WHAT HAVE WE LEARNED?
By Mark Skousen

"What Have We Learned?" It's an important question because the events of the past have much to teach us about making money today.

In fact, for 20 years I have been applying that truism in the financial business. From Managing Editor of The Inflation Survival Letter (now Personal Finance) in 1974 to Editor of Forecasts & Strategies, today, I've seen a great deal over the years: bull markets, bear markets and everything in between. During these 20 years, my wife, children (now five) and I have lived in Washington (D.C.), Nassau (the Bahamas), London (England) and Orlando (Florida) and have visited 50 countries. We've been around the world and back to learn the lessons of economics and finance, and in this special issue I'd like to share them as my special holiday gift to you.

A PERIOD OF UPHEAVAL THAT CHANGED MANY INVESTORS FOREVER

I cut my teeth in the upside-down market of 1973-74, a period of major upheaval in the financial and economic world: the energy crisis, commodity shortages, double-digit inflation and the beginning of a financial revolution as money market funds, precious metals, real estate, foreign currencies and survival foods moved into the spotlight.

A new coalition was formed, the "hard money" movement, made up of investors fed up with politics as usual who sought to protect themselves from bad government and preserve their capital by investing in inflation hedges, offshore accounts and non-reportable investments. Rejecting traditional investments such as stocks and bonds, their rally cry was, "Buy gold, buy silver, buy Swiss francs!" My first investment was not GM, Disney or McDonald's stock, but a silver dollar.

The early 1970s was the first inflationary phase, quickly culminating in the horrific 1979-80 blow-off of runaway inflation. The bond market was rocked by skyrocketing interest rates; Jimmy Carter seemed helpless to stem the tide. The election of Ronald Reagan and the trauma of the 1980-82 credit crunch, marked by historically high real interest rates, introduced "Reaganomics," which brought us seven fat years of an unprecedented bull market in stocks and bonds - traditional investments we had dumped just a decade before - and a disinflationary environment. Investors who failed to change were hit hard.

Now in the 1990s we are profiting from the great transition to a new global economy, a technological revolution and emerging free markets around the world. In sum, the sea changes in the financial markets and the world economy over the past two decades have been dramatic and breathtaking. What have e learned from these exciting years of boom and bust, inflation and deflation, and bull and bear markets? Here are seven key lessons I have learned:

Lesson One
GOVERNMENT POLICIES AREN'T ALWAYS BAD

The first lesson is that government policies can be good or bad, depending on who is in charge. In the 1970s, many investors concluded that government could do no good. "Politics is dead," proclaimed Libertarian mentor Karl Hess. Whether under Republican or Democratic leadership, we suffered from more inflation, higher interest rates, more socialism and greater instability in the economy. Around the world, nationalization and totalitarianism were on the rise. It seemed that the world was sliding downhill and the only protection was to withdraw from the political system and traditional investments.

But then the world's geo-politics changed. Thatcher was elected in Britain and Reagan in the United States. Both brought a new mandate to the world - government must be fiscally and monetarily responsible. Government isn't the solution, they insisted, it's part of the problem. The state can do only a few good things - it should deregulate, decontrol and denationalize everything else. The supply-side, free-market revolution became a reality, with Britain and the United States leading the way.

Many hard-money investment gurus failed to adjust to this dramatic change. Even today, they are primarily gold bugs, hoping gold will rise again. Meanwhile, they've missed out on some fantastic investment opportunities in stocks and bonds around the world.

Luckily, I saw it coming. When Reagan was elected, I proclaimed, "The Financial Shock of 1981: Reaganomics Will Work!" I recommended selling gold and silver and buying U.S. stocks and bonds. Very few listened, and I was denounced by many stalwarts in the hard-money movement. Yet my prediction turned out to be accurate.

The sea change under Reagan taught me another important lesson: Wealth is created from the production of goods and services in the U.S. and around the world. And stock markets best reflect that growth in wealth, not collectibles or precious metals. This is a difficult, but critical, lesson for all gold bugs to learn, especially for those of us who started in this business investing in hard assets, not traditional investments.

WE CAN PROFIT FROM WORLDWIDE POLITICAL CHANGES

Now in the 1990s, we are witnessing governments making dramatic changes for the better, with multitudinous opportunities for investors. Full-scale socialism and Marxism were shattered when the Berlin Wall came down. Third World countries have shifted dramatically in favor of free markets, deregulation, privatization and foreign capital. Each has, in turn, seen its stock market skyrocket. Examples include Chile, Mexico, Argentina, Turkey, New Zealand and India. This new trend is still in its infancy. Investors should look for opportunities to buy these country funds.

Other nations, especially in Asia, are opening up their markets and avoiding the sins of the past. Countries such as Hong Kong, Taiwan, Korea, Thailand, Malaysia and Indonesia are growing rapidly because they rely on free markets, not a large public sector, to determine their destiny. China, the largest country in the world, is growing dramatically for the first time in 50 years because it has made significant pro-market reforms (although they still have a long way to go).

Many positive changes are taking place in Europe. Europeans are now free to move goods, labor and money to their most efficient use within the European Community, an underlying factor in the bull markets there. This new measure of freedom will help offset their high levels of socialism and welfare.

Not every nation is making the right decision, however. Each country must be judged on its own merits. Some nations are going in the wrong direction by raising taxes, increasing the size of government intervention and using artificial means to create prosperity. They include the United States, Canada, Japan, France and other industrial nations. But clearly, the trend is toward less government intervention in most countries, and it would not surprise me to see leaders in the Group of 7 reverse their anti-growth policies or be removed from office. Until that happens, though, we will be cautious about their potential. Investors must not cynically assume that government will always make the wrong choice in policy. In general, when politicians do the right thing, investors should get in. When they do the wrong thing, investors should get out. Today, our opportunities lie largely overseas with funds such as Janus Worldwide (800/525-3713), T. Rowe Price International Stock (800/638-5660) and Morgan Stanley Emerging Markets (NYSE: MSF, $27), which can take advantage of governments and markets that are doing the right thing. While we may avoid getting involved in politics, we must know how to read the political "signs of the times" for maximum profit.

Lesson Two
DOOMSDAY KAS DEEN POSTPONED (AGAIN)

The second lesson is that the global economy is far more resilient than anyone imagined. During the past 20 years, we have suffered through two major energy crises, double digit inflation, stock market and real estate crashes in the U.S. and Japan, an unprecedented credit crunch, mammoth federal deficits, the AIDS crisis, several major wars, terrorist attacks, the collapse of the Soviet Union and many other mini-panics, and yet we continue to survive and even prosper. We are not depression-proof, but we are surprisingly depression-resistant. Armageddon has again been postponed.

Given the expansion of political and economic freedom, the advances in technology and other favorable trends, it is highly likely that we will see more prosperity in the future before we see another Great Depression. Many parts of the world are coming out of depression. Bear that in mind the next time you read a best-selling book predicting the end of the world in 1995.

Granted, our nation faces many serious problems, including the deficit, high taxes, business regulation, unemployment, bankruptcies, crime and government intrusion in our private lives, but let us not ignore the good developments - low interest rates, livable inflation, increased quality and variety of goods and services, and a fairly decent degree of personal and financial freedom. For almost every bad statistic, there is a good statistic. Banks and S&Ls are failing in record numbers, but more banks and S&Ls are profitable than ever before. Bankruptcies may be at all-time highs, but so are new incorporations. It's easy to dwell on the bad side of things when, in fact, things aren't always as bad as they seem. Remember, bears make headlines, bulls make money! When the bears move to cash, we'll move to explosive growth opportunities, like Montgomery Global Communications (800/526-8600) and Fidelity Select Telecommunications (800/544-s888).

Lesson Three
DON'T RELY ON TRADITIONAL ECONOMIC THEORY

The third lesson is that all modern establishment economic theories have failed and can't be relied upon for forecasting the future. The first model to collapse was the Keynesian model, in the early 1970s. The Keynesians arrogantly claimed the ability to ban the business cycle forever through tracking the vast powers of government fiscal policy. But when inflation and recession occurred simultaneously in the early 1970s, their model was repudiated. Deficit spending and bigger government are no longer considered the cure-all for our problems.

The monetarist philosophy of the Chicago School was the next model to fall, in the 1980s. According to their Quantity Theory of' Money, when the money supply goes up, so should prices. Therefore, when the Fed adopted an easy money policy in the early 1980s, Milton Friedman and other monetarists predicted a return to rapid price inflation. Yet it never happened. Instead, the new money went into real estate, stocks and bonds.

Finally, the Marxist model self-destructed when the Berlin Wall came down in 1989, and the Soviet Union disintegrated a year later. The long debate between capitalism and socialism was over. "Capitalism has won," Robert Heilbroner confessed. "Ludwig von Mises was right."

Throughout these two decades, government and academic economists have relied on sophisticated econometric models to predict the direction of the economy. Yet they failed time and time again. The last straw was when they applied their techniques to the 1929-32 Great Depression era to see if they could predict the crash and depression using their sophisticated time series data. They failed miserably.

Where does this leave us? Devoid of any reliable economic model to predict the future! The economics establishment has no model to predict the next business cycle, whether boom or bust. In fact, last month, two studies were issued by top economists at the National Bureau of Economic Research attempting to determine the cause of economic growth. Their conclusion? There is no sure cause - not savings, investment, education or any of the other common explanations. It was all "just plain luck"! (Source: Business Week, Nov. 1, 1993) No wonder Herbert Stein, former chairman of the President's Council of Economic Advisors, recently stated, "This is the age of ignorance." And Alfred Malabre, economics editor of The Wall Street Journal, calls today's economists "Lost Prophets," the title of his new book.

FREE MARKET MODEL PROVES ITSELF AS A TRIED AND TRUE WINNER

Fortunately, there is one model that is powerful and useful in forecasting the future: the free-market model of the Austrian School. Building on the work of von Mises and Hayek, the Austrian model breaks down the economy into various sectors and stages of production, focusing on the micro-foundations of the macro-economy. This is precisely the model I use to determine the direction of the economy and the financial markets in Forecasts & Strategies I believe it is one reason our Ideal Portfolio is up 28% so far in 1993.

If the Fed inflates or the government spends more money, I ask the all-important question, "Where does the new money go?" None of the other schools ask this question. The Austrian school also maintains that the government causes a business cycle of boom and bust when it embarks on an inflationary course. Inflation creates the seeds of its own destruction. Therefore, according to the Austrian school, no boom can last forever. Eventually a bust must come.

In the financial markets, this means that no bull market lasts forever. There is a time to buy and a time to sell. That's why until now, we've been optimistic on the U.S. stock market and even more bullish on emerging markets. The Austrian school doesn't claim the ability to predict the exact time or magnitude of moves in the markets, but it can offer general directions.

Lesson Four
THERE IS NO SUCH THING AS A PERFECT INVESTMENT

The fourth lesson is that there are no "sure-fire" investments - all investments go through cycles of bull and bear markets. An amazing number of investments have been touted as "no lose" money-makers: "investment grade" diamonds ("never a down tick"), real estate ("they're not making any more land"), rare coins ("never a down year, according to Salomon Brothers") and stocks paying increasing dividends ("if earnings are rising, the price must go up"). We were also told that becoming a "name" at Lloyd's of London was virtually risk-free. Or that oil and gas limited partnerships were conservative investments ("with the tax advantages, you can't lose").

All these claims turned out to be fictitious, often the hopeful dreams of those who made their living in those markets. Even if there is a limited supply of rare coins or beachfront property, demand can fall and so can prices. Companies with rising dividends can still get ahead of themselves. Claims against Lloyds of London overwhelmed them in the late 1980s. And dry holes could never make up for the tax deductions from "conservative" limited partnerships. (Why were investments with 90% losses ever considered "conservative")!

In a frenzied boom, prices can be bid sky-high to excessive values. We witnessed the madness of crowds in the oil and gold markets in 1979-80, real estate in 1987-89, and Japanese stocks in 1988-89. Then sellers came out of the woodwork, and prices eventually declined.

Sometimes the tailspin turns into a rout, and prices are bid to bargain levels. We witnessed that, too, in stocks and bonds in 1982, and then again right after the 1987 crash. Real estate hit bottom in the early 1990s. In sum, all investments have their days in the sun - and in the shade.

The same is largely true of mutual fund performance. A fund can have a great track record for a decade, then suddenly lose steam. In the 1970s, United Services Fund (gold) and 44 Wall Street (junior oils) were the darlings of Wall Street, but in the 1980s, they were the dogs. Mutual Shares (specializing in turnaround situations) even went through a dry spell. There are no sure deals.

During the past decade, with all the turmoil in markets, we have all tried to become "contrarians," but it's easier said than done. Only a small minority of astute investors can outsmart everyone else by buying at the bottom and selling at the top. The key to successful investing is to search for bargain prices in investments that are bound to increase over time, and to avoid buying-fever at the tops of markets. The most successful investors over the long run (J. Paul Getty, Warren Buffett, John Templeton and Peter Lynch) have held to this approach.

Lesson Five
INFLATION ISN'T WHAT IT USED TO BE

The fifth lesson is that consumer price inflation is not as reliable an investment indicator as it once was. That's because today it's more difficult for the government to create consumer price inflation. Witness the growth in gold stocks in 1993. Even though consumer prices remained steady, gold soared. The government is still inflating the money supply at a rapid pace, but the money is being absorbed in higher stock, bond, real estate, precious metal, commodity and consumer goods prices.

But note: Just because the CPI rate stays in the single digits doesn't mean real inflation isn't going on or that gold won't rise. Gold is not dead by any means. It may be sleeping from time to time, but it can awaken at a moment's notice.

Because inflation is likely to rise only gradually, rather than rapidly as it did in the 1970s, you should expect gold and silver to rise by fits and starts. Stick with high-quality favorites like United Services Gold Shares (800/873-8637) and BGR Precious Metals (T: BPTA-T, $11-1/4), but don't count on doubling your money every year in gold stocks as we did in 1993!

Lesson Six
BEWARE OF CYCLE THEORIES

The sixth lesson is to be skeptical of "guaranteed" technical trading systems, such as cycle theory. It is easy for investors and financial "gurus" to get hooked on a particular theory of investing. Once a financial advisor publishes a book or a newsletter defending a certain trading device, he has a vested interest in the theory and will be reluctant to abandon it, even in the face of clear evidence.

I've seen this time and time again. Advisors get caught up in a pet theory, and they refuse to see evidence to the contrary. If you write a doom-and-gloom book, you will likely only focus on bad news in the economy. But the wise investor is always flexible, knowing that times change and his investment approach must always be up-to-date.

I've also seen numerous "guaranteed" investment systems come and go. Usually they are technical trading methods. I've even reported on some of them in my newsletter. But almost every one has eventually collapsed. Somehow more and more people find out about them, which throws the system off balance, and they lose their advantage.

Always be careful of technical systems. I am reminded of the time a famous investment newsletter writer attended the New Orleans conference a month after the October 1987 crash. He confidently showed us a chart of the Dow Industrials, pointing to the technical triangle that had developed since the crash. "If the Dow falls through the triangle, it means sharply lower stock prices the Dow could fall to 1,000." A few days later, the Dow did indeed fall outside the triangle, but the chartist's prediction proved wrong. The market quickly reversed itself and headed toward new highs.

COUNTING ON HISTORY TO REPEAT ITSELF IS DANGEROUS

Not all technical analysis is bogus. To the extent that price trends, volume, new highs/new lows, put-call ratio, and other "technical" indicators reflect the psychology of investors, technical analysis has considerable value. But cycle analysis and wave theory are a different matter. They put investment strategy into a strait-jacket.

Cycle theory assumes that history repeats itself in the same way every time, as if human beings have no free will, no ability to change the powers that be. It is as if it doesn't matter who is in the White House or directing the Federal Reserve, as if prices are predetermined by some deep, hidden instinct. This mechanistic approach to investing has serious weaknesses, and investors relying on it can fall into fatal traps.

The classic example of cycle analysis gone awry was the so-called six-year cycle in gold and silver, a technical system popular in the early 19sOs. Proponents argued that since gold and silver topped out in 1974 and then in 1980 at higher prices, the metals should reach another new high in 1986. While they did pick the precise bottom for precious metals in the summer of 1982, the new bull market never materialized six years later. Gold never came close to $6,000 an ounce and silver didn't reach $100. In 1986, gold was lucky to reach $450 and silver barely touched $6. This kind of crude cycle analysis was discredited.

Another example is the Kondratieff long wave, named after the Russian economist Nicholas Kondratieff, who predicted 50- to 60-year business cycles in the capitalist system. Since 1929-32 was the last depression, proponents began predicting a similar event in recent times. I remember some forecasting a devastating depression as early as 1973-74. Others said the depression would hit in 1980-82. Some predicted that the 1980s would be a replay of the 1920s, year by year. When the stock market crash occurred in 1987, instead of 1989, they had to rethink their position. All the Kondratieff followers were disappointed in their forecasts because they were based on faulty understanding of human action.

Experienced traders still use cycle and wave analysis, but they know that cycles and waves are subject to frequent and unpredictable changes. While it is true that investors often have a herd instinct, it is also true that investors can learn from their mistakes and can react differently in the future. There is always some degree of uncertainty in the markets, an uncertainty which reflects human action. Markets do not always respond as we think they will, so predicting the future is difficult at best and often humbling. There are always unknown factors.

Use of probabilities is the best way to predict the future. But no matter what, every investor and financial analyst makes mistakes (and yes, that includes me too). It's part of the process.

BEWARE OF THE "RANDOM WALK" THEORY OF INVESTING

At the same time, let us not go to the opposite extreme and conclude that the financial markets are completely unpredictable at all times. In the early 1970s, the Efficient Market Theory became all the rage in academic circles. Their studies demonstrated forcefully that almost all professional money managers did not beat the market. They concluded that full service brokers, security analysts, money managers and other stock pickers were wasting their time and your money.

In fact, they claimed, a randomly selected group of stocks might do just as well. The financial wizards recommended that you simply buy stock index funds (such as the Vanguard Index 500 Fund) and hold through thick and thin. Eventually Wall Street bought into this argument, and today there is over half a trillion dollars invested in stock index funds.

However, recent evidence suggests that the ivory tower financial analysts might have drawn their conclusions hastily. A small number of money managers and commodity traders have consistently outperformed the averages, including Warren Buffett, George Sores, Peter Lynch and others.

Over the years, I have learned that the agile financial entrepreneur and speculator, relying on sound economic principles (especially from the Austrian school), can foresee changes in the financial markets before the crowd and be rewarded accordingly. Often the establishment interpretation of events is grossly inaccurate, as was the case in 1987 before the stock market crash, or in 1992 before the European currency crisis. By understanding what's really going on, one can profit handsomely when the truth becomes apparent and the markets respond to new information. We were fortunate to achieve a 28% return on our ideal portfolio in 1993 - far ahead of the S&P 500 - but beating the market is never easy.

Lesson Seven
DON'T RELY ON BROKERS, MONEY MANAGERS, OR THE GOVERNMENT TO PROTECT YOUR ASSETS

The seventh lesson is that no one is better-suited than you are to manage your financial affairs. During my 20 years in this business, I've attended dozens of investment seminars, met thousands of investors and reviewed hundreds of financial statements. Those who have lost the most money have, almost without exception, blindly turned their money over to brokers, money managers or financial planners and let someone else manage their affairs.

I've seen a lot of fraud-peddlers and bad advisors over the years, and you have to be really careful to avoid them. You generally can't tell a fraud-peddler or bad advisors just by meeting them, although my wife does a pretty good job of sizing up people.

There are no shortcuts to making money. It requires hard work, study and experience. If you invest your funds in managed accounts or mutual funds, find out as much as you can about them. Do your homework and monitor carefully how your money is invested. Whatever your source of information about a particular investment - whether you get that information from reading an article in a magazine, talking to an exhibitor at an investment conference or discussing it with a broker over the telephone - get the advice of an independent, unbiased person before acting. (This is one important reason why I do not sell or receive commissions for any of my recommendations.)

Over 20 years, I have seen few opportunities that have benefited the investor more than the broker/dealer. It's tough to find new investment gems. A few exceptions that we took advantage of were Magma Copper Indexed Bonds and Convertible Holdings Capital (NYSE:CNV, $11-1/2). Often the best deals come from undervalued investments created by panicky investors who overbought or oversold the market. Two recent examples that we capitalized on were Unimar (an Indonesian oil play yielding 29% in 1992) and closed-end high yield bond funds Clunk bonds yielding 25% in 1991). Neither opportunity for high yield exists today, though I'm sure others will come along occasionally.

Wherever you place your investments, don't go overboard by investing too much in any one category. I remember people in the 1970s loading up on gold and silver, up to 50% of their portfolio, only to discover they had overdone it and lost a great deal during the 1980s. Others made the same mistake in real estate, rare coins and bonds. The easiest thing to do is get greedy and invest too much in an investment or managed account that promises more than it can deliver.

GOVERNMENT IS NOT YOUR FRIEND

Don't count on government agencies to protect your hard-earned assets. Just because the Securities & Exchange Commission exists doesn't mean you can't be taken for a ride. Sometimes there is little recourse if you are defrauded.

Taxation and inflation, both government creations, are two of your greatest enemies. Throughout the past 20 years, I don't know of one year when taxation and inflation didn't eat away at your capital. You'll never maintain your purchasing power by investing in government bonds, T-bills or U.S. Savings Bonds. In today's world, you need to increase your investment portfolio by 10% or more each year just to stay even. Do you think government bonds will give you that 10%? No, they are long-term losers.

The best formula for capital preservation is to invest in free enterprise (through the stock market) and keep your powder dry by putting a portion into precious metals and investments outside the control of government. You'll have to take some prudent risks to preserve your investments, and for that goal, my newsletter can be of service.

-- Mark Skousen