Peter Schiff - EuroPacific Capital

  1. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, December 7, 2017

    After supposedly chomping on the bit for years to pass meaningful tax reform, Republicans are now set to blow an historic opportunity. Whatever version of the Bill that emerges from the House and Senate Conference Committee (which will be signed by President Trump faster than he can down a Filet o’Fish), will be far less than the Republicans envisioned when they finally captured the White House and both Congressional Chambers in 2016. But from what I have seen of the particulars, the revisions to the tax code will offer a marginal, although temporary, win for low income individuals, a major slap for moderately successful wage earners and home owners, (especially in the high tax Blue States) and a huge victory for the extremely wealthy and certain categories of business owners. While it is certain that the plan will add to the growing deficit, its immediate economic and political impact is hard to predict.

    For generations, taxpayers and politicians alike lambasted our overly complex tax code for its myriad of economic distorting loopholes that seemed to produce nothing except employment for legions of accountants and tax lawyers adept at gaming the system. As a result, talk about tax reform has always included proposals to make the system simpler, fairer, and more transparent. But on that front, the Republican proposals fail miserably. Trump and Congress will hail this achievement as being a major victory for the American people. But the true winner will be the swamp that Trump promised to drain.

    Unlike Ronald Reagan, who passed tax reform in 1986 by striking a deal with Democrat House Speaker Tip O'Neill, Trump and Congressional Republicans faced no particular need to compromise. If Reagan had the benefits enjoyed by Trump, Ryan and McConnell, his tax cuts would have been paired with significant spending cuts and perhaps a balanced budget. But to get O’Neill (and his whopping 71 seat House majority) to go along, Reagan's ideals of fiscal prudence and smaller government had to be set aside. But Trump is no Reagan, and today’s Republican Party has about as much commitment to shrinking the size of government as did the Democrats in the 1980s.

    Taxes are the price we pay for government. If Republicans want to reduce the tax burden, they need to make government less expensive. Tax cuts without spending cuts is the Republican version of a free lunch. But if government spending is not paid for with tax revenue, alternate sources must be found that will ultimately prove more costly than the forgone tax revenue.

    Despite endless campaign rhetoric to the contrary, the Republican Party is no longer the party of limited government, fiscal responsibility, Federalism, the Constitution, sound money, or any of the principals that they typically espouse while stumping for office or raising money. Instead of reducing the size of government, thereby lightening the burden on taxpayers and limiting the economic drag caused by government, Republicans have chosen the easy course of tax cuts, replete with overly optimistic assumptions and gimmicks meant to disguise their true impact on future deficits. Adding insult to injury, they leave in place an even more complex tax code, replete with even more loopholes, that limits individual freedom and undermines economic growth.

    True reform would have eliminated the income tax completely, or at a minimum, replaced it with a flat tax. It would have abolished the corporate income tax, payroll taxes, and the estate and gift taxes, and replaced them with a tax system based on consumption rather than production. Such a system would encourage savings rather than debt accumulation, and would restore some semblance of sanity to a system increasingly dependent on borrowing. Real reform would have included entitlement reform, as well as across the board reductions in government spending. Entire agencies and departments would have been eliminated, making government smaller and less expensive. These are the types of changes that are needed to head off a possible looming debt crisis and put the country back on a path to achieve real economic growth, not the phony financial gains we have seen in the past generation.

    But instead, Republicans crafted a plan that would cut taxes for some while raising taxes for others. The political genius of the plan can be found in the elimination of state and local tax deductions that will raise taxes predominantly on higher wage earners in Democrat controlled states with high taxes. This move was a political freebie for Republicans, as it largely spares their constituents from tax hikes, but prevents Democrats from protecting theirs because to do so would require them to argue against raising taxes on the "wealthy." It may also trigger a fiscal crisis in largely Democrat states as high earners, who provide an outsize share of state tax revenue, consider pulling up stakes for lower tax jurisdictions.  But Republicans did not leave well enough alone. The taxes raised on rich Democrats will not nearly be enough to pay for the cuts they offer business owners, passive investors, and corporations. The balance will be "paid for" by borrowing. In addition, high tax states may be forced to scramble to adjust their tax policies in an attempt to forestall defections of the wealthy. To do so, they may shift taxes to businesses (for which state taxes will still be deductible from federal taxes). The businesses in turn, can pass these costs onto their employees in the form of lower wages and their customers in the form of higher prices.

    Republicans, of course, argue that the economic growth that will be generated by lowering the corporate tax rate from 35% to 20% will generate enough new tax revenue to offset what is lost. While that idea is sound in theory, nothing about our current situation would suggest that a growth surge is around the corner, with or without corporate tax cuts.

    We are already in the ninth year of a supposed economic expansion. Over the last century, these expansions (the time between recessions) have lasted, on average, about five and a quarter years. So, already our current “expansion” has lasted nearly twice the average. Also, this expansion has been extraordinarily weak, with growth averaging around 2% since 2009. This is far below the 3% to 4% rate seen in prior recoveries. (data from the National Bureau of Economic Research and Bureau of Labor Statistics) It is also clear that this tepid number has relied heavily on surging asset prices in stocks, real estate, and bonds. But all three of those markets could easily reverse course.

    The stock market has surged to all-time highs based on the expected likelihood that tax reform would be passed early in the Trump Administration. When this hope becomes reality, it may be that we will get a “buy the rumor, sell the fact” decline, especially if the final package is not all that investors hoped it would be. The real estate market may actually suffer under the new rules as high-end properties become more expensive to own and less attractive to buy given the limits on property tax and mortgage deductions. On the lower end of the market, the expansion of the standard deduction could mean far fewer will receive a tax benefit from buying modestly priced homes, thereby mitigating the advantages of buying over renting. (It is no accident that some of the biggest objections to the new proposals have come from real estate industry groups). And lastly, the bond market faces no shortage of headwinds. With the Fed threatening to sell much of its $4.5 Trillion holdings of Treasury and Mortgage bonds, the likelihood of falling bond prices and rising yields looms large. (In the past three months, 10-year Treasury yields have increased 30 basis points). Even the tax bill’s supporters acknowledge that it will increase the deficit significantly in the near term, thereby requiring the Treasury to sell more bonds to fill the gap. The extra supply could put downward pressure on bond prices and raise yields on the long end, creating losses in the bond market and raising borrowing costs for government, businesses and consumers.

    For these reasons, it is logical to assume that the current tax proposals will have a more modest economic impact than the Tax Cuts of 1986 or even the Bush tax cuts of 2001. It is important to note that the Bush tax cuts occurred while the economy was already in recession, a time where economists could at least plausibly argue that fiscal stimulus was needed. But by putting these cuts through now, while the economy is still expanding (at least on paper), by the time the next recession arrives, the fiscal bullets will have already been fired.

    Assuming that the hoped for economic growth does not materialize, the money borrowed now must eventually be repaid. Deficit spending means that today’s tax cuts merely sow the seeds for tomorrow’s tax hikes. But since taxpayers will not only be on the hook for the money borrowed, but the added interest associated with that debt, the future tax hikes could be larger than today’s cuts.

    Of course, instead of raising future taxes to repay the money borrowed to fund today’s cuts, a cooperative Federal Reserve could simply print the money needed to buy the additional Treasury debt. But this does not mean we get all this government for free. The cost will come in the form of higher consumer prices as a new round of monetary expansion could cause a continuing drop in the dollar. So Americans may end up with more after tax dollars in their paychecks, but the reduced value of those dollars means they will actually be able to afford to buy less stuff. Just because it appears consumers dodged this bullet during the first three phases of Quantitative Easing does not mean that we will be as lucky with additional rounds.

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  2. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, October 19, 2017

    In light of the 30-year anniversary of the Black Monday Crash in 1987 (when the Dow lost more than 20% in "one day", we should be reminded that investor anxiety usually increases when markets get to extremes. If stock prices fall steeply, people fret about money lost, and if they move too high too fast, they worry about sudden reversals. As greed is supposed to be counterbalanced by fear, this relationship should not be surprising. But sometimes the formula breaks down and stocks become very expensive even while investors become increasingly complacent. History has shown that such periods of untethered optimism have often presaged major market corrections. Current data suggests that we are in such a period, and in the words of our current President, we may be "in the calm before the storm."

    Many market analysts consider the Cyclically Adjusted Price to Earnings (CAPE) ratio to be the best measure of stock valuation. Also known as the “Shiller Ratio” (after Yale professor Robert Shiller), the number is derived by dividing the current price of a stock by its average inflation-adjusted earnings over the last 10 years. Since 1990, the CAPE ratio of the S&P 500 has averaged 25.6. The ratio got particularly bubbly, 44.2, during the 1999 crescendo of the “earnings don’t matter” dotcom era of the late 1990’s. But after the tech crash of 2000, the ratio was cut in half, drifting down to 21.3 by March of 2003. For the next five years, the CAPE hung around historic averages before collapsing to 13.3 in the market crash of 2008-2009. Since then, the ratio has moved steadily upward, returning to the upper 20s by 2015. But in July of this year, the CAPE breached 30 for the first time since March 2002. It has been there ever since (which is high when compared to most developed markets around the world). (data from Irrational Exuberance, Princeton University Press 2000, 2005, 2015, updated Robert J. Shiller)

    But unlike earlier periods of stock market gains, the extraordinary run-up in CAPE over the past eight years has not been built on top of strong economic growth. The gains of 1996-1999 came when quarterly GDP growth averaged 4.6%, and the gains of 2003-2007 came when quarterly GDP averaged 2.96%. In contrast Between 2010 and 2017, GDP growth had averaged only 2.1% (data from Bureau of Economic Analysis). It is clear to some that the Fed has substituted itself for growth as the primary driver for stocks.

    Investors typically measure market anxiety by looking at the VIX index, also known as “the fear index”. This data point, calculated by the Chicago Board Options Exchange, looks at the amount of put vs. call contracts to determine sentiment about how much the markets may fluctuate over the coming 30 days. A number greater than 30 indicates high anxiety while a number less than 20 suggests that investors see little reason to lose sleep.

    Since 1990, the VIX has averaged 19.5 and has generally tended to move up and down with CAPE valuations. Spikes to the upside also tended to occur during periods of economic uncertainty like recessions. (The economic crisis of 2008 sent the VIX into orbit, hitting an all-time high of 59.9 in October 2008.) However, the Federal Reserve’s Quantitative Easing bond-buying program, which came online in March of 2009, may have short-circuited this fundamental relationship.

    Before the crisis, there was still a strong belief that stock investing entailed real risk. The period of stock stagnation of the 1970s and 1980s was still well remembered, as were the crashes of 1987, 2000, and 2008. But the existence of the Greenspan/Bernanke/Yellen “Put” (the idea that the Fed would back stop market losses), came to ease many of the anxieties on Wall Street. Over the past few years, the Fed has consistently demonstrated that it is willing to use its new tool kit in extraordinary ways.

    While many economists had expected the Fed to roll back its QE purchases as soon as the immediate economic crisis had passed, the program steamed at full speed through 2015, long past the point where the economy had apparently recovered. Time and again, the Fed cited fragile financial conditions as the reason it persisted, even while unemployment dropped and the stock market soared.

    The Fed further showcased its maternal instinct in early 2016 when a surprise 8% drop in stocks in the first two weeks of January (the worst ever start of a calendar year on Wall Street) led it to abandon its carefully laid groundwork for multiple rate hikes in 2016. As investors seem to have interpreted this as the Fed leaving the safety net firmly in place, the VIX has dropped steadily from that time. In September of this year, the VIX fell below 10.

    Untethered optimism can be seen most clearly by looking at the relationship between the VIX and the CAPE ratio. Over the past 27 years, this figure has averaged 1.43. But just this month, the ratio approached 3 for the first time on record, increasing 100% in just a year and a half. This means that the gap between how expensive stocks have become and how little this increase concerns investors has never been wider. But history has shown that bad things can happen after periods in which fear takes a back seat.

    Past performance is not indicative of future results. Created by Euro Pacific Capital from data culled from econ.yale.edu & Bloomberg.

    On September 1 of 2000, the S&P 500 hit 1520, very close to its (up to then) all-time peak. The 167% increase in prices over the prior five years should have raised alarm bells. It didn't. At that point, the VIX/CAPE ratio hit 1.97…a high number. In the two years after September 2000, the S&P 500 retreated 46%. Ouch.

    Unfortunately, the lesson wasn’t well learned. The next time the VIX/CAPE hit a high watermark was in January 2007 when it reached 2.39. At that point, the S&P 500 had hit 1438 a 71% increase from February of 2003. As they had seven years earlier, the investing public was not overly concerned. In just over two years after the VIX/CAPE had peaked the S&P 500 declined 43%. Double Ouch.

    For much of the next decade investors seemed to have been twice bitten and once shy. The VIX/CAPE stayed below 2 for most of that time. But after the election of 2016, the caution waned and the ratio breached 2. In the past few months, the metric has risen to record territory, hitting 2.57 in June, and 2.93 in October. These levels suggest that a record low percentage of investors are concerned by valuations that are as high as they have ever been outside of the four-year “dotcom” period.

    Investors may be trying to convince themselves that the outcome will be different this time around. But the only thing that is likely to be different is the Fed's ability to limit the damage. In 2000-2002, the Fed was able to cut interest rates 500 basis points (from 6% to 1%) in order to counter the effects of the imploding tech stock bubble. Seven years later, it cut rates 500 basis points (from 5% to 0) in response to the deflating housing bubble. Stocks still fell anyway, but they probably would have fallen further if the Fed hadn't been able to deliver these massive stimuli. In hindsight, investors would have been wise to move some funds out of U.S. stocks when the CAPE/VIX ratio moved into record territory. While stocks fell following those peaks, gold rose nicely.

    Past performance is not indicative of future results. Created by Euro Pacific Capital from data culled from Bloomberg.

    Past performance is not indicative of future results. Created by Euro Pacific Capital from data culled from Bloomberg.

    But interest rates are now at just 1.25%. If the stock market were again to drop in such a manner, the Fed has far less fire power to bring to bear. It could cut rates to zero and then re-launch another round of QE bond buying to flood the financial sector with liquidity. But that may not be nearly as effective as it was in 2008. Given that the big problem at that point was bad mortgage debt, the QE program’s purchase of mortgage bonds was a fairly effective solution (although we believe a misguided one). But propping up overvalued stocks, many of which have nothing to do with the financial sector, is a far more difficult challenge. The Fed may have to buy stocks on the open market, a tactic that has been used by the Bank of Japan.

    It should be clear to anyone that since the 1990s the Fed has inflated three stock market bubbles. As each of the prior two popped, the Fed inflated larger ones to mitigate the damage. The tendency to cushion the downside and to then provide enough extra liquidity to send stock prices back to new highs seems to have emboldened investors to downplay the risks and focus on the potential gains. This has been particularly true given that the Fed’s low interest rate policies have caused traditionally conservative bond investors to seek higher returns in stocks. Without the Fed’s safety net, many of these investors perhaps would not be willing to walk this high wire.

    But investors may be over-estimating the Fed's ability to blow up another bubble if the current one pops. Since this one is so large, the amount of stimulus required to inflate a larger one may produce the monetary equivalent of an overdose. It may be impossible to revive the markets without killing the dollar in the process. The currency crisis the Fed might unleash might prove more destructive to the economy than the repeat financial crisis it's hoping to avoid.

    We believe the writing is clearly on the wall and all investors need do is read it. It’s not written in Sanskrit or Hieroglyphics, but about as plainly as the gods of finance can make it. Should the current mother-of-all bubbles pop, for investors and the Fed it won’t be third time’s the charm, but three strikes and you’re out.

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  3. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, September 8, 2017
    Of all the absurd Washington pantomimes none has been as reliably entertaining and maddening as the annual debates to raise the debt ceiling. Although the outcome was always a foregone conclusion (the ceiling would be raised), the excitement came when fiscal conservatives bemoaned the perils of runaway debt and “attempted” to exact spending restrictions through threats “to shut down the government,” (which often led to news coverage of tourists being turned away from national parks.) On the other side of the aisle Democrats would rail that the ceiling must be raised “because America always pays her bills.” Lost was the irony that “paying” bills with borrowed money was fiscally responsible, and that raising the ceiling actually enabled America to continue to avoid paying its bills. After these amateur theatrics, the ceiling would be lifted and Washington would go on as if nothing happened. But at least the performance threw occasional light on the nation’s debt problems.
      
    But this week the news dropped that President Trump had made a “gentleman’s agreement” with Senate Minority Leader Chuck Schumer to permanently scrap the  “debt ceiling” so that government borrowing can occur perpetually without the need to air the nation’s fiscal dirty laundry. Given how much the national debt has exploded in recent decades, and how reluctant Congress has been to address the problem, it should be no surprise that the proposal has finally been made. The only shock is that it happening when the Republicans control the White House and both houses of Congress.

    The news came just a day after the President stunned the Republican party by abruptly siding with Congressional Democrats over the best way to deal with current debt ceiling negotiations. These developments should make it clear, as I described in the weeks after Trump moved into the White House, that budget deficits during the Trump administration will be far larger than just about anyone predicted. In fact, the self-proclaimed “King of Debt” is reaching for his crown and the coronation profoundly affect the fate of the U.S. dollar and the American economy.

    Trump came to the White House with essentially no history of stated aversion to government spending and debt accumulation. Instead, he won the votes of Republicans and some independents by staking out extreme positions on immigration, terrorism, and economic nationalism, and by thumbing his nose at a political establishment much deserving of ridicule. Unlike almost all other Republicans, he had nothing to say about fiscal prudence, limited government, entitlement reform, spending cuts, or balanced budgets. In fact, he very rarely criticized government for being too large, but simply for being too stupid.

    But as a businessman Trump had made his successes by borrowing, and then by borrowing even bigger when his ventures fell deeply into the red. There really should have been no doubt that he would bring those instincts with him into the Oval Office. Republicans who thought otherwise have no one but themselves to blame for what the future holds. 

    The debt ceiling came into existence just a few years after the Federal Reserve was created in 1913. At the time that the bank was established many politicians, and certainly many citizens, were concerned that it could potentially lend unlimited funds to the government, a capacity that could short-circuit constitutional checks and balances and lead to the development of a Federal behemoth. As a result, the Fed’s original charter prevented the bank from buying or owning obligations of the U.S. Treasury. This provision allayed the fears of unlimited borrowing and it helped Congress approve the Act.

    But just a few years later the United States entered the First World War. The massive expenses associated with quickly waging war on an unprecedented scale was too much for the government’s ability to tax or borrow directly from the public. Instead Congress changed the charter to allow the Fed to buy debt from the government. But to prevent this power from being absolute, Congress set limits. This “debt ceiling” has been with us ever since. But since it has been raised so many times in the past 100 years (every time the issue has come up), the intent of the law has been essentially neutered and now appears to be an archaic vestige with no real purpose; the fiscal equivalent of an appendix.  

    But in reality it is much more than that. For years Republicans have paid mountains of lip service to the need for a Balanced Budget Amendment as the only way to force government to live within its means. But the existence of the Debt Ceiling had given them that power all along. Like Dorothy in the Wizard of Oz, all conservatives had to do was click their heels together three times and not vote to raise the debt ceiling. And just like that our budgets would have had to be balanced. But Republicans just like to talk about balanced budgets. They never really wanted to actually balance them. 
     
    But even the possibility helped. One of the primary reasons that annual government deficits declined by two thirds between 2010 and 2015 (from $1.4 trillion to $450 billion) was because the Republican-controlled Congress was able to get the Obama administration to agree to the so-called “sequester” which capped the level of growth in a variety of Federal programs, including social programs and the military. Absent the leverage provided by the debt ceiling, sequester never would have seen the light of day. It is clear however that most of those negotiations were political in nature: Republicans beating on a Democrat president with any club they could find. But the end result was good for the country. Now that a “Republican” is on the other end of Pennsylvania Avenue, no clubs are being sought.   

    In fact, voting to raise the debt ceiling was always politically embarrassing for Republicans. To provide cover the measures were usually pared with some other politically popular legislation. In many cases some Republicans would be given the nod from leadership to vote no, as they could cast their votes against it knowing it would pass anyway. But eliminating the ceiling makes it that much easier for Republicans to campaign one way and govern another.

    But the potential failure to raise the debt ceiling has never been the problem. It’s the debt that’s the problem, and the ceiling is a tool to solve the problem that vote-seeking politicians are afraid to actually use. If we eliminate the only tool, the problem will never be fixed. If the debt ceiling were to be cut out like an unneeded appendix, we should expect that America’s foray into debt creation, which has already been fantastical, to journey even farther into the looking glass. America’s funded national debt is already just a few clicks below $20 Trillion. If we were able to amass that much debt with a ceiling, even one that could be raised, imagine how much more debt will be run up with no ceiling at all! 

    In the end we may be able to repeal our self-imposed debt ceiling, but our creditors may not care. When we drop even the pretense of a theoretic limit to our profligacy, our lenders may decide its time to impose a lending ceiling of their own. That is a ceiling we have no power to raise, and it could force our leaders to finally make some very unpopular choices. Massive cuts to government spending, including to current Social Security and Medicare benefits, huge middle class tax hikes, or an actual default on the national debt. Since neither of these alternatives is politically viable, I believe the coward’s way out will be a massive QE program where the Fed buys the bonds our creditors no longer want. This could be the worst possible choice for the U.S. economy, and investors should be prepared. It could produce a dollar and sovereign debt crisis that will dwarf the financial crisis of 2008 with respect to its impact on the American economy. It could make hurricane Irma look like a sun shower.
     
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    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

  4. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Friday, September 1, 2017
    The media has taken President Trump to task for all manner of false or exaggerated claims, but surprisingly little has been said about Trump’s most glaring forays into abject hypocrisy. Recently, on the Joe Rogan podcast, economist Peter Schiff outlined how Candidate Trump rightly questioned the reliability of unemployment data and stock market performance, but reversed himself completely on those fundamental views after the election.
     
     
    On the campaign trail, Trump consistently described the stock market gains of the Obama years (Dow up 147% in 8 years)* as an artificial bubble created by the Federal Reserve that would eventually pop as soon as interest rates rose. Similarly, he described Obama-era unemployment statistics (which showed joblessness in the 5% range) as “the biggest hoax in history” as the data did not reflect how Obama’s regulations had encouraged employers to replace full time workers with part time workers. Candidate Trump’s views on these issues resonated as truthful to voters and stood in contrast to happy talk from Democrats. The breadth of candor helped him carry the election.
     
    But as president, Trump has done an unabashed 180 on both of these points. He continuously credits the 10% gain in stocks since his inauguration as a sure sign of his success. He also claims that recent drops in the unemployment rate (which have brought the numbers into 4% territory – the lowest rates in 16 years) are the proof that his policies (whatever they may be) are creating confidence and success.
     
    The truth is that the current drift of stock prices and unemployment data is simply continuations of trends seen under Obama. No more, no less. Nothing material has been done on the monetary, fiscal or regulatory level that would have changed the course of these trends. Phony statistics then, are just as phony now. To get elected Trump claimed that the economy was a disaster. But now that he is President, he describes a nearly identical economy as a miracle of success. Of all the reversals Trump has made since taking office, these are perhaps the most brazen.
     
    www.macrotrends.net (100 year historical by president)
     
    Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday!
     


    To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy - How to Save Yourself and Your Country, click here.

    For in-depth analysis of this and other investment topics, subscribe to Peter Schiff's Global Investor newsletter. CLICK HERE for your free subscription.

  5. Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
    By: 
    Peter Schiff
    Thursday, July 20, 2017
    Typically, U.S. Presidents are wary of claiming stock market performance as a referendum on their success. Most have seemed to understand that taking credit also means accepting blame, and no one would want to make the tortured argument that the positive moves reflect well on their presidency but that the negative moves do not. But Donald Trump has shown no reluctance to make any argument that suits his political purpose of the day, no matter its absurdity, and no matter if he has to contradict the arguments he made last year, or last week. Perhaps he assumes, as most investors seem to, that the risks are minimal because the Federal Reserve will jump in to save the markets if things turn bad. But in binding his performance so closely to the markets he overlooks the possibility that the Fed will be far less charitable to him than it was to Obama.
     
    The Federal Reserve’s Quantitative Easing program, which lasted from the end of 2008 to October 2014, was specifically intended to push up asset prices by lowering long-term interest rates and reducing financial risk. This provides a good explanation why the stock market gained nearly 200% from the bottom in March 2009 to October 2014 despite the fact that the U.S. economy persistently performed below expectations during that time.
     
    Many people, myself included, argued that once the stimulus was removed stock prices would have to fall. Two and a half years later that has yet to occur. Although U.S. stocks are no longer rocketing upwards like they were during the QE era (the S&P 500 is up just 19% since the program wound down completely in November 2014), they have yet to experience any type of meaningful correction. Certainly market observers sense danger, but with the Federal Reserve cavalry always ready to ride to the rescue (as they did in January of 2016), markets have been free to drift upward.
     
    Right up until his election, Trump argued, correctly in my view, that statistics suggesting economic strength, such as the employment or GDP reports, were fake news designed to hide the truth of a faltering Obama economy. He similarly argued, also correctly in my view, that stock market gains were evidence of a “big, fat, ugly bubble” created by the Fed in order to bail out Obama’s bad economic policies. But the day after the election, all that changed. Now he claims that the very same statistics (which haven’t moved much over the past year) are proof of his success. Gone are the claims that employment and GDP reports are fakes. Similarly, he has fully embraced the 18% rally on Wall Street since right before his election as proof of his deft economic stewardship. The fact that he is placing his own neck clearly on the chopping block does not seem to deter him at all.
     
    The President’s gambit does present the Federal Reserve with a huge opportunity to exert political power. There can be little doubt that Trump does not enjoy tremendous support from the members of the Fed’s Open Market Committee, who are generally drawn from the center to the center-left of the economic spectrum. Most members, including Chairwoman Yellen herself, are products of the academic world, where wonkish devotion to theory and mild-mannered communications style are the ideals. Trump is the opposite of this profile, and may be the kind of leader who they are pre-programmed to dislike. The fact that Trump has openly vowed to replace Yellen next year likely adds to the bad blood.
     
    This was not the case with Obama for whom the Fed was much more inclined to give breathing room. In fact, even Ben Bernanke later admitted that his optimistic assessments of the U.S. economy, and his dismissal of the housing and mortgage risks leading up to the Crisis of 2008, resulted from his perception that he was speaking as a member of the Bush Administration (he was a Bush appointee), and should therefore not undercut the optimistic narrative put out by the White House. I seriously doubt Janet Yellen fancies herself a member of Team Trump.
     
    The Fed delivered its first rate hike of the current cycle (in fact its first rate hike in nine years) in December of 2015 when it raised rates from zero percent to 25 basis points. Although such a move had been expected for many years, most market observers had been assured that the economy would be on solid ground when it finally came. In fact, when the year began, many expected the first hike to occur in March, with several more hikes happening before year-end. Yet a data-dependent Fed held fire until December. After that first raise, the consensus on Wall Street was that Fed funds would be between one and two percent by the end of 2016. Those expectations were largely echoed in the Fed’s own communications. But when 2016 got underway, economic data began to soften and Wall Street suffered a panic attack, falling eight percent in the first two weeks of the year.
     
    I believe that the Fed, sensing that continued market declines could devastate Obama’s final year in office and make it harder for Hillary Clinton to ride his coattails into office, acted in mid-January and threw out its prior commitments to raise rates and made it clear that it would keep rates low for as long as it took to restore “financial stability.” In other words, it was not prepared to stand by and let markets fall. The shot of confidence reversed the losses, and stocks have been trending upward ever since.
     
    However, Clinton still lost the election. I believe this was primarily because Trump was right in his claims that the economic recovery touted by the Fed, the Obama Administration, and Wall Street, was primarily an illusion, and that the stock market rally was nothing more than a bubble that would inevitably pop.
     
    It is also significant to note that a “data-dependent” Fed used weak economic data as an excuse to delay its long-expected initial rate hike to December of 2015, and then another full year (and a presidential election) to raise them again. In fact, the Fed had consistently used weak current data as an excuse to delay hikes for nearly the entire eight years of Obama’s presidency. But the data is as weak now, or even weaker, than it was then. Despite this, the Fed has already raised rates three times since Trump was elected. Perhaps it has removed the kid gloves?
     
    There could be no easier way to undermine the entire Trump presidency than an official bear market to erupt on Wall Street. In that sense, as I have said in a prior commentary, Janet Yellen presents a much greater threat to Trump than does Robert Mueller or Chuck Schumer. Yet despite these warning signs, investors have not yet shown much concern. They still seem to believe that if anything goes wrong, the Fed will provide the bail out. But that is not a risk Wall Street should be eager to test. My guess is that the “Yellen Put” is still in effect, but the strike price may be much lower than most investors believe, meaning more substantial losses could be required before the Fed acts.
     
    One indication that the markets may be coming to grips with the heightened risk is the way in which new technology IPOs have been treated. These can often be used as a barometer of investor sentiment. Lately the news hasn't been good. Two weeks ago, the highly anticipated IPO of Blue Apron, an online service that delivers pre-packaged baskets of uncooked food so that consumers can prepare gourmet recipes at home, fell flat on its face. In order to debut successfully, Blue Apron’s bankers slashed their initial valuation by 1/3. Despite that, the stock opened flat on its opening day. From then, it’s almost been straight down, with the stock falling almost 35% below its IPO price.
     
    It should have been clear that the company was a bust from the start. Its losses have been staggering, and just about any rival can replicate its services with minimal expenditure. But in good times new technology IPOs have gone up no matter the fundamentals. Yet one week following its $10 per share IPO, a Wall Street analyst slapped a $2 price target on it, which values the entire company at approximately $380 million, just $80 million more than was raised by selling just 15% of the Company to stock investors. Ouch.
     
    Also, shares of SNAP, another high profile tech IPO, have recently come under pressure. The stock went public back in March at $17, quickly surging to a high of $29.44. Yet in recent days the shares have traded below $15 per share, 12% below its IPO price, and half the high price enthusiastic investors paid just a few months ago.
     
    Aside from these IPO flameouts, there is gathering evidence that corporate earnings assumptions will be downgraded. A key factor in the post-election stock market rally was that corporate earnings would benefit from Trump’s anticipated pro-business tax and regulatory reforms. His failure to deliver on these fronts (as well as the failure to repeal Obamacare) have helped lead to a complete reversal of the U.S. dollar rally that began right after the election (the Dollar Index has since fallen 9% since its January high). How soon before stock market investors connect the same dots? With the Fed not only threatening more rate hikes, but also making noises that it will draw down its balance sheet, which would result in "quantitative tightening,” U.S. stock market investors should not be getting too comfortable.
     
    Instead, the falling dollar and the more positive economic results coming from non-U.S. economies might suggest that a move into long-beaten down foreign markets may be opportune. It should not be overlooked that thus far this year the Vanguard FTSE all World ex-US ETF (which measures the cumulative results of all markets outside the U.S.) is beating the S&P 500 by almost 60%.
     
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