From the May 2011 issue of Investment Advisor • Subscribe!

The Bear Truth

Bullish investors are seeing the markets through overly rose-colored glasses

As U.S. market averages have drifted higher over the last two years, despite any serious conviction that the U.S. economy is on a sustainable road to recovery, there can be no doubt that an overall sense of invincibility has settled in among investors. (Much of that confidence stems from the Federal Reserve’s now explicit commitment to backstop falling markets with unending monetary stimulus.) As a result, those like me who are perceived as “bearish” are characterized as money-losing mattress-stuffers who refuse to wake up and smell the coffee.

Not surprisingly then, in early April I was asked by CNBC to participate on a segment that they entitled “When will the bears throw in the towel?” But the truth is that “bears” like me, who have shunned U.S. stocks and bonds in favor of gold, commodities, foreign currencies and foreign equities, have typically done better over the past decade than the “bulls” who are leading the parade on Wall Street. Why should those who have outpointed their opponents in nearly every round consider “throwing in the towel?” It should be the bulls that finally cry uncle.

In the more than 20 years that I have been providing investment advice, I have never had a simpler roadmap to follow than the one currently being provided to me by Ben Bernanke and his colleagues at the Federal Reserve. By refusing to acknowledge a growing inflation problem, even as the evidence becomes inescapable, and openly committing itself to a policy of asset price support and quantitative easing, the Fed has made it an easy decision to abandon dollar-based assets. The urge is becoming infectious. Even Bill Gross, the largest private bond buyer in the world, recently announced that he has reduced his holdings of U.S. Treasuries to zero.

But unlike most economists, I do not believe that the Fed’s policy of quantitative easing, combined with the Federal government’s policy of deficit spending, will restore health to the U.S. economy. In fact, I feel the opposite is true. The Fed is preventing market forces from doing the hard work of rebuilding our economy from the ground up. I believe these policies will simply bankrupt our country, destroy business, and crash the currency. But I do not believe that a tanking U.S. dollar or a faltering American economy will pull the rest of the world into recession. As a result, despite my “bearish” reputation I have long recommended significant exposure to commodities, non-dollar equities and precious metals. This formula is very different from the traditionally conservative “bearish” prescription of CDs, Treasuries and muni bonds. In fact, those are the types of assets that I avoid at all costs.

The results over the past decade are striking. Since the year 2000, the S&P 500 is essentially flat. Factor in the significant inflation that has occurred since then, and it is easy to see how the average investor has lost purchasing power with U.S. stocks. Similarly, over the last decade rates on government bonds have been consistently below the level of inflation. In contrast, commodities, precious metals, most foreign stock indexes and foreign currencies are up considerably.

Given the debt pressure that will likely drag down the dollar for years to come, investment advisors should focus less on nominal investment returns and worry about purchasing power. I do not dispute that the price of U.S. stocks may continue to rise in the coming years. But everything priced in U.S. dollars will likely rise as well, oftentimes faster. If food, energy, education, health care and travel costs rise faster than stocks, what good is investing? Advisors can hope that clients will be satisfied with nominal returns. Some may be. But others may notice that they are getting poorer even while they get rich on paper.

Bears are known for worrying about risk, and in that sense I growl loudly. But I see more risk in the U.S. dollar than in just about any other asset class. I also see risk in a U.S. economy that has grown completely dependent on debt, and monetary and fiscal stimulus. Those risks are far more manageable abroad.

I believe therefore that the onus should fall on the bulls. Their investments in the S&P 500 have failed to keep pace and their belief in the sustainability of the current U.S. “recovery” defies logic. Perhaps they should finally stop fighting the tide and swim with it instead.

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