OUZILLY, France – Imagine the poor economist without a sense of humor.

How he must suffer!

This week was to be dominated by central banks. Two big ones – the Bank of Japan (BoJ) and the Fed – were to make important policy announcements.

The speculators placed their bets, front-running the news, and sat on the edge of their chairs.

More Mumbo-Jumbo

This morning, the BoJ came out with more mumbo-jumbo.

“Yield curve control,” it promised.

The central bank says it will target a 0% yield on 10-year Japanese government bonds.

It added that it would continue buying the nation’s stocks (by way of exchange-traded funds) and charging a negative interest rate of 0.1% on the accounts banks keep with it.

Japan’s stock market crashed in 1989. Since then, the no-luck Japanese have had sluggish growth, recession, and on-again/off-again deflation.

For more than a quarter-century, the gears of Japan, Inc. have turned slowly. And not for lack of trying.

The government spent hundreds of trillions of yen on “infrastructure” projects in an attempt to “jump start” the economy with fiscal stimulus.

At one point, they were pouring more concrete – on roads, bridges, dams, and other public works – than the entire U.S.

Critics charged that so much cement was used – channeling rivers in the countryside and building ugly bridges to nowhere – that it amounted to the largest vandalization program in history.

The Japanese feds tried monetary policy, too.

ZIRP (zero-interest-rate policy) began in Tokyo. They invented QE (quantitative easing) too; it was supposed to get more “liquidity” into the system and boost stock and bond returns.

And yet, nothing seemed to work.

From Tokyo to Harare

But rather than admit its manipulations have done no good – rather than raise a white flag… back off… and let the market sort itself out – Japanese authorities march on with more claptrap announcements, more pigheaded interventions, and more of the nation’s real wealth squandered on dumbbell projects.

Like soldiers of the Imperial Japanese Army abandoned on a remote atoll in 1945, they continue to fight a lost war.

The Japanese government already has the highest debt load in the world, at 230% of GDP.

Now that the older Japanese, in retirement, are selling their Japanese government bonds rather than buying them, the central bank funds the entire government deficit.

And the BoJ buys so many stocks and bonds, hustlers are said to be creating new investments just so the naïve geniuses can buy them.

Today’s announcement tells us that the central bank will buy more government debt, adding to its pile – already about one-third of all outstanding Japanese government debt.

This is what Zimbabwe and Argentina did. It is a classic way to ruin an economy, by “monetizing” debt.

It amounts to paying government expenses with newly invented money.

Eventually, the extra money leads to consumer price inflation.

Rude Shock

Consumer price increases are what the BoJ is aiming for.

It has even developed an Orwellian lie to describe its main policy goal. It says it wants “price stability of 2%.”

No kidding. It describes 2% annual inflation as “stability.” Maybe it’s a translation problem.

But just as the authorities have been unable to lure price increases up to their quacky 2% level… so will they be unable to keep them there once they arrive.

Instead, inflation will keep right on going. The authorities, who built an economy where companies, households, and the government can barely survive at zero interest rates, will be unable to bring it under control.

Then retirees will get a rude shock. They put their savings into government bonds yielding almost nothing. They’ll find out what they’re worth when consumer price inflation is running at 3% or 5% or 10%. (ZILCH is the answer.) 

And then, the whole illusion that the authorities know what they are doing will give way to the reality that they are no better than witchdoctors, fortune-tellers, or presidential candidates. 

Meanwhile, today is a big day for the Fed, too…

Again, speculators sit on the edge of their seats, awaiting the latest gibberish.

Will the Fed tell us that, since the economy is strengthening, the time has come for another 25-basis-point increase (effectively, nada)?

Or will it say that it will remain watchful… “data dependent”… like a sentry at a volcano ready to throw a maiden over the edge if the rumblings increase?

We don’t know. But here at the Diary, we are on the alert… ready to laugh when the news comes out.




Investor Focus

By Chris Mayer, Chief Investment Strategist, Bonner Private Portfolio

Yesterday, we talked about three special “100-baggers” (Southwest Airlines, L Brands, and H&R Block). These companies returned more than 100x to investors during a period when the broader market went absolutely nowhere.

And there is something these three companies had in common.

Southwest recorded $6 million in sales in 1972. By 1975, it did $23 million in sales. And by the end of the decade, it hit $200 million in sales.

L Brands had sales of $210 million in 1978. It hit $1 billion dollars in sales in 1980. By the end of the 1980s, it hit $5 billion in sales.

H&R Block did just $14 million in sales in 1967. In 1975, it passed the $100-million mark in sales.

See a pattern here?

All three were small companies with lots of room to grow.

For larger companies, the condition of the economy can be a constraint. They depend on broad-based economic growth. It is hard for Coca-Cola or McDonald’s to grow faster than the overall economy. They’re just so big already.

It’s really just a matter of scale.

McDonald’s did about $25 billion in sales last year. So if it wants to double that number, it would need to sell an extra 5 billion Big Macs next year. Granted, this is an oversimplified example, but you get the idea.

But it’s not as hard for a small company to increase its sales by double, triple, or more.

Not all small companies become big companies, of course. But after studying over 360 100-baggers, I have a basic few clues to look for.

The ability to expand into national and/or international markets – Think about the three big winners above. You had a small tax preparer, an airline, and a retailer. All three started as local, or regional, businesses. And all three grew into national brands. To get those big returns, even in lousy economic environments, you need to have room to grow.

Strong returns on the capital invested in the business – If you invest $100 in a business and it generates a cash profit of $20, that’s a 20% return on equity, or ROE. You don’t need to know a lot about finance to know that is a very good return.

Well, nearly all of the stocks in my 100-bagger study were good businesses by this measure. They earned returns of 20% and above.

H&R Block, for example, earned astronomical returns on its equity – in the early days especially. ROEs were well over 30% in most years. For L Brands, ROE was over 25% for years and years. And low-cost Southwest had – and still has – among the best economics of any airline.

Which brings me to the final – and perhaps most important – clue I’ll share with you today…

The ability to reinvest profits and earn high returns again and again and again – This one is just math. If you can earn 30% on your equity and reinvest your profits and earn 30% again… well, the dollars start to pile up real fast.

Take a look:

Year Return
1 1.3x
5 3.7x
10 13.8x
20 190.0x

After ten years, you’ll have 14x what you started with. After about 18 years, you’ll have a 100-bagger. This is how you power through bad economic times.

Finally, there is a great Charlie Munger quote I want to share because it shows you the importance of this concept of ROE:

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.

So there you have it. Even though the overall market looks expensive, remember that you are not buying the market. You’re buying individual stocks.

That’s why you should look for great small-cap stocks with the traits I’ve shared above.

If you find a business that can earn 25% or so on its capital over many years, what happens to the overall market won’t matter.

Editor’s Note: Over the last two days, more than 13,000 Diary readers tuned in to learn an investment strategy Chris calls “the biggest breakthrough of my career.” And part 3 of this special series was just released today.

For the first time ever, Chris is teaching his secret for identifying “the next Starbucks,” “the next Apple,” and “the next Wal-Mart” years in advance of anyone on Wall Street… We’re talking about stocks that can return 100-to-1.

The best part is, this series is absolutely free. Register here to start watching now.

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Yesterday, Bill heaped praise on former Fed chief Paul Volcker for taming the inflation that ravaged the U.S. in the late 1970s. But not everyone is a fan of Volcker’s policies…

Bill, I really like your Diary, and I’ve learned a tremendous amount from it. But we just don’t agree about the early 1980s at all.

I was there then. I know what Volker’s policies and interest rates did. They just about shut down our whole society. The part you don’t mention was unemployment (remember the “Misery Index”?).

Business can’t run on 20% interest rates… and it didn’t. What saved the day was the tidal wave of upward momentum coming from the emotional response people had to Reagan’s leadership and the somewhat beneficial effects of the supply-side emphasis of Arthur Laffer and Jack Kemp.

Although Reagan achieved those restorative results with some brutal and unwarranted methods – including tossing thousands of mentally-ill people out on the streets (where they still are to this day, just walk down the street in any urban area and you see it) – nonetheless, the impact of promoting business growth had a positive effect that sustained this country through the 1980s and 1090s.

That Obama chose Volker to be one of “his” economic advisors tells the whole story of Volker: antique, anti-growth policies with their devastating negative impact on the lives of many hard-working Americans… an impact we still see today in a national willingness to accept an unemployment rate that is (actually) maybe 15%, and the actual GDP in decline.

– Dave F.

In Case You Missed It…

Over 13,000 of your fellow Diary readers have already watched the first two parts of Chris Mayer’s investment masterclass… and now part 3 is available as well.

Don’t miss your special opportunity to learn Chris’s tips for identifying “the next Starbucks,” “the next Apple,” and “the next Wal-Mart” years in advance of anyone on Wall Street. Register for free here.