by Dr. Mark Skousen, Advisory Panelist, Investment U
Friday, December 10, 2008: Issue #898
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” ~John Maynard Keynes, 1936
When it comes to the best strategy to use during a treacherous bear market, I turn to advice from my favorite guru. The British economist, John Maynard Keynes (1883-1946), made a ton of money during the Great Depression.
It was he who turned the world upside down in the late 1930s when he advocated that the government should counter the Depression by deliberately cutting interest rates, inflating the money supply, and run huge deficits. And during this year’s financial panic, Keynes (his name rhymes with “brains”) is back in vogue.
Today, both Republicans (George Bush) and Democrats (Barack Obama) are joining the Keynesian bandwagon in favor of bailouts, injecting liquidity in the markets, and cutting interest rates. Not surprisingly, this year the Nobel Prize in economics went to Paul Krugman, an outspoken “big government” Keynesian.
As a free-market economist, I am not a big fan of Keynesian prescriptions of inflation and progressive taxation as a cure for depression. I prefer tax cuts, privatization and a stable monetary policy.
While the Keynesian policies of reinflation and deficit spending may avert another Great Depression, it threatens to reignite price inflation and another dollar crisis down the road.
Making Money With John Maynard Keynes
But when it comes to making money, nobody can beat John Maynard Keynes. In 1927, he was appointed manager of the “Chest Fund” at King’s College in Cambridge. As the chart shows below, he was extremely successful as a money manager during a time of unprecedented deflation, depression, bear markets and world war. His fund was up an average annualized return of 9.1% compared to -1% of UK stocks.
Chest Fund Performance 1927 to 1946
John Maynard Keynes’s investment strategy is, in many respects, similar to Warren Buffett’s investment strategy. And even he is impressed. In his 1991 shareholder’s report, Buffett has acknowledged Keynes’s influence on him. Keynes was a man “whose brilliance as a practicing investor matched his brilliance in thought.”
John Maynard Keynes’s Contrarian Investment Strategy
How did John Maynard Keynes achieve such a remarkable success? Years later, he revealed his technique: “My central principle of investment is to go contrary to general opinion, on the ground that, if everyone is agreed about its merits, the investment is inevitably too dear and therefore unattractive.”
In 1933, at the depth of the Great Depression, Keynes took a contrarian position by acquiring the preferred shares of big-utility holding companies in the United States. “They are now hopelessly out of favor with American investors and deeply depressed below their real value,” he said.
He bought, amongst others, National Power & Light Preferred, which he noted yielded 15%, was awash with cash and whose earnings were rising again. He even bought these and other high dividend-paying stocks on margin.
His bet proved to be highly profitable, as his preferred stocks doubled and tripled in value over the next few years. But, I should also emphasize that Keynes was no trader. He bought and held these stocks through thick and thin. He even held good-quality stocks during the 1929-33 bear market, and he was almost wiped out.
Thus, Keynes, like most of us, lost big money during the 1929 crash and subsequent bear market. But surprisingly he didn’t see this as a weakness. He took a positive attitude about bear markets:
“I feel no shame at being found still owning a share when the bottom of the market comes… I would go much further than that. I should say that it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. Any other policy is anti-social, destructive of confidence and incompatible with the working of the economic system. An investor…should be aiming primarily at long-period results, and should be solely judged by these.”
John Maynard Keynes’s Strategy Still Works Today
I recommend John Maynard Keynes’s strategy today: Buy quality companies that are paying consistently high dividends, and hold through thick and thin during the coming years.
If you want to follow Keynes’s idea of buying preferred stocks, consider buying the John Hancock Preferred Income Fund (NYSE: HPI), a closed-end fund that uses a value-oriented approach to invest in preferred stocks and other fixed-income securities rated “investment grade” by Moody’s or S&P.
Currently it pays a monthly income of 15.5 cents a share, for a current yield of 17.5%. It’s selling for an 11.6% discount from its Net Asset Value ($11.86). You could make a substantial capital gain plus the 17.5% dividend yield – almost 30%.
As the economy recovers, and I expect it will in 2009, undervalued companies with strong yields are one of the best ways to land big gains.
Today’s Investment U Crib Sheet
Most Americans are familiar with open-end funds, or mutual funds. But many have never heard of closed-end funds. And if you aren’t familiar with them, you should be. Closed-end funds hold much less in total assets, and are generally a better bargain. You always know if you’re buying them at a discount or premium
Open-end funds, like those offered by T. Rowe Price, Vanguard and other leading mutual fund groups, continuously offer and redeem shares based on each day’s closing net asset value (NAV).
Closed-end funds are different. They raise money on an initial public offering, just like a company going public, and then begin trading on an exchange.
Because these funds trade like stocks, you buy them through a brokerage account. And you can trade them intra-day using market orders, limit orders, or stop orders. They are marginable like stocks, too.
A closed-end fund’s market price at any given time may be higher or lower than its net asset value. If it is trading above the NAV, it is said to be trading at a premium. If it is trading below the NAV, it is trading at a discount.
There are few buy or sell signals that are more obvious than buying these funds at a discount and selling them when they are at a premium. If you do this successfully, you’ll not only benefit from the fund’s rising net asset value, but also the shrinking discount.
To find more closed-end funds, visit www.etfconnect.com. You can sort them by asset class, region and whether they’re trading at a discount or a premium to NAV.