INVESTMENT STRATEGY HANDBOOK FOR   VOLATILE MARKETS

Carl M. Birkelbach

DUE TO THE LIMITATIONS OF THIS DASHBOARD SYSTEM WE ARE NOT ABLE TO SHOW ANY OF THE CHARTS IN THIS BOOK. HOWEVER, PLEASE CONTACT THE AUTHOR AT CARLBIS@AOL.COM FOR AVAILABILITY

 INTRODUCTION

THE TIMES ARE CHANGING  The “American Dream” that your children will be better off than you, is quickly fading. Most of us, from the top 20% to the bottom 80% are fearful that their life style is being threatened. This fear is not based on paranoia. Many are now not only facing unemployment uncertainty and reduced equity in their homes, but because of sustained low interest rates and volatile 401Ks, the “ideal retirement” has become virtually unobtainable.  How can you cope with the challenges of today’s economic environment?  You have the freedom to invest and the markets to invest in. However, volatile stock markets have disappointed many investors and have driven many individual investors away from the markets.  I believe that this exodus is because the old traditional methods of “buy and hold” and Modern Portfolio Theory, (which dictates diversification in mutual fund portfolios) are not designed to offer investors an investment strategy that deals with the reality of today’s current volatile investment environment. Don’t be discouraged, this book will equip you with tools needed to make the necessary decision, so that you can use the markets to become financially independent.

YOUR MONEY AND YOUR EGO

I have been giving investment seminars throughout the United States for some 30 years. I always begin by asking the audience a question: How many of you believe the Dow will go up 1,000 points before it goes down 1,000 points?” Then I ask the opposite “How many of you think the stock market will go down 1,000 points before it goes up 1,000 points?” It’s not easy making investment decisions. We involve our money and our ego. Not a good combination. Our ego demands that we be “right”. When my wife and I get into a heated discussion with differing opinions, she says to me “Would you rather be right or would you rather be happy”. When investing, it is not important to be right, it is important to make money and that will make you happy. It is natural to want to be “right”, but we often see things and the markets not as they are, but as who we are. We can accumulate vast amounts of data to rationalize our position. If the price of our investments goes down along with our money, we will likely argue that the market was “wrong” and we are still “right”. However the market is what it is. Just like in the Bible, when Moses asked the Burning Bush who are you? God answered “I am what I am”. The current price is reality staring you in the face. As British Economist John Maynard Keynes said “markets cay stay irrational longer than we can stay solvent”. Sometimes when you buy a security and it immediately goes down or when you sell and it immediately goes up, you think the security is sentient and is punishing you for trying to make money the “easy” way.  But you know logically that security doesn’t know of your existence. It is no more than a vehicle that transports your money and has no feelings for you. You don’t have to be loyal to it. No amount of praying or rationalizing is going to move the price. The future is always uncertain and the current price is the “perception” of what investors think the facts will be like in the future. You can be right about  the future, but wrong about the markets. It is supply and demand that moves prices. You want to be rational, but the markets are not necessarily rational. As a normal business cycle goes through expansion, peaks and contraction, prices go up too far and go down too far. That’s always been the case and always will be. Now add the computerized trading that generally accounts for some 70% of the volume and you have even more irrational markets[1]. So stop trying to be right and start making money.

You are not a philosopher like Plato and Socrates in search of the “Truth.” You are an investor who is trying to use your access to investment vehicles that will give you financial independence.  So take a deep breath!   Why not, you are no responsible for the state of the world or the economy.  When it comes to investing, you don’t have to make a judgment about the size and the role of government.  That’s not your responsibility. You only have to decide how the markets perceive the current political and economic environment, which this book will help you to do.   OK.  Find that neutral center within yourself where negative and positive forces cancel each other.  Be nonjudgmental. Stop trying to tell the markets what to do.  Open yourself up to a different approach. Got it!  Now take a deep breath – Oh heck, take three deep breaths.  You deserve it.

GETTING INTO THE ZONE OF SUCCESS

This book will outline an investment strategy and a methodology that will hopefully make you self-reliant and make your decision making easier. Although this book emphasis is mostly about the stock market, the methods can be used for anything that you can make a price chart for, including bonds, commodities and derivatives as well  I believe that while markets are irrational, they can be irrational in a predictable way! Rather than telling the markets what to do, instead this book will teach you how to listen to the markets and let the markets tell you what to do. As Bob Dylan sang “The Times they are a changing- Either learn to swim or sink like a Rock”.

I will refer to music to accompany some of my points. That’s because the state of mind and zone that you need to enter into is an emotional one. Facts alone will not get you there. Remember markets are not necessarily rational. They go too far up and too far down. So the reference to music is my way of saying, let’s go beyond the rational and be able to get in touch with the emotional side of the market. I am not talking about the kind of emotions that has your hands sweating, eyes hurting and head pounding. That definitely means you’re not in touch with the “Zone”.  The “Zone” you are looking for is a place where you are able to quietly look at the rational and irrational aspect of the current markets and not be judgmental.  Investing successfully will require both right and left side brain process.  The left of the brain is analytical, structured, factual and objective.  The right side of the brain is subjective, emotional and intuitive.

Hopefully there will be a time when the answers you seek will suddenly click into place for you. It’s like the tumbles of a lock, that one by one fall into place and the lock opens. The methodology I am suggesting is an art, not a science. You will use the right side of the brain to analyze data and input related news, chart patterns, trends and ratios to arrive at your decision. However, only the left side of the human mind can judge the nuances, intricacies and the “feel” that is needed to be “in touch” with the markets. The answer you seek will not necessarily come to you by just listing all the facts or looking at algorithms. You are not a computer or like any machine. You are better. The methodology I am suggesting is a process. You can’t take emotions out of this process. You have to find a place where your emotions are at peace, so that you can get in touch with the emotions of the buyers and sellers in the markets. It has been my experience that the tumbles of the lock that give you the desired perspective can suddenly fall into place when you least expect it to happen. It may happen when you are listening to music or driving your car or digging in the garden. So, therefore be open to finding a place that helps you to be open to revelations. That brings us to another explanation. The other thing I do in this book is to relate investment decisions and successful investing to a Buddhist Zen philosophy. At the end of this chapter you will find the “Four Nobel Truth for Investing” and in the last chapter “The Eight Fold Way to Investment Success.” This metaphysical philosophy has to do with the peaceful state of mind I believe you need to be in, in order to make wise investment decisions and for investment revelations to occur. It has been my experience that in order to be a successful investor you need to find that quiet place that resides within yourself that can be achieved only when you are at peace within yourself and at peace with others. I believe you need to find this nonjudgmental metaphysical place in order to be in touch with the forces that affect your investment strategy. Look at this force as friendly. In the right state of mind you will join in the flow of “the harmony of the spheres” as Pythagoras called them and they will guide you to success. The laws that govern the markets are the same that flow through the universe. Awaken!

GOOD AND BAD ARE RELATIVE

For those of us who invest (or speculate) in the markets (stocks, bonds, derivatives commodities etc.) it is important to examine the process and the methodology you now use to determine your decisions. It is human nature for most investors to be positive and patriotic and therefore to be Bullish. We want prices to go up because it is in our general “best interests” that the economy prospers, so our careers, economy and families can ptosper. At one time I labeled my charts as GOOD when a security broke out on the upside and BAD when a breakout occurs on the downside. This is a BAD habit that we as investor have to break. The outcome for us is only GOOD if we are “Long” a security when it goes up or “Short” a security when it goes down. There is a misconception among most investor that they can only make money if the market goes up.  Investors no longer have to rely on only making money in up markets.

THE FINANCIAL INDUSTRY

A large part of the Investment Industry is built upon you keep repeating this old BAD habit of thinking you can only make money in up markets.  In general 401k’s, Banks or Mutual Funds or most Financial Planners do not provide a facility for investor to make money when the market goes down. The Financial Industry is built on a “Buy and Hold” strategy[2] .  I believe this “Buy and Hold” strategy has been created by the banking, mutual fund and the financial planning industry to make investors feel artificially “safe.” “They” explain to you that over the last 50 years the stock market has gone up on average over 9% per year. So your Financial Planner suggests that you buy a good allocation of mutual funds and all you have to do is close your eyes and “hang in there” because on the long term you will just be fine. This “safe” feeling perpetuated by the industry is nothing more than an illusion.   The May 2011 cover of National Geographic Magazine shows a person standing on a small ledge half way up the side of El Capitan in Yosemite National Park.  It’s dangerous up and it’s dangerous down.  In investing, if you feel safe, you just don’t understand the situation.

Most MBAs, Chartered Financial Analysts (CFA) and Certified Financial Planner (CFP) have been taught this one “Buy and Hold” methodology. They have been taught that Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM).  These investment strategies  assumes that price changes are always rational and that investors always accurately forecast the future and that the risk reward ratio to owning stocks versus cash, over a long time period, favors being long stocks. Further, the Efficient Market Hypotheses Theory (EMHT) proposes that it is impossible to beat the market by trading in and out  and therefore investors should  be fully invested in the market in the aggregate by owning an allocation of mutual funds. The dangerous beauty of these theories, models and hypotheses is that accordingly, your goals will always be achieved sometime in the future. Just “hang in there” long enough. This approach gives investors a false sense of contentment.  The investment industry would have you believe that any other methodology means that investors are using the “heretical tactic” of trying to beat the market by using individual stock selection and timing as a strategy.

THE GREAT SIDEWAYS

Since 1997 –  2012     UP 50%   &   DOWN     50%

Let’s look at chart of the S&P500 Index since 1997. This chart clearly shows that since 1997 the market has been up 50% of the time and down 50% of the time.  From 1997 to 2000 the market went up from about 800 to 1500 and then after the “high tech” bubble bust in 2000 it went down to about 800 again in 2002.  From 2002 to 2007 the market went up from 800 to 1500 again and then as the housing bubble burst, down to the ‘biblical demonic low’ of 666 in 2009.  If you invested in the stock market since 1999, you are lucky to be long term even. As pensions are no longer prevalent, employees have been forced into 401ks.  The investment industry has emphasized that 401k’s be invested in the stock market with the inferred promise that on the long run, it is the best investment alternative. The chart below shows that in the last 10 years there have been attractive alternatives to stocks AND THE BUY AND HOLD STRATEGY HAS NOT BEEN SUCCESSFUL. The Investment Industry has investors inappropriately looking at the last 30 to 84 years. It is time for an updated strategy!