Marc Faber Report Card

Let's talk about interest rates. Marc, you've been uncharacteristically quiet. Aren't you feeling well?
Faber: I am well and happy because I talked about many of these issues a year ago and recommended shorting the brokers. Subprime is a symptom of a much wider problem: the huge credit bubble built over the past 25 years. It is just the appetizer to something bigger, which will lead to relative illiquidity in the world. I travel around the world regularly, and every place I've gone has had a boom. The U.S. already would be in recession if government statistics were correct. The rest of the world will see a meaningful slowdown because global financial connectivity is greater than ever before.
The Fed brought about the latest boom by cutting the federal-funds rate from 6.5% in January 2001 to 1%. It kept fed funds at 1% until June 2004, even though the recovery in the U.S. began in November 2001. In other words, almost three years into a recovery [then-Fed Chairman] Alan Greenspan still had the fed-funds rate at 1%. This led to huge liquidity in the system -- asset bubbles, debt growth and growth in the trade and current-account deficits. Now those deficits are shrinking. This is an unfriendly environment for economic growth, financial markets and even industrial commodities. But it is friendly for the U.S. dollar.
Faber: I took a taxi from Times Square to lower Manhattan this morning and paid $14. In Europe the ride would have cost me three times as much. Prices in the U.S. are relatively inexpensive, as Abby learned at breakfast in Paris. This reminds me of other economies in which prices became low and inflation picked up. The taxi driver will increase his price massively sooner or later. Let me stress that weak currencies don't produce inflation. Inflation in the system produces a weak currency.
Faber: U.S. exports have gone up a bit, especially because of price increases in agricultural commodities and some capital goods. But the number of inbound and arriving containers at U.S. ports is down year on year, as are rail-car loadings. The trucking index is down. These statistics point to a recession in the U.S.
Faber: Scott, your fiscal policy will be another disaster superimposed on a disastrous monetary policy.
Faber: The average citizen will be in a recession anyway, because inflation will be higher than the benefits he gets from the tax cuts you propose. I also see a stagflation scenario similar to the 1970s, with high volatility in financial markets. Corporate earnings get squeezed nicely, with S&P earnings falling
Faber: U.S. policy is misguided in targeting consumption, not investments.
Faber: Equity prices have increased in dollar terms, but in euros the S&P 500 is down about 45% from its peak in 2000 and the Nasdaq is down 60%. Measured in gold, the markets have done horribly and the economy has been in a recession for a long time. I'm not bullish about U.S. stocks, but everything is so bad on a global basis that they might do better on a relative basis. That doesn't mean they go up, but the U.S. market might go down less than China, India, Vietnam and some of the other markets that are in cuckoo land. These markets have gone up because people believe in decoupling. Economically we could see a decoupling, whereby the U.S. is in a recession and China still grows by 5% or 10%. The financial markets won't decouple. Unless, Mario, they reintroduce that uptick rule.
Five years ago I visited family offices and financial institutions that had practically no exposure to international stocks. Today the same people have 50% of their money in emerging markets. Valuations in these markets aren't compelling any more, except for real estate in emerging economies.
Marc, what do you think of gold?
Faber: There are times when stocks do fantastically well and there are times when commodities do well. On a relative basis, gold became unbelievably inexpensive in the years 1999 to 2001. Now, prices have gone up. We had a bubble in Japan in 1989. Then we had the Nasdaq bubble, and bubbles in countries like China, and in the credit markets. The last big bubble to burst will be gold.
Black: If gold rallies at least 15%, to $1,000 an ounce, wouldn't it be better to buy an exploration and production company that could rally more?
Faber: Not necessarily. You want to own gold because you think something will go wrong, leading to deflation or hyperinflation. Mines can be expropriated. Also, exploration companies are like biotechnology and nanotechnology companies. One in a hundred will succeed.
Faber: A company like this is likely to be bought by a major miner, because the majors, like big pharmaceutical companies, don't spend much on research. They would rather buy
Marc, man of the world and proprietor of Marc Faber Ltd. in Hong Kong, says all asset markets are oversold "in the very short term" and due to rebound strongly, although he doubts they'll go to new highs. Equity investors, he grouses, still are focused on buying the dips, not selling the bounces, and sentiment is negative not because they have liquidated their shares, but because they're sitting on large losses. Emerging markets, he adds, have "considerable downside risk," but recoveries of 10% to 15% are common in bear markets. Marc's picks this year are mostly pans -- of several currencies and emerging-market shares.
2008 Barron's Roundtable Members
Marc Faber, Managing director, Marc Faber Ltd., Hong Kong
Thanks, Abby. Marc, what have you got for us?
Faber: We aren't dealing purely with market forces today, but with an economy that is largely manipulated by central banks, which create excess liquidity by cutting interest rates dramatically and letting credit growth accelerate dramatically. I'd like to read a quote from a German newspaper published in 1923, when Germany was dealing with hyperinflation: 'There have been extraordinary rises in the quotations for all shares, the chief cause being the catastrophic change in the economic situation.' In other words, you could have a slump in the economy, yet share markets could go up simply because of excessive liquidity and interest rates being cut, theoretically, to zero.
Since 2002, all asset prices have risen substantially. Against this backdrop, I'll focus on pair trades -- assets that will perform better in the next three to six months relative to others. The U.S. is in a bear market, and earnings will disappoint here and worldwide. Cost pressures will diminish profit margins. The stock market doesn't have a bubble valuation, though the Standard & Poor's 500 is selling at a higher price-earnings multiple than is evident. Take out the energy sector and the S&P has a P/E of 20, not 15. If earnings decline -- partly because the energy sector won't have higher earnings this year than last, and also because the financial sector has diminishing earnings and the economy is in a recession -- then the S&P isn't cheap.
Cohen: If you were to sector-weight the S&P with the same sector weights as in Europe, the P/Es are identical.
Faber: I didn't say Europe is cheap. Stocks in the U.S. probably are cheaper than 10-year Treasuries. Cash has been a disastrous investment for the past 40 years because the purchasing power of money has diminished. I don't find any great values in the stock market now. If people want to buy stocks, stick to the recommendations I made last year. [You'll find them listed free of charge on Barron's Online, www.barrons.com, under the 2007 Roundtable Report Card.]
I still like gold, cotton and sugar. My new recommendation is to short the British pound against the yen. The pound, as Felix explained, is overvalued. It doesn't have a lot of upside potential compared to the dollar. It is probably less risky to short it against the yen than the dollar. [The pound has fallen 3.3% against the yen since Jan. 7. Faber remains short the pound.]
You can also short the euro against the yen. The euro is a relatively expensive currency and European economies aren't going to perform well. Europe also had a lot of excesses, and the ECB [European Central Bank] will cut rates dramatically. Central-bank monetary policies are leading to the competitive devaluation of currencies.
Zulauf: Which is good for gold.
Faber: I suppose so. Since 2001, emerging stock markets have significantly outperformed the U.S. It's not that I am bullish about the S&P 500 or the Dow Jones [industrial average], but they may go down less than emerging markets. If there's a strong rally in financial assets, it could be that the Dow outperforms emerging markets. I would short an emerging-market index via the ProShares Short MSCI Emerging Markets exchange-traded fund. You could also short the FXI, the iShares FTSE/Xinhua China 25, which mimics the 25 largest Chinese stocks listed in Hong Kong and China. And, there's an ETF, the ProShares UltraShort FTSE/Xinhua China 25, which appreciates twice as much when the Chinese market goes down.
In the long run, the U.S. dollar will go down, but because of the diminishing current-account deficit, it doesn't have huge downside risk now. Negative sentiment on the dollar reached an extreme recently, with many front-page articles noting its decline.
Sentiment on the dollar was very bearish a year ago, too. Sentiment in this case didn't count.
Faber: It has reached extremes. It also has depreciated considerably against the euro. Today, I would buy the dollar.
At the moment, there is a war: The private sector is cutting credit and the central banks are cutting interest rates because they are desperate to revitalize credit growth. In the long run, the central banks will win, but in the next six to 12 months, relative credit contraction isn't going to be good for any asset class. In a year's time, the S&P 500 will be lower than it is today.
Marc Faber's Picks 1/4/08
Investment Ticker Price Currency Pair Trades

Short the British pound/Buy the Yen £1=¥211.97

Short the Euro/Buy the Yen €1=¥160.09

Buy the U.S. Dollar /Sell the Euro €1=$1.47

Short Emerging Markets

Buy: ProShares Short MSCI Emerging Mkt.
EUM $75.40

Short: iShares FTSE/Xinhua China 25 Index
FXI 163.61

Buy: ProShares UltraSht FTSE/Xinhua China 25
FXP 82.51

Buy
iShares MSCI Japan Small Cap*
SCJ $49.94

Short
DryShips
DRYS 73.17

Future Investment Opportunities:
Cambodia
*Buy after a 10% correction.
Source: Bloomberg

My next recommendation is a shipping short. I turned bearish about home-building stocks in 2005, and felt the troubles in the housing market would hurt the subprime-lending industry and spread to other sectors of the economy -- in particular, consumption. Private consumption now accounts for more than 70% of U.S. GDP, which is why I'm negative about the U.S. economy. The problems here will also affect other economies. The Chinese stock market is closely correlated with the Baltic Dry Index, a shipping index. Tanker rates have plunged, but the Baltic Dry Index is still in the sky. If you can't short the index, short DryShips [DRYS]. The BDI has fallen 28% since Jan. 7. Faber suggests remaining short DryShips.
Any other ideas, Marc?
Faber: Two trades today are totally out of favor. One is betting on the dollar, and the other is buying Japanese shares. I go to seminars, and whereas 10, 15 years ago there were hundreds of people attending the Japanese sessions, today there are hundreds attending sessions on investing in Vietnam. Nobody goes to the Japanese sessions anymore. It's remarkable that people talk about equity valuations being low in the U.S. compared with bond yields, while valuations in Japan are very low compared to the Japanese bond yield. Buy the Japanese stock market on a correction of 10% or so.
What would you buy?
Faber: Give your money to a good money manager, or just buy the index. The small-cap index is interesting. You can buy the iShares MSCI Japan Small Cap Index, an ETF.
Faber: Many countries have opened up following the breakdowns of communism and socialism. China began opening in 1978, proceeding at different times and in different sectors. The same has occurred since the late '90s in India, and more recently, Vietnam. One country in Asia hasn't begun to attract a lot of attention, but has great potential. It is Cambodia. You can't play Cambodia now, but some Cambodia funds will be launched this year.
Eastern Europe has climbed the value scale. There isn't a big difference anymore between, say, Slovenia and Austria. Go further east, into Ukraine, and you'll find big opportunities in real estate, in particular agricultural land.
Basically, investors should avoid correlated assets such as the S&P 500 and the FTSE index, emerging markets, art prices and real estate in financial centers. I'm ultra-bearish about the financial sector, as it will contract for many years, not just one year. I wouldn't buy Citigroup [C] here, or Merrill Lynch [MER]. And as much as I like Abby, I wouldn't buy Goldman Sachs [GS]. I anticipate the day when half of Wall Street will be looking for jobs as drivers of tractors and combine machines.