Riding the Roller Coaster

This is normal.  Many people simply cannot handle stock market volatility, which is why the people who DO have, historically, tended to make more, over multiple ups and downs, than the people who kept all their money stashed away in Treasury bonds.

The question is: is there better way to handle the inevitable anxiety that comes with buying stocks?

Psychologist Ken Haman, who now works at the investment firm AllianceBernstein, says that the key is to stay rational.  He points to studies of the human brain which shows that all of us actually have two brains.  One is the neocortex, where all of your higher thought processes take place.  Below the neocortex is a primitive brain which is about as smart as an alligator, and this lower brain happens to be where all of our survival instincts are housed.  Whenever you experience panic, the primitive brain immediately takes over and shuts down the neocortex–which allows you to respond instantly (rather than thoughtfully) on those many occasions when a saber-toothed tiger is running in your direction.

So when the markets have spent the past quarter giving up all the gains they generated in the first quarter, what do you do?  First, talk with somebody who actually listens to you about how you’re feeling.  Then start to engage your neocortex.  What do you imagine is going to happen in the future?  Then move to: is that what you think, or how it feels?

If you’re talking with a professional advisor, the advisor can guide you through this process, and then, when your neocortex is functioning again, you can look at some of the past market declines and see what happened next, or look at your financial situation and take stock of your progress toward your financial goals.

People who can handle the stock market roller coaster without getting sick seem to have an unfair advantage over everybody else in the investment world.  It seems to depend on which part of your brain is in control.

This is post written by Bob Veres.  He is the publisher of Inside Information, an industry leading publication for financial advisors.

Photo Credit: royal19

We spotted a story in the WSJ recently, which described how the Dow’s performance in May was the worst May since 1940.  So we thought it might be helpful to take a trip back to the 1940’s and investigate what the general mood of investors might have looked like during that time.  Most investor’s confidence in the stock market had to be incredibly shaken due to the erratic volatility at that time.  The decade they had just lived through, the 1930’s, saw the Dow register eight calendar months in which it rose or fell by more than 20%. They also had to withstand three stock market drops of 30% or more (with the 1929 crash falling 89%) during that period. Now entering the 1940’s, a pervasive attitude of gloom had spread across our nation.  Many of the messages in the media characterized the build-up of a country preparing for war.

From a 1935 edition of Modern Mechanix

Headlines and News of the 1940’s

• Germans invade Western Europe, France and Great Britain; London suffering bombing attacks daily for almost 2 months
  
• Unemployment drops but is still over 14%; “Union Closes Plant” 200 Men Reported Discharged by Boeing Company; Retaliation Suspected
  
• FDR signs legislation requiring US men Register for Draft
  
• Automobile Production Ceased in 1942 due to need for steel

War on the Horizon

It’s not a far stretch to say that people then were probably even more fearful about economic conditions than they are today.  While fear continued to escalate, U.S. federal debt expanded rapidly, t- bills were near 0% and war savings bonds with a guaranteed 2.9% annual interest rate over 10 years became one of the more popular investments.  However, the investors who were able to put aside their emotions and continue to invest in stocks fared much better.  Dollars invested in the stock market from 1940-1949 averaged more than 9% per year over that decade.  In fact, for the three decades beginning in January of 1941-1943, the annual returns were even stronger averaging in a range from 12% – 15.5%.

That means if you had invested $100K each in stocks, bonds and cash on January 1, 1940 and left it alone through December 31, 1949 your $100k would have grown to the following totals identified by asset class:

What You’ve Seen Often Isn’t What You Get

As the graph clearly shows the price you pay for safety in the short-term could likely be a costly one over the long-term.   By many accounts, at the end of the 1940’s, Americans never had it so good.  The war was over, jobs were plentiful, housing was affordable and the American Dream was in reach for more people than ever before.   How truly valuable this knowledge could have been for an investor at the beginning of 1940.

For many investors in 2010, the strain of watching their investments swing on the roller coaster ride we’ve had since late 2007 has left them fatigued and ready to give up.  However, as much as it goes against our psyche, a negative return for an entire decade is a powerful reason as to why we should be excited about the prospects for the next 10 years.

Deflation Fighter?

Gold’s average annual return (using average monthly price) from 1980 through 1986 as it followed the inflation rate down is a negative 10%; from 1980 to 2005 it is a negative 2%.  Meanwhile, gold didn’t hit its average monthly high again until over twenty five years later when it began its recent bull run in 2006.  Since 2006, gold has averaged a return of over 17% per year.  However, inflation has hardly been out of control during this time and, in fact, the prevailing fears currently facing the markets are those of deflation.  So how is it that a commodity that has a history of being used as protection against inflation is suddenly a haven in a deflationary environment?

Yosemite Sam’s Investment Choice

Gold is also a reflection of the overall faith (or lack thereof) in the economic and political system. Issues such as the European debt crisis, the Gulf oil spill, persistent joblessness, a housing crash hangover, etc. have created a sense that the problems we face are too big and might lead to widespread economic collapse.  Currencies will tumble in value in a collapse scenario, so the hedge with gold is that you will have protected your ability to trade for goods and services through the relative stability of its value.  That, in effect, is the bet that is being made by those who are pushing gold up into stratospheric territory.  The gold bet in 1980 didn’t break even for another twenty five years (even longer when adjusted for inflation), it will be interesting to see how well today’s gold bet plays out.

At the beginning of every month, during what we’ve coined our long-term investment “Outlook” meeting, our investment team gets together to debate different investment ideas of where we each see opportunity in the marketplace, while also trying to identify potential risks that could trip us up.  This process involves detailed discussions in which we compile a healthy collection of economic data and opinions to determine where the financial markets may be headed.  One of the things we have learned in our meetings is that a big part of being a successful investor is understanding where and how you have a competitive advantage over another investor.  A key to identifying these opportunities is knowing which sources are worth listening to vs. which ones are using biased assumptions to create support for their opinions.  After formalizing how these scenarios may or may not develop, we investigate specific ways that we can position our clients’ assets with the expectation that their portfolios will most advantageously benefit.  So without further ado, following is a summary of a few of the issues we discussed in our January “Outlook” meeting:

• Even though the unemployment percentage still hovers around 10%, this could be yet another positive for future stock market growth.  Typically, high unemployment coincides with the start of an economic expansion which is good for the stock market.

• Consumers and US corporations continue to improve their balance sheets.  Both groups have built up a healthy amount of pent-up demand which will likely continue to fuel the recovery.

• The average age of a car on the road is now 9.5 years old (which is the oldest average ever) and 2009 saw new car sales reach their lowest unit level since 1982, even with the added cash for clunkers steroid shot.

• China is now the largest consumer of cars in the world, which increases global demand for oil however; at some point other energy sources will become viable which would reverse this trend.  We realize that as oil prices rise, pressure for alternatives will continue but in the short-term we are not decreasing our energy holdings.

• One of the pressing primary risks is how smoothly the hand-off will be from government stimulus to private sector growth.  It’s important to remember that discussions about the removal of stimulus funds, interest rate increases, the speed of recovery and inflationary threats are a part of all economic recoveries and are typical for a bull market as it climbs its wall of worry.

• On average the market experiences a 10% drop at some point every year, so it’s not out of the realm of possibility that these lingering fears could cause some short-term market fluctuations.

• We feel that US high quality dividend focused companies’ likely hold the most opportunity for 2010.  However, we’re still allocating a significant portion to foreign stocks as a way to add diversity to client portfolios as well as provide a hedge against the US dollar.

• We still see little threat of inflation in the short term as the world has substantial under utilized resources. It will likely take years to re-employ those resources, though we may still get an up tick in inflation in the medium term.

How did your investments fare during the Lost Decade?

He writes:

“The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters, helping us make the transition away from huge trade deficits to a more sustainable international position.”

While we agree with Professor Krugman that a lower dollar can help to even out our trade balance, if it falls too low, however, it could create unwelcome inflationary pressures. The Federal Reserve will look to prevent an inflationary event by tightening the monetary spigot which includes raising interest rates.  Krugman argues that this would be a disastrous policy move at this stage of the economic recovery.  He was an ardent proponent of government intervention in the form of stimulus and believes that we didn’t do enough.

Click here for the original article, “Misquided Monetary Mentalities.”

http://www.chartoftheday.com

The rest of the story is that the last 12 months of earnings are not
representative of what earnings will be going forward.  Our best estimate is
that at current price levels, the PE ratio is actually around 13 to 17.  Most
definitely not the most expensive market in history.

Much of our research effort involves separating good data from bad data,
which is essential to gain and maintain a competitive edge against other investors.

Here is Bill’s response:

“The housing market is not going to be the engine leading us out of the recession, but clearly it is going to be less of a drag than it has been or should be.”

Click here to view the original article entitled  Pending Home Sales and Affordability Numbers Jump Higher.