Friday, August 6, 2010

Cold War: yellow alert.

Do you remember Barry McGuire’s 1965 hit, Eve of Destruction? “If the button is pushed, there’s no runnin’ away… Can’t you see the fears that I’m feeling today?” His protest song reflected the wide-spread belief that we lived in a time of danger.

In the 1950s, The Saturday Evening Post featured articles like: Will A-bombs Fall? – and College Communists. The underlying sentiment was the same as McGuire’s protest song: we live in a time of danger and we need to stay alert and protect ourselves.

That sentiment was a big part of life in the 1950s and 60s: two generations had been involved in world wars. The widely recognized baby boomers had parents and grandparents who were directly involved in massive world wars. War had become part of their personal psyche. Danger was part of their up-bringing. For them, world politics involved constant vigilance: in order to protect ourselves, we need to see danger way earlier and respond way earlier. They lived their lives on yellow alert.

But 60 or 70 years of relative peace have lulled their baby boomer children and grandchildren into complacency. Bobby McFerrin’s reggae song, Don’t Worry, Be Happy reflects their rosy optimistic state of un-alertness.

We see the same phenomenon in the financial world. The 1929 to 1932 collapse of the stock market and the 1930s depression impacted our parents and grandparents: they handled their investments with caution, constantly maintaining monetary yellow alert.

In my investment book, Beyond the Bull, I discuss the concept of yellow alert as it applies to investing. In my CD, The Five Levels of Investor Consciousness, I site modern day examples of a variety of financial disasters and how they destroyed investors wealth. My goal is to help people do their investing in the mindset of yellow alert.

But so far, it’s not working. It seems the impact of the 1982 to 2000 bull market has lulled investors into complacency. In the 1990s mutual funds boom we were told we could become rich like Warren Buffet by buying mutual funds and holding them for the long term. But when the bear market began in the year 2000, the rules changed. And now, ten years later, Warren Buffet is even richer, but investors in typical equity mutual funds are not. After ten years of poor performance, stock market investors should be getting back to the yellow alert attitude of the previous generation. But that’s not happening. Stock market investors are still complacent.

What will it take to wake people up?

That’s the problem. We know from studying the alertness of the population for 100 years that it takes a disaster to wake people up. Two world wars put our parents and grandparents on “international politics yellow alert.” A stock market crash and a depression put the same generations on “financial yellow alert.” Will it take another mega-war to alert this generation to the notion of international self defense? Will it take the another stock market crash to alert us to the notion of financial self defense? What will it take?

Here’s how it looks so far:
1. Yellow Alert International Politics Observation: A dictator in North Korea has openly threatened nuclear war. He is intentionally provoking a war with South Korea and with The West. Rosy Complacency Response: This dictator no longer has the unfailing support of The People’s Republic of China and is not going to start a war without it.
2. Yellow Alert Observation: The government of Iran is developing a program designed to give them nuclear weapons. The Iranian president is openly denying it, but Iran’s nuclear program just keeps rolling along. Rosy Complacency Response: When Iraq tried to do the same thing decades ago, the Israeli Air Force bombed the nuclear installation. No problem. If worse comes to worse and Iran doesn’t stop their nuclear program, the Israelis will stop it for us.
3. Yellow Alert Financial Observation: America’s biggest bank, insurance company, auto manufacturer, stock broker and mortgage company all had to be bailed out in the last two years. Certain sovereign states are unable to pay their debts and are being bailed out by the European Common Market. This indicates that the decline of corporate America may not be over. Rosy Complacency Response: the stock market climbs a wall of worry. The early stages of all long term bull markets are accompanied by unfavourable economic news (the so-called wall of worry).
4. Yellow Alert Observation: Americans are currently debating re-stimulating their economy because some are worried that a second wave of recession could start at any time. Such an occurrence could trigger another dramatic 2008-style sell-off in the stock market. Rosy Complacency Response: same as above - the stock market climbs a wall of worry. The early stages of all long term bull markets are accompanied by unfavourable economic news.

Advice for those who have achieved yellow alert status: reduce risk in your portfolios. For most people, this means investing less in the stock market and more in the bond market. Change your asset mix and become more safety oriented, less growth oriented.

Advice for those who are continuing with their original plan of buying and holding for the long term: listen more to your own instincts; less to your financial planner, mutual funds salesman or stock broker.

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