Perhaps. But how long should an investor be willing to wait to see if Mr. Schiff is right? The investment math is working against his client accounts. It takes only a 33% portfolio gain to recover from a 25% loss. But it takes a 100% gain to recover from a 50% decline, and a 150% gain to recover from a 60% loss. This is why Warren Buffet says, "The first rule of investing is not to lose; the second rule is not to forget the first rule."

Even if Mr. Schiff's investment thesis does eventually pan out, long-term investors are left with another question: was his success the result of skill that can be repeated over the decades, or was it simply luck? For example, back in 1987, a little-known analyst Elaine Garzarelli became an overnight guru after predicting the October crash with uncanny precision. Just a few years later, however, she was fired from her position as a mutual-fund manager after her subsequent forecasts fell far off the mark and her investment returns were so poor.

As the clients of Mr. Schiff have experienced, the attempt to avoid one type of financial risk typically exposes us to another. A portfolio whose assets are designed to perform well during one phase of the business cycle may experience problems in the next. Moreover, the phases of the business cycle are irregular, making it even more difficult to predict how the markets will move and when. In fact, "[h]istory shows that the vast majority of the time, the stock market does next to nothing. Then, when no one expects it, the market delivers a giant gain or loss – and promptly lapses back into its usual stupor."10

This is why most successful long-term investors structure their portfolios broadly to perform reasonably well through a variety of economic conditions, rather than betting the farm on one or two scenarios. It's true that a globally diversified portfolio gives up the chance for a home run. But it also reduces the likelihood of a strikeout.

The next time someone presents a compelling economic case and a narrow investment bet to profit from it, congratulate them on their perspicacious insights. But think twice before committing any capital to their care.

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From the BFA Blog
We update our blog at almost weekly. You can access it from the link or by going directly to our website at You can also click on the links below to go directly to recommended posts.

Fund Managers in 2008: Falling Stars
2008 was the year the best fund managers should have shined. But when the market dropped out in the fourth quarter, the best-rated managers fell right along with it.

Stockbrokering: Who Said Retail Wasn't Profitable?
Banks and brokerage firms who need a federal subsidy just to survive are paying their stockbrokers large retention bonuses. How will the firms recoup all those payments?

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BFA Notes & Media Quotes
Website Revision
Our website has a new look, new content, and new functionality. For example, you can see the most recent blog posts from the home page, and we've highlighted newsletter articles and selected blog posts under a new "Worth A Look" section.

You can see all the changes here:

Recent Media Quotes
BusinessWeek Online, February 11, 2009
Milo was quoted in Ben Steverman's article, "A Changed World for Financial Advisers," which addresses how advisors are responding to the Crash of 2008. Milo notes that advisors who are suddenly looking to overhaul their investment strategies may have taken on too much risk from the beginning with client portfolios. "Less than half a year since the steepest market declines, it's not too soon to ask questions, but 'it seems awfully soon to be drawing any strong conclusions,' Benningfield says. 'What happened here is extraordinary but not unprecedented,' he adds. Within living memory, investors lived through the Great Depression, the stagflation of the 1970s, and the dot-com bust." Read the article.

That's it for now. Thank you for reading. Please look for our next newsletter in April.

Best Regards,

Milo Benningfield

1 "Peter Schiff: Oh, He Saw It Coming," Fortune, January 23, 2009.

2 "Peter Schiff Was Right," YouTube (2009):

3 "Right Forecast by Schiff, Wrong Plan?", Wall Street Journal, January 30, 2009.

4 "Peter Schiff Was Wrong," Mish's Global Economic Trend Analysis (blog).

5 Pioneering Portfolio Management, David F. Swensen (New York: The Free Press 2000): 180.

6 "Peter Schiff Was Wrong," Mish's Global Economic Trend Analysis (blog), January 25, 2009.

7 John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt and Brace, 1964): 1956.

8 "Right Forecast by Schiff, Wrong Plan?", Wall Street Journal.

9 "Our Investing Plan Is Right, if Slightly Ahead of the Times," Peter Schiff Letter Editor, Wall Street Journal, February 10, 2009.

10 "Why Market Forecasts Keep Missing the Mark," Wall Street Journal, January 24, 2009.

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