Educating, Protecting & Empowering the Investor

Can Fear Make Us Better Investors?

It’s an investment dilemma. In tough markets, investors are sometimes wracked by fear and anxiety raising the question; Are either of these emotions helpful? 

Feeling fear can be a healthy response to real danger for which you can prepare a plan of action. For example, if you meet a bear in the woods, this is a real danger which is accompanied by fear. As the cowboy stranger so rightly said in the “The Great Lebowski”, one of my all time favorite movies, “Sometimes you eat the bar (sic), and sometimes, well, he eats you.”

The fear we feel when confronting the bear is real and can be handled with a series of actions and a lot of praying. You don’t chase or approach a bear at close range. You shout, wave your arms, bang pots and metal objects. You stand your ground hoping the bear will go away sooner or later.

Feeling anxiety over the possibility of encountering a bear could cause you to exaggerate the danger, and lead to irrational responses like forever avoiding the woods. 

In today’s modern world, the chance of meeting a real bear is unlikely, but a type of bear that investors will always encounter is the bear market.

Which emotion does a bear market instill in you? Fear or anxiety?

If you are feeling fearful, you can take appropriate action:

1.      Identify the fear. If you have a fear of losing your money permanently, examine your portfolio. It is important to assess whether the failure of any one investment would irreparably harm your overall wealth, or simply reduce your future rate of return.

2.      Formulate a plan of action to respond to real danger. For example, you can sell the stock, and make sure your remaining investments are well diversified. Mutual funds or index funds are a good way to diversify. Healthy fear. Healthy reaction.

If you are feeling anxious, consider the following:

You may have already diversified your portfolio, but continue to remain overly anxious and tempted to sell everything. This unwise move may cause permanent damage to your future security. It is an irrational action created by anxiety, not fear. Try to keep the big picture in mind remembering that markets and economies are always cyclical. 

Extrapolation

Definition: The taking of recent current events and projecting them into the future.

I once read that in 19^th century London a magistrate complained that in the not too distant future the growing number of horses would create unbearable health and traffic problems. The city would be overrun with filth and disease. This person was extrapolating the current horse population straight out into the modern era, without any knowledge of the changes that would take place just a few decades later.

In 1999, stock prices had been going up double digits for 4 consecutive years. Everyone was talking about the stock market and many were jumping in for the first time thinking that investing was easy. The media paraded a number of gurus who declared the “death of the business cycle” due to the invention of the internet. No doubt the internet has significantly changed our world, but it has definitely NOT abolished the business cycle.

In 1999, two internet companies with NO earnings, CMGI and Internet Capital Group (ICGE) were worth more than the combined value of:

• International Paper
• Alcoa
• GM
• Honeywell
• AT&T
• Eastman Kodak — Remember, I said combined!

 Back then, CMGI traded at $163 and ICGE traded at $212. Today they are $3.72 and $3.85, respectively.

In 2002, after 3 bloody years of declining stock prices, most pundits and investment fortune-tellers forecasted more years of stock price declines. The Dow fell to 7,286 and many were saying it was going to 5,000. A Dow of 5,000 struck fear in my heart, I confess, but I did not react to my anxiety. Just one year later the Dow was at 9,617- an increase of 32%.

In 2005 I gave a speech to the American Association of Individual Investors, and asked this question: “If bubbles occur because of constantly rising markets, what market are people most bullish about right now?”

The answer back then?  Real Estate, and we now know the danger of extrapolating a continuously rising bull market in Real Estate. It’s the disaster which haunts us now.

Let’s come back to the present day. In 11 months, this bear market has done the same amount of damage which took 3 years to accomplish in 2002. Like then you will now hear gurus and fortune-tellers parading around telling us the world is going to hell in a hand basket and prices will continue to go lower. That’s not to say that prices won’t continue to decline. No one can really say,….but don’t forget they have already come down a long, long way. There is an old saying for bull markets: “Trees don’t grow to the sky”. Bear markets aren’t a bottomless pit either so don’t make the mistake of extrapolating the recent declines to zero.

As a matter of fact if you can turn your thinking around and contemplate the idea called “reversion to the mean”, you may start to become very successful at the investing game. Reversion to the mean suggests that prices and returns eventually move back towards the mean or average.

Like a rubber band that stretches but will eventually bounce back, mean reversion suggests the same thing for stock prices —and the longer the rubber band is stretched, the bigger the snap back. This idea can give you the courage to enter this market even if it declines further from here.

Stock prices are already down 40% since the beginning of the year. I suppose they can go down a lot more, but that seems highly unlikely. Investing in the market now will have a higher likelihood of success at today’s low prices than investing when prices were much higher. At some point business will begin accelerating again and stock prices will jump quite high. To quote Warren Buffett, “Be greedy when others are fearful and fearful when others are greedy.”

Learning to avoid extrapolation, while understanding the difference between fear and anxiety, can make the difference between creating substantial wealth or losing it.

The Double-Bind

The mother says to her son: “Come here, darling, why don’t you come and kiss Mommy? You never kiss Mommy.” As the child comes the Mother stiffens and freezes. When the child stops, confused, she says: “Come darling don’t ever be afraid of expressing your feelings.”

A wife laments that her husband never brings her flowers spontaneously and she tells him so. He is in a double-bind. If he brings her flowers, it’s not being spontaneous, if he doesn’t, her accusation is correct and he can’t please her.

It’s a “damned if you do, damned if you don’t” situation.

The most famous double-bind comes from the book Joseph Heller’s Catch-22. Here’s a taste.

 Your broker, advisor, or radio personality tells you to hold onto your stocks in a terrible, terrible market. He says; “Stocks beat all other investments in the long-run.” As a matter of fact, he points to many very successful investors and says: “They are buying now, not selling. He tells you that calculations of future returns for the stock market in 10 years call for a likely 10-12% rate of return. He asks: “Do you really want to sell everything now that the market has fallen to such historically low levels? You grit your teeth and hold.

Yet, each day you are tested. Each day you see your investments fall in value. The news is bleak and you are afraid to look at your monthly statement. If you do, you feel nauseous.

You’re in a classic double-bind. Caught between your desires to earn a high return and avoid your past mistakes of selling out of fear.

It’s a double-bind. Damned if you do–damned if you don’t.

The Way Out

So what do you do? How do you get out of this dilemma?

One of the first rules of getting out of a double-bind situation is to realize that one person or entity in the relationship is the so-called “power person”. It is usually the one presenting the double-bind, whether it’s the Mother, the Wife, The Army or your broker. They are setting the limits of the discussion putting you in this double-bind situation. So firstly, you need to understand who this “power-person” is.

Secondly, you have to make up your mind to determine what you should do. If the child was an adult, he could say: “Why do you recoil from me when I try to kiss you? How can you expect me not to be confused when your words and actions are different? This way, he regains his power back in the conversation. The husband could take on more power by saying: “I don’t bring you flowers, but I do other things, spontaneously and from my heart.”

To your broker or advisor: You have decided to give this person whom you trust, the power to guide you and make some important decisions for you. You have decided to give up some power and follow the professional’s guidance. But you still have to have the power. You should ask yourself if there are any events of reasons that have diminished your level of trust. I’m not talking about predicting the market’s decline. No one can consistently do that correctly. As a matter of fact, the best investors don’t even try. But is your advisor meeting with you through these tough times? Is he or she taking your call and explaining as many times necessary, why you are invested in “this or that”? Is he acutely aware of your emotional risk tolerance? Are you confident that despite the markets weakness, your total portfolio is basically sound? If not, you have the power to change and break the double-bind.

What about your humble radio advisor? Should you follow what I or any other TV or magazine guru has to say? Do you want to give your power over to a person that has to speak in generalities to get a point across? No.  Take in the info, feed it through your logic, learn a little more, talk to others and get your own view. Ask your advisor to comment on these questions. Any good advisor will take other’s words and thoughts into consideration.

What about my original challenge to break the double-bind? The challenge was: “Hold on and watch your investments decline in value, or sell everything and get out of the market entirely?”

It’s in your power; there is no real double-bind when you know what to do.  Do you really think you’re problems will be solved by buying CDs at 4%? If so, do it and don’t look back.    

Is the current value of your portfolio, as dismal as it is, having an effect on you right now, other than emotionally? If not, why the panic? If you can be sure of anything, what goes down will come up eventually. No one’s life and no market experiences wonderful times exclusively. 

There are always the bad days, months and sometimes even years. Can you wait? Can you “tough” this one out? If so, stay in. invest on dips and don’t look back.

 Make your decision. Stick with it and get out of your double-bind.   

 Get your power back!

Are CDs The Right Investment Today?

 

Everyone is talking about safety these days and many people are looking to money markets (now that the Fed is behind them), Treasury Bills and CDs for the safety they crave. These have become the investments of choice for many of the fearful. I have even seen statistics showing a large increase in the sales of in-home safes (I suppose it’s today’s equivalent of putting your money under the mattress) as people run for cover when the markets go down.  When things are good, they start following the crowd once again and reach too far for investment return. I’m sorry to say I have seen this reaction time and time again in my 28 years. Why does this happen? In my view, it’s the way many understand the term “risk”. There are different types of risk and investors tend to focus on the wrong type. Here’s what I mean.

 

What if you needed to go from New York to LA and wanted to do it in the fastest, safest way? What would you do: Would you fly? Take a train? Drive? Without delving into statistics and with a little Google research, I’ve discovered what most people know; flying is the safest, fastest, followed by train followed by car.

 

Now let’s talk fear and perception. When you get into your car, all four wheels are on the ground, you’re in control surrounded by a seat belt and air bags to boot! You FEEL relatively safe. There is no turbulence and you point the car and go. You feel safe and you are willing to give up getting to LA quickly, with the notion that you will get there more safely.

 

When flying, you have the same seat belt (a lot of good it would do!) and a huge machine under you pulling 120,000 tons of weight into the air. You may feel nervous at take off, I know I do, and the flight may contain numerous bumps and ups and downs as the plane adjusts to atmospheric conditions. You may even feel a little air sick because of the turbulence. And yet…it’s the fastest and statistically the safest mode of transport.

 

How do we define safety? Is it the turbulence you experience? Or is it the fear you feel because of it? Shouldn’t it be the ultimate goal of getting to your destination safely? No one thinks air travel is safe because there is no turbulence; it’s safe because more people arrive safely per mile travelled.

 

When you look at the two modes of transportation, by air or by car, air travel wins by a large margin. It’s much safer and much faster than driving.

 

What does this have to do with investing? I bet you’re a little ahead of me. The question is: What is the fastest and safest way to get to your financial destination?  Is it CDs? Stocks? Bonds? Real Estate? Gold?

 

Here’s my take on it… Let’s start with the fastest mode and use the Rule of 72 to calculate speed. The Rule of 72 states that to find out how long it will take for your money will double, divide the rate of return you receive into 72. For example, a 10% return, will double your money in 7.2 years. At 5%, your money will double in 14.4 years. Simple, right?

Looking at today’s CDs, we find current rates to be about 4.5%. At a 4.5% rate, your money will double in 16 years. If we take taxes into account, the doubling time is 20 years. A very long time, right? Fast or not fast? Not fast. What about the ride? Volatile or smooth as silk? Smoooth…..Is this best for your financial help because of the lack of turbulence? I would argue no. 4.5% net of taxes is about 3.5%. If you consider a reduction in your standard of living a serious risk, you must take inflation into account. If inflation is 3%, then you are left with little if any left over to take income or any other benefits from your savings. This is a greater risk.

 

What about stocks? These days the turbulence is breathtaking and not a little nauseating. Down 400 points on a Wednesday up 557 points on Thursday, and no one knows what it’s going to do on any given day. In terms of safety, if you are trading this mess, it’s extremely risky. If you own a diversified portfolio that you don’t need to touch for 5 to 10 years, history has shown that the volatility of stocks over a long term diminishes. But today there is even more. Now when everyone is travelling “by-land”, meaning they are rushing to CDs in order to avoid the turbulence, current prices are indicating that stock investment returns for the next 10 years could be 10%-12%. Why do you think he’s buying along with so many other successful value investors?

 

Recently I read the weekly report from John Hussman. He is the money manager of the Hussman Funds. (www.hussmanfunds.com) and has been bearish as long as I can remember. His management style enables him to buy stocks and hedge them at the same time with various financial instruments. He has been hedged all year and his fund has held up very well.  In his most recent column, which can be found at his web site (www.hussmanfunds.com), John wrote that based on the current value of US stocks, and using normalized earnings projections going forward, he expects stocks to earn 10-12% over the next 10 years. Yes, this is prediction like so many others (everyone has an opinion don’t they?), but at the very least, his is based on level-headed, established mathematics and proven experience in the real world. Not on emotion, hearsay or the desire to sell you a quick road to riches. He also says that volatility (read turbulence) is going to be high. So he’s still keeping part of his hedges.

 

A 10% return means 7.2 years to double. 12% is 6 years. These are predictions, not guarantees or facts, but I think it’s high quality information to help guide you forward.

 

Decent quality Corporate Bonds are yielding 6% to 8% these days. Some volatility, some uncertainty, but in my opinion, definitely a rate of return which pays you for these attributes. 6% doubles in 12 years, 8% in 9 years.

 

So the point is: are CDs the fastest and safest? Not even slightly, in my opinion. Not the fastest, nor (relative to inflation), the safest.

 

Stocks are fastest and if we define risk as the probability of reaching your destination in 10 years, the safest.

 

Bonds are faster than CDs. And (inflation adjusted) safer. —More like taking the train.

 

So what do you think? Are you ready to take be more courageous by not allowing the turbulence to dissuade you from getting to your destination with a higher probability of a safe arrival? Or are you going to be lured into the seeming coziness of your comfy car thinking your safe arrival is assured (when statistically, it’s not)?

 

I guess it depends how you define safety. I know how I define it, how about you?

America is Amazing.

America is amazing. 100s of years of racial strife and struggle have all been turned on their ears on one date, a fateful and historic date of 11/4/2008. It sort of makes one wonder how such a milestone could have been passed with such seeming ease? One minute, the idea of electing a woman as President seemed barely possible, but the thought of electing an African American? It would have been unthinkable just a year ago. America is amazing. Congratulations to us all. Whether you voted for him or not, Congratulations to us all.

So what now? The market’s reaction to his election was not very good as the market sold off about 10% in the following two days. Truly, what can this man do? What can any man do under these circumstances? We know that he will have to hit the ground running even before his inauguration.

First, with George Bush’s approval, the congress should pass another stimulus bill as a down payment of more to come after the inauguration. This stimulus, if not paired with deficit reduction, will create the biggest deficit in history. The issues will be challenging.

The early consensus indicates that the stimulus bill will be geared toward direct checks for consumers, a tax credit for job creation and spending on public works such as school repairs, roads and bridges.

After the inauguration, Obama has proposed investing $150 billion over 10 years in clean energy plus a fund to invest in manufacturing research, new job training programs and an infrastructure investment bank.

He wants to temporarily suspend the rule which requires seniors to take required annual distributions from their retirement accounts at age 70 ½ and give a temporary tax credit of $3,000 in 2009 and 2010 to companies for each new full-time employee they hire in the United States.

Proposals include requiring financial institutions participating in the bailout to put a 90-day moratorium on foreclosures for homeowners acting in good faith, plus lending to state and municipal governments facing budget crunches due to the mortgage crisis. 

Taxing Wealth 

With regard to income taxes, Obama has stated many times that he wants to raise income tax rates on those earning over $250k joint and $200k single to their pre-2001 levels of 36% and 39.6%. Currently they’re 33% and 35%.

Social Security taxes could also rise for high income earners. Currently, if you earn over $102,000 you are no longer required to pay social security tax. This would continue for those who earn from 102k to 250k but would rise by some number for those earning over $250,000.

The Social Security tax is already 12.4%. You and your employer each pay half. We don’t know what the rate for those making over $250k will be at this time; hopefully those paying more will get some extra benefit for their investment.

It will be interesting to see if these added taxes will be a burden to the economy. If you live in states like NY, Pennsylvania or California and you are taxed at the 39% rate, add in the extra cost of state and city tax plus extra SS tax and the government will be taking well over 50% of your salary.  This will not spur investment and spending. We’ll have to see if this slows the economy even more.

First things first, expect some year-end selling as investors take advantage of this year’s lower capital gains rates.

Investment wise, there may be a shift toward infrastructure and health care stocks due to Obama’s longer term goals. Right now President-Elect Obama will need to clarify his short-term positions on a range of economic issues in order for the market to stabilize and get a more solid footing.

At the very least, what we want to see immediately is a market more focused on fundamentals; a market that can price securities relative to their perceived future value taking interest rates, inflation and the prospects for world growth into consideration. At that point we will see money managers have more control over their performance numbers. Right now only those managers who have their money in cash or have shorted the market are doing okay. Cash and speculation are not a long-term solution and those managers that own stocks and manage conservatively will do considerably better over time.

We’ll continue to keep you informed.

Get Your Power Back!

Feeling down? Market making you nervous? Are you suffering from the anguish of mental neuritis and emotional neuralgia just because the stock market refuses to go up? Is your anti-perspirant and anti- depressant not holding up under the strain?

Then you need some relief. Relief that can only come from a combination of uplifting stories of famous investors who have thrived in markets like these. Investors who have been around the block so many times that this time around seems like just another trip to the the candy store for them.

I’m not talking about antidotes, I’m talking about anecdotes, I’m talking about stories of the great investors. Stories of courage and perseverance. Stories of personal triumph overcoming all the odds.

I’m talking about the greats from Warren Buffett to Jim Rogers. From John Templeton to Napoleon Hill, the author of “Think and Grow Rich”.

This is the true medicine and it’s guaranteed to help you get your power back. That’s what I’m talking about today. Get that pep back in your step and give you the courage to actually open your monthly statements with a smile. 

I’ll say it again, great fortunes, whether new or a continuation, all begin with markets just like these.

Let’s start with our Napoleon Hill.

•  “Every adversity, every failure, every heartache carries with it the seed of an equal or greater benefit.”  

Failure: let’s deal with it. One of Hill’s biggest findings was that before people achieve success, they must first find themselves on the brink of failure. Say this one again, out loud: “Every adversity, every failure, every heartache carries with it the seed of an equal or greater benefit.”

• “Opportunity often comes disguised in the form of misfortune or temporary defeat.”

Stay on the look out for opportunities. Keep your confidence and be alert to opportunities.

• Don’t join the quitters. The key word here is “temporary.” Defeat is temporary unless you help make it permanent. No matter how difficult things may get, “this too shall pass.” Make sure you don’t fall into the all-too-common trap of becoming paralyzed by inaction. As long as you are willing to get back up and fight another day, failure is only a temporary condition. Never give in!

How about Warren Buffett?

Consider his recent statement on Friday, October 17, 2008, in the New York Times:

“I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.“

“It’s only when the tide goes out that you can see who’s been swimming naked. What I think this means is “Know what you own and use conservative analysis to reduce the amount of mistakes you may make because the future is uncertain.”

“A group of lemmings looks like a pack of individuals compared with Wall Street when it gets a concept in its teeth.” —Warren Buffett

“People’s investments would be more intelligent if stocks were quoted once a year.”
—Warren Buffett

John Templeton

There was a man who borrowed money in the 1930s to buy 124 U.S. stocks for under a $1 apiece. He bought all of them he could find with the hope that a small percentage of winners would more than make up for the slew of losers that were likely to come. His name was John Templeton, the Templeton of Franklin-Templeton Funds. Before the merger many years ago, the Templeton Funds were famous for outstanding performance and conservative investing style. John Templeton is considered the father of the mutual fund by many.

“To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude, even while offering the greatest reward.” —Sir John Templeton

Jim Rogers, Arbitrageur and financial editor says:

“The smart investor . . . learns to buy fear and panic and to sell greed and hysteria.”

Daniel Drew, notorious stock market speculator, found from notes in his trunk after his death in 1870:

“The way to make money on Wall Street . . .is to calculate what the common people are going to do, and then go and do just the opposite.”

—Paul Samuelson, economist

—Peter Lynch, very successful manager of the Fidelity Magellan fund.

—Bernard Baruch, famous financier, investor and confidant of presidents

—Winston Churchill

“A kite rises highest against the wind, not with it.”

These are some smart words from some very smart people that can help you get your power back. Sorry that I mislead you by promising fast acting relief for your emotional neuralgia (what ever that is) and I hinted at the likelihood that a simple pill would solve your problems. There is no pill and this is not easy to do. That’s why so few get it right. But you CAN get it right if you get your power back. These ARE the times when future fortunes are made.

—and even though the blood running in the streets today may be yours, Warren Buffett, John Templeton, Jim Rogers,  Bernard Buruch, all made their fortunes in times like these.

It’s your turn now.

The markets continued their up and down rollercoaster last week as pundits and investors tried to figure out why this or that was happening.

It was a big case for: “one man’s ceiling is another man’s floor”. I’m talking about oil in particular. Last week oil hit $68 per barrel, ending slightly over $70. So why is the media so quiet? When oil was $145, everyone was screaming about the terrible effects on the economy. These days the media is so preoccupied with the “bailout” story, oil is barely mentioned. Oil is trading at a 14-month low potentially saving the economy an estimated $330 billion (every decline of $10 saves $70 billion). So let’s take a look at a wider picture and figure out how the media shapes our thinking.

In his book The Black Swan, Nassim Taleb describes the condition that no matter what is happening in the market, a seemingly plausible reason is always given. Last week for example, Gold fell $40 per ounce. Why? Are central banks selling? Are investors no longer worried about financial Armageddon? Did inflation disappear? Is this what drove investors to sell gold? We heard all these reasons for this large one day selloff because we are always looking for the reason for things. It’s human nature. But you know what? No one really knows why. Sometimes when asked why the market rose or fell, I kid around and say: “more sellers than buyers” or “buyers than sellers”. But the fact is: that is the only reason one can know for sure why investments rise or fall.

Take those lowly pools of mortgages that seemingly started everything. The general consensus among experts is that these pools will pay back the majority of principal, there is just tremendous uncertainty about exactly how much and when. For lots of reasons, buyers have stepped aside because they are afraid. This leaves the sellers in charge. When sellers are in charge prices drop. When there are NO buyers, prices collapse. These days, prices are collapsing a lot in many markets because everyone is afraid to buy. So why have mortgage prices collapsed? Foreclosures? Worries about the economy?  Greedy bankers?  Sure. Take your pick. Prices have dropped because sellers are in charge right now.

There is no doubt that during the week ending October 10^th, sellers had the upper hand. So much so, that it seemed like a panic. Buyers had to step away. but, as is often the case, buyers are showing more interest and have come back to the market.. Even to say that buyers and sellers are about even causing the market to have a slight upward bias. This is better news.

Forget the reasons why, it’s all about buyers and sellers.

The same thing happened in the bond market. There has been so much fear (so the media says) that investors sought the safety of U.S. Treasury bonds. The yield on one month t-bills dropped to .05%. You might as well put your money under the mattress. That’s how scared everyone was.  

Key lending rates had also spiked because sellers were in control. That has eased too. This is better news.

So the lesson here is don’t focus on the reasons these things happen. Like the reasons given for the original spike in oil, no one knows why prices spiked. They’ll say it was tight supply or point to fantastic projections for future growth or blame the speculators. Maybe those are the reasons. Maybe yes—maybe no. But I can tell you one thing. It’s was more buyers than sellers but now the reverse is true. Sellers are in control. Is it because of the fear of recession? Are Hedge funds selling out to pay for other bad investments? Is it the speculators again? Maybe yes…. maybe no.

Just more sellers. That’s all we can say.

Summary: 

Someday in the future, someone will study what happened and we will have our answer (we probably won’t care because we’ll have another set of perceived problems). In the meantime, the lesson to be learned is: you don’t need to know “why” to be a successful investor. You just need to know who’s in charge, buyers or sellers.  

So, don’t buy a word of the “why”. You don’t need to know the “reason” to create a successful investment strategy, so, don’t make it part of your investment strategy.

Good investors know that the truth is far harder to come by and to a large extent, unknowable.

Just understand what you own and stay clear of the reasons why. Creating wealth is reason enough.

What a wild ride. Nothing like it has ever been witnessed. Nine months worth of bear market decline took place in just two weeks. Was this just an emotional sell-off, based on fear or was it a foretelling of a future of impending doom?

Let’s look at the cycle of market emotions. I have been saying since December to be cautious. Don’t sell everything but don’t chase the market either. Keep some money in cash, diversify and know what you own. Good words, the right words, but based on last weeks trading, the wrong words, at least temporarily.

You see, there is a great unwinding of credit all over the world. Investment companies that were borrowing yen in Japan, at near 0% interest were buying assets of other countries and making money hand over fist. Now that those investments have declined, they have to sell to pay off their loans and a downward spiral is created around the world.

Add to this the degree to which the central banks have had to intervene to keep the financial community afloat and the uncertainty has brought even more sellers into the market; and, it seemed last week that there was no end in sight.

Most of the selling is from the big players in the global market. What about you and me; the little guys?

What are you doing? Are you selling you’re stock funds in your 401k? Stock fund money managers see the flow of buy and sell orders throughout the day, and they will sell securities to meet those redemptions. This means even more downward pressure on the stock market adding our little bit to the spiral.

There is so much panic selling now, that only a very few are stepping in to buy. Who are these people who are buying now? Is it you? Probably not, right?

Of course, every time you sell a stock, someone is buying it. Do you ever look at the historical prices of a security you were considering for purchase? The stock you’re looking at for example, is now priced at $40 but sometime in the last 20 years the stock was just $1.50. Ask yourself: Who was it that bought this and how did he or she get this low, low price? What were market conditions like at that time? Were they just like they were now?

I remember back in the early 1990’s when the market was swooning, (Remember the S&L crisis and the RTC)? The Tisch family bought a lot of stock of the Bank of New York at about $15 per share. The stock continued to decline. If my memory serves me correctly, they picked up some more at 11 but the stock continued to decline to $8. I said to myself, at the time (I was very young then) — see they are wrong they have made a mistake! Two years later the stock was at $30.

If you wonder who is buying now, when everyone is running around selling, it’s those kinds of long-term value investors who are now stepping in. Remember these are the days from which future fortunes are made.

So let’s get back to this idea of the cycle of market emotions.

Imagine looking at roller coaster from the side. The track goes up and down and up and down. Now imagine this coaster is your emotions. When you start up the first hill, you are feeling a little anxiety but if you’re like me, excitement is building. Going back to your investing strategy, maybe your 401k is rising every month and you can literally see yourself get richer by the day. You become more optimistic and put more money into the market and if your advisor has suggested the same, he or she looks very smart around this time. If this goes on long enough, you are really feeling great. Confident, optimistic, even euphoric as all your recent decisions have been right. You’re feeling smart, very smart. You may even decide that you are so smart that you put all your money in the market or maybe get aggressive and buy the latest and greatest darlings of Wall Street.

But guess what. Nothing lasts forever and the market starts to go down. You feel some anxiety, but remember that the last time this happened it was a little sell-off and the market rose again. Only this time, it doesn’t happen. It begins to fall more. Your anxiety turns into fear, but, you tell yourself, “You’re a long-term investor” and will hold on.

But the market continues to decline. Now your feeling that holding may have been a mistake. The newspapers are talking seriously about recession with possibilities of depression, and selling is rife. Now you’re getting desperate. Why didn’t I sell before? Why didn’t my broker tell me to sell? Maybe I know nothing, but he or she is supposed to know! Then, ouch, a few really nasty days take place and you become terrified. Maybe it is the end of the world? Maybe I’ll never get to retire? Maybe those that are saying “sell if you have to retire in 5 years” are right. Do they know something I don’t? You call your broker and tell him to sell, sell, sell. Sell at any price; Sell everything no matter how good it’s supposed to be, just put me in a safe place until this terrible storm blows over.

Whew………-back to the rollercoaster.

You have just been on the 300 foot drop and you thought you were going to die. You negotiated with God and promised never to do this again. Back to the market. The market starts rising again. But you’re not gonna get suckered into buying. Oh no. never again! But the market continues to rise and your 401k is looking better once again. You start to feel a little more confident. The financial news networks are telling which stocks to buy now. Money Magazine’s cover is “The Best 10 Stocks to Buy Now” and you put in your toe; you call your broker for a recommendation. You are feeling more optimistic, more excitement and you are feeling smarter once again. You have just been through the Cycle of Market Emotions.

So, what should you have done? Buy when you were most euphoric or buy when you are the most depressed? I think you know the answer. Now the question is: how are you feeling today, and can you fight your fear to buy now when it feels so scary?

Remember, someone is buying. Someone’s future fortune is being started right now.

Could it finally be yours this time?

The seeds of future fortunes are now being sewn.

With so many things breaking down and so much worry about the many new financial issues appearing day to day, it’s time to take a step back and garner a larger view of the investing landscape.

What can we see from our perch?

We see Wall Street seething and frothing at the mess they have gotten themselves into.  Right now the blame is not important; there is plenty to go around.  Capitalism tends to go to these extreme cycles.  And this extreme has now brought “once venerable” companies to their knees.  Companies like AIG, Wachovia, and Merrill Lynch.  Even Goldman Sachs, with its savvy management and high quality personnel couldn’t escape from this market’s wrath.

The reason?

The answer is: leverage, leverage, leverage.  You see, borrowing money to buy investments with 50% down is risky, but while you and I can only leverage 2 maybe 3-to-one in the market, financial companies have no such rules.  They can borrow over 30 times and more on their own capital.  Wall Street plays to a different tune.

If you or I put 50 dollars up to buy a 100 dollar investment, a 10% move is magnified 2 times.  A 10% rise in your investment means a 20% return.  Your 50 dollars is now worth $60.  A 10% fall means a 20% loss.  You’re $50 is now worth $40.  It hurts a bit but not devastating.  It’s dangerous but manageable.

Wall Street firms were putting 3% down or 3 dollars for every 100 invested.  This means every move is magnified 30 times.  A 10% gain in the investment is a 300% profit.  Your $3 goes to $9. Wow…happy days.

But a 300% loss means - not only have you lost your $3 dollars but you now owe the bank 30 dollars and that money has to be paid or the bank will take everything.

What do you do? You sell your best assets and everyone on Wall Street who is in the same position does the same. Your best assets this year are oil, gold and blue chip stocks.  So oil goes from $145 a barrel to $100 a barrel.  Gold goes from $960 an ounce to $800 an ounce.  The Dow Jones goes from $12,500 to $10,000.

But guess what, even that was not enough, so the companies in this mess need new investors to give them capital to survive.  They begin offering sweet deals to white knights like Warren Buffet and foreign investors.  Then consolidation begins.  Weaker companies fall into stronger hands.  Merrill Lynch goes to Bank America. Wachovia goes to Citibank or Wells Fargo.  Washington Mutual goes to JP Morgan and so on.

So you see, 300% profit….Glory Days.

300% loss….utter disaster with consequences.

The next problem occurs because of human nature.  You see, even though banks are rebuilding their capital, they are now afraid to lend.  The world has changed on them, and until they get a better view of this new world, they want to avoid making ANY mistakes.

So now, some good customers of the bank can’t get the money they need to keep their companies going.  Those companies may not be able to make payroll, while others may have to lay off workers.

So the cycle deepens and soon, Wall Street feels the squeeze.  This is not a myth.  It’s real and it’s coming to town near you.

So how does this get fixed?  Unfortunately there is only one player at the table with the resources, time horizon and unlimited capital to do something.  Guess who……It’s you and me….collectively; In other words, it’s the Federal government.

You see, now that all the major institutions in the world are trying to undo their leverage, and this is what we want them to do, the problem is they’re all trying to de-leverage at the same time.  So if huge institutions are trying to de-leverage, you need someone in the world that’s willing to take their place and increase their leverage.  And there’s no one that can leverage like the United States government.  The amount of leverage needed is the $700 billion everyone is talking about.  And I’m pretty sure if they do it even close to right, the government should make a lot of money on it.

So this is all fine but the important question is:  What do you do with your own money.

The mantra is the same.  Control what you can and lessen your exposure to events you cannot control.

Keep a good size portion of your money in safe, liquid assets and only add investments when you know what they are and you are reasonably assured you can make a large return.

If you don’t know how to do this yourself, find someone who does; a mutual fund manager, an excellent advisor or a money manager.  But be careful. Do your homework.

Cash is not something to be afraid of.  Money markets and CD’s are safe. If you want to know more go to:

1.      www.fdic.gov

2.      For money markets: (www.treasury.gov)

3.      How safe are my assets at my brokerage firm?: www.sipc.org

Looking back 5 or 10 years from now you will see that today, in these times of great disruption and uncertainty, the seeds for future fortunes are now being sewn.  Keep your emotions in check keep your eyes open and become a real investor.  

Take the long term view, don’t speculate and don’t invest in something you don’t understand.