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The Daily Reckoning | Tuesday, May 4, 2010 Double-digit returns in Great Depression markets, Trade less - succeed more...and other little-known investing secrets, Plus, Bill Bonner on the growing police state and the beginning of  five individual corrections... Learning to Say "No" The Most Important Word in an Investor's Vocabulary Eric Fry Reporting from Laguna Beach, California... Your California editor remembers an old man once telling him, "My biggest regrets in life were the things I did not do. I've almost never regretted any of the things I did do." Undoubtedly, lots of other folks would testify to the contrary. They would lament their choices more than their abstentions. Your editor, for his part, sympathizes with the old man's perspective...but not to the point of engaging wantonly in high-risk behavior like running with the bulls in Pamplona, base-jumping off the Eiffel Tower in Paris, hypnotizing cobras in Delhi or buying long-dated Treasury bonds in New York. Let the reader decide whether deeds of commission or omission contain the greater potential for regret. Your editor has already decided the matter for himself. He has resolved to think twice before saying "No." He has also resolved never to repeat the same mistakes... He should have asked Melanie Richards to "go steady" in the sixth grade (or in the seventh grade...or in the eighth grade), but he didn't do it. He chickened out. So if he ever again attends junior high with Melanie, he won't repeat THAT mistake. He has also resolved to listen patiently to every unfamiliar idea before rejecting it, rather than the other way around. Lastly, your editor has resolved to expand the breadth of his life experiences - like experimenting with pinot grigio in the place of chardonnay. After all, he does not want to end up as a bitter old man, full of regrets. But your editor's liberal, adventuresome attitude isn't for everyone. Embracing novelty involves risk. Taken to extreme, the consequences can be disastrous. We are reminded of that joke about the most common last words of an Australian: "Hold my beer and watch this!" (If you are Australian and are offended by this joke, please direct your indignation toward Joel, the Australian who shared this joke with us).  In most aspects of life, "yes" often contains more intrigue, delight and satisfaction than "no." But in the world of successful investing, the opposite principal pertains. If you look behind almost any successful investor and you will find many more "nos" than "yeses." John Laporte, the recently retired money manager of the New Horizons Fund, provides an interesting case study. Laporte surrendered the reins of his fund two months ago, after running it since 1987. If you had put $10,000 in his fund when he started and left it there, you'd have had $78,000 when he hung up his spurs. By comparison, the Russell 2000 - an index made up of small caps - returned $52,000. "Barely trading at all," was the key to Laporte's success, according to Wall Street Journal writer, Jason Zweig. Laporte held his stocks for an average of four years, whereas his peers would hang onto their stocks for only eight months on average. "In seeking the great growth companies of tomorrow," Zweig explains, "Mr. Laporte looks for creative leaders, a strong corporate culture and innovative ways of doing business. He hunts in service industries and in markets not controlled by a handful of giant firms. He also insists on strong cash flows, high returns on capital and low debt." Since companies that meet these exacting criteria are rare, Laporte found himself saying "no" to potential investments far more often than he would say "yes." "It often takes me years to get confident in the business strategy and the management team," Laporte said of his due diligence process. So what were Laporte's main regrets? The things he did do, rather than the things he didn't do. In other words, he should have been even less active than he was. He should have held his winning positions even longer than he did. For example, Laporte's New Horizons Fund held a venture capital investment in Starbucks. But he sold it after only two years because he was afraid that rising coffee prices would go up and hurt Starbucks' profit margins. He forfeited hundreds of millions of dollars of gains by selling too soon over a short-term worry. "I have long held the opinion that the greatest mistakes investors make are not in the stocks they buy and lose money on, but in the stocks they sold too soon," asserts Chris Mayer, editor of Capital & Crisis. "Academic research, too, supports the idea that investors ought to hold onto their stocks longer. I'll cite here the work of professors Terrance Odean and Brad Barber. They found that investors do not benefit from active trading. 'On average, the stocks they buy subsequently underperform those they sell,' Odean writes, 'and the most active traders underperform those who trade less.' "There is more to Laporte than just the patience of Job," Mayer continues. "He also invested in small-cap stocks in the early phase of their growth cycles. This practice requires a lot of patience as well, but it also requires a lot of digging into more obscure stocks. Again, this is another area where academic research supports Laporte's record and ideas. "Odean and Barber, for instance, also found that individual investors are more likely to buy attention-getting stocks - stocks in the news or stocks showing extreme short-term returns," says Mayer. "Not surprisingly, these buying patterns do not generate superior returns. The professors use the analogy of a great vacation spot with few tourists. A travel writer comes in and writes about it for a national glossy. And soon enough, lots of tourists follow and they wind up complaining about the crowds. Markets work the same way. Odds are if you are reading about it in the paper, it's too late." In the essentials of Laporte's investment strategy, he continued the impressive legacy of T. Rowe Price, himself. Simply stated, Laporte believed investors should invest selectively, invest early in a company's growth cycle, and then hang on for the ride. So did Thomas Rowe Price. The Daily Reckoning Presents The Investment Secrets of T. Rowe Price Chris Mayer Buy early and hang on. Such was the investment process of Thomas Rowe Price. Price is most famous for founding the investment firm that bears his name. But he was a very successful investor in his own right. He was an advocate of buying obscure or out-of-favor growth stocks. In general, Price bought growth stocks only when they were cheap. He knew price paid was the most important consideration. In fact, twice in his career, Price closed his fund because he thought the market was too expensive, based on his inability to find cheap growth stocks. Once he closed it from October 1967-June 1970. And the other time was from March 1972-September 1974. During both periods, the market slumped. Keep in mind that when he closed these funds, he could have been taking in more than $1 million a day in new money from investors wanting to get in the market. Few fund managers today would have the integrity to close their fund when so much money - the source of their fees - was coming in. But this integrity enabled Price to invest when stock prices were reasonable. Ironically, when Price reopened his fund near the market bottoms - when things were cheap - investor interest was minimal. So there you go. Some things never change. Price's idea was very simple on the surface. He thought the best way for an investor to make money in stocks was to buy growth - and then hang on for the long haul. He defined a growth stock this way: "Long- term earnings growth, reaching a new high level per share at the peak of each succeeding major business cycle and which gives indications of reaching new high earnings at the peak of future business cycles." Note, by Price's definition, you could own cyclical stocks, which many growth investors these days shun. Where Price turned Wall Street on its head was in what he thought was the least risky time to own such stocks. Price thought the best and least risky time to own a growth stock was during the early stages of growth. Most people think that larger, more mature companies are less risky than younger, faster-growing ones. Not so for Price, who looked at companies as following a life cycle, like people do. There was growth, maturity and, finally, degradation. Here is Price in his own words, from a 1939 pamphlet: "Insurance companies know that a greater risk is involved in insuring the life of a man 50 years old than a man 25, and that a much greater risk is involved in insuring a man of 75 than one of 50. They know, in other words, that risk increases as a man reaches maturity and starts to decline... "In very much the same way, common sense tells us that an investment in a business affords great gain possibilities and involves less risk of loss while the long-term, or secular, earnings trend is still growing than after it has reached maturity and starts to decline... The risk factor increases when maturity is reached and decadence begins..." Price went on to show that investing his way during the Great Depression would've produced a 67% gain, whereas the rest of the market lost money. In the 1930s, people focused on current dividends, and that meant they were reluctant to invest in a growth stock (which typically pays no dividend). Price thought that was a mistake. "High current income," he wrote, "is obtained at the sacrifice of future income..." He wasn't just talking. Price did very well by his own ideas. He is somewhat forgotten today, probably because he did not write a book that people can refer to now as a classic. But maybe it's time for some publisher to cobble together Price's work. (Hmm...) In his day, Price was a force of nature. He was known as "Mr. Price" to nearly everyone. He was passionate about investing and still came to the office at the age of 83, rising at 5 a.m. every day. If you want to read more about Price, I would recommend John Train's The Money Masters, which includes a chapter on Price, along with chapters on many other great investors. Chris Mayer,  for The Daily Reckoning Bill Bonner An Even Better Trade of the Decade,  Part II Bill Bonner Reckoning from Baltimore, Maryland... The lies that bind... News Flash: WASHINGTON (AP) - Consumer spending rose in March by the largest amount in five months but the gains were financed out of savings, which fell to the lowest level in 18 months. A slight rise in incomes added to concerns that the recovery could weaken unless income growth increases more rapidly. This is supposed to be a recovery. Everyone thinks it's a recovery. All the papers say so. Investors are betting on it. Politicians and economists are congratulating themselves for it.  The only trouble is, the things that need to recover so that there can be a genuine recovery are not recovering.  On the surface... Monster.com says the job situation is improving.  Case & Shiller say the housing market is improving. Yesterday's news also told us that Europe has agreed to bail out its problem child, Greece. The New York Times: ATHENS - Greece announced on Sunday that it had reached agreement on a long-delayed financial rescue package that would require years of painful belt-tightening, but the deal might not be enough to stop the spread of economic contagion to other European countries with mounting debts and troubled economies.  The bailout, which was worked out over weeks of negotiations with the International Monetary Fund and Greece's European partners, calls for 110 billion euros, or $146 billion, in loans over the next three years intended to avoid a debt default. And so, on the back of this good news, the Dow recovered what it had lost on Friday. Oil traded at $86. And gold edged up 2 bucks. Up, down, up, down - suddenly, the stock market seems nervous. Maybe it is beginning to realize that the recovery story is a lie...a fake- out...  We have a feeling that the present volatility is going to be resolved by a decisive move to the downside. So, we'll keep our 'Crash Alert' flag up the pole for a bit longer. Of course, we've been wrong about the timing before. And if we're wrong this time, don't bother to send us an email. Some of the world's most important fortunes have been preserved by selling too soon. We won't mind being a bit premature again.  "This recovery has nothing in common with typical post-war recoveries," we told our audience in Las Vegas on Saturday, "because the recession has nothing in common with the garden-variety recessions of the post- war period. This time it's different..." Which is to say, this time it's the same...it's coming back to normal...not getting more bizarre.  In the meantime, unemployment benefits have been extended three times. Now, they're going to expire with some 15 million people out of work. The first-time house-buyer credit has expired too. And the feds have already shot off their monetary and fiscal ammunition... They've already used more stimulus than any time government ever used.  And what did we get for it? After $8 trillion worth of banking and financial guarantees...plus deficits greater than any the country has seen since WWII... ..all we get is a small upturn in the key figures. They're still terrible. They're just not getting terribler...at least, not right now. What do you expect? The figures can't do down forever. They've got to turn up. But they look more consistent with a zombie economy and a long, drawn-out correction than with a real, robust recovery... But wait. The government keeps track of these things, doesn't it? And it reported on Friday that the US GDP grew at an annual rate of 3.2% during the first quarter. Well, well, well...guess that settles it. We are wrong again. Recession is over. Break out the champagne. That makes three quarters in a row with positive GDP growth. But hold on...  The GDP number is just another one of the lies that bind investors and consumers to bad ideas and keep them coming back to bad habits. More on that later in the week... And more thoughts... "This country is turning into a police state, and no one seems to notice," said a young voice over the weekend. "Mom and I were having dinner in Charlottesville. I thought I'd have a glass of wine with dinner. But the waitress asked to see my ID. It hadn't occurred to me that I needed to be 21 to have a glass of wine with dinner. I thought that was just for alcohol, like whiskey.  "Mom told the waitress that it was okay, because I was with her. But she said she couldn't serve me... "So Mom said, 'okay, just bring me a class of wine and I'll share it with him.' And the waitress said, 'you better not let me see you doing that.'  "The waitress had somehow turned into a police agent...trying to prevent a college student from having half a glass of wine with his mother..." More on the police state of things...tomorrow... Part II of our speech in Las Vegas, in which we explain why the US will go broke: What does it mean when the financial intelligentsia seems to have no idea what is going on? It means they've got the wrong idea about the way things work...and probably no incentive to have the right one. Goldman Sachs had 21 billion reasons to think it was a good idea to bail out AIG. The bankers who hold Greek debt have 146 billion reasons to like the bailout announced yesterday. And the US government has about 2 trillion reasons to believe the economy is growing. [As we explained yesterday], there were 8,000 billion numbers between Hank Paulson's estimate of how much taxpayers' money would be put at risk rescuing Wall Street and the actual fact. But Hank Paulson is by no means the only major authority or financial celebrity to be wrong. The folks running money for Harvard and Yale - the crème de la crème of financial managers - were spectacularly wrong too.  And so were the people running major banks. But today I will mention just one of them...someone who had already settled up when the financial crisis of '07-09 arrived. Walter Wriston was the Chairman of Citibank...the bank that eventually got taken over the federal government in the general panic of 2008...he remarked that: "Governments can't go broke." And here I'll do a little speculation - I bet that Citibank would NOT have had to seek government support if it had been run by a historian.  Financial history is full of government bankruptcies. The first modern nation to go broke was Spain - which did so 4 times in the 16th century.  The book by Ken Rogoff and Carmen Reinhardt has a nice list of these state bankruptcies. You'll see there are dozens of them. Some countries seem to be bankrupt all the time. Greece, for example. According to Rogoff and Reinhardt, Greece has been in default about every other year since it gained its independence in the 1820s. And I'll offer you a prediction, before this decade is over...or perhaps the next one...dozens of countries will go broke, including the United States of America. I don't mean they will close down and go out of business. But they will default on their debts - either by ceasing payment, by forced restructuring, or by intentional inflation. How do I know that? Well, I don't. It's just a guess. And it's a guess that comes from reading history...not from doing mathematics. Generally, as I told an audience in India, we seem to be at some major inflation point. I call this period the Great Correction, because it appears that there are several things that are in the process...or perhaps only the very beginning...of being corrected. 1. There is the 50+ year credit expansion - centered in the US...largely a product of the modern, numbers-oriented way of looking at economics 2. There is the bull market in stocks, begun in 1982...correction began in 2000 and still is not fully realized. That bull market too owed a lot to modern financial thinking 3. There is the 28-year-old bull market in bonds, which apparently came to an end in the fall of 2008...but has not yet been completed. Again, this was made possible and sustained by the financial ideas of the mid- 20th century 4. There is even a 400-year boom in Anglo-Saxon culture - backed by military and economic force - which may be beginning a correction too. And it wouldn't surprise you to know that these new, modern financial theories are almost entirely the product of Anglo-Saxon academics... All of these things are connected. The common thread is the 5th thing that needs to be corrected...and the thing I'm going to focus on here today. It's the rise of a body of thought concerning the way the world works - at least the world of money - which began in England and then was developed in the United States... ..on Friday, I called it "Fab Finance" after the Frenchman who got charged with fraud by the SEC. The idea is to put together slimy packages of debt and sell them to people who don't know what's in them. "Lumps for Chumps," you might call it. Poor Fabulous Fab got stuck in the hot seat, but he was only following the logical development of a whole body of thinking that dates back almost 100 years.... ..and which now seems to be leading the world to something much bigger and much more dangerous than just blowing up a few hedge funds and German banks... Now, practically all the world's countries are using Fab Finance. They're gradually absorbing all the world's financial risks and putting them on the public accounts...ultimately backed by the full faith and credit of the United States of America. This year, governments around the globe will issue $4.5 trillion in debt - three times the average over the last 5 years. About $2 trillion of that will be issued by the US.  What's more, there is NO EXIT from this debt build up. Only about 10% of these deficits is really caused by the financial downturn. Most of it is structural. That is, it is the result of programs that have been in place for years... These programs just grow and grow...year after year...until they become unsupportable. And most of these programs are sold as Fab Finance...they transfer small, individual risks onto the balance sheet of the whole country. In fact, if you had to sum up the entire effect of Fab Finance - the whole body of ideas and theories of modern, anglo-saxon economics in the 20th century - you could say that they took small problems and turned them into big ones. Instead of running the risk that a few people will retire without sufficient funds, we now face the risk that the whole country will run out of money. Instead of taking the risk that some people will not be able to afford health care, we now run the risk that the whole nation will be bankrupted by public health care costs. Instead of allowing a few badly managed financial institutions to go under, the feds have put the entire credit of the United States of America at risk. And in Europe, we see the same thing. Instead of allowing tiny little Greece to go bust, the Europeans are spreading the risks out all over the Eurozone.  I'm sure other speakers will talk about this, so I won't go into details. It's the most important economic event of our time. After a huge run up in debt in the private sector, now the public sector is having a go at it...and rolling it up into bigger and heavier balls. And what happens when the government spends too much and borrows too much? History tells us what happened in the past. Philosophy tells us what should happen. Governments go broke. Always have. Always will. But I'd like to share with you a headline from The Washington Post on Wednesday. The Post is the paper the politicians and bureaucrats read. So you can imagine how penetrating its insights are. Well, the headline that made me laugh was this: "Task force to tackle National Debt." Not many things are certain in this life. But I can guarantee you that the bipartisan task force will not get close enough to the National Debt to read the number on its jersey, let alone tackle it.  The Great Depression convinced economists that they needed to be more activist. Now, our economy is responding to economic activism. And it will be destroyed by these modern ideas...and then, and only then, will new ideas arise. We're going to see a correction...a regression to the mean of a number of things...including the way people think.  It is not normal to think you can spend your way out of debt. It's not normal to think you can consume capital and get richer. It's not normal to believe that central economic planning will make the world a better place. The Soviets proved that central planning doesn't work. We got to see that experiment. But instead of learning from it...we seem destined to repeat it. More tomorrow...  Regards, Bill Bonner,  for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com