Column: major bear markets and "irrational exuberance"

Every major bear market of the 20th century resulted from investor "irrational exuberance" caused by unrealistic profit expectations based on what was perceived at the time as a technological new economic era.

In the 1920s, it was the revolutionary productivity improvements from electricity and the automobile. In the 1960s, it was the transistor. Today, it is the Internet.

Can investors now afford to relax their vigilance? No! Does history repeat itself? Not exactly. The song changes but the rhythms are very repetitious. Think back to the year 1968, the year before the Crash of 1969.

In 1968, where were you? Most of today's stockbrokers and investment advisers were either in diapers or were yet unborn. America's military had been fighting in Vietnam for more than 10 years, though most Americans were ignorant of the fact. The stock market started falling into what would be a 14-year bear market, at one point losing almost 50 percent of its former value, especially devastating to retirees.

I was 23 years old, almost having completed my first year of a doctoral program in history at the University of Illinois in Urbana, Ill., when my "greetings letter" arrived from Uncle Sam.

Over the next 3 1/2 years, I would become an infantry officer, serving first as an infantry platoon leader, outliving other young lieutenants in my unit to become a company commander until my luck ran out and I was wounded.

I returned to the world wounded physically and spiritually, but infinitely wiser. Isn't it strange how the acquisition of wisdom almost always carries the price of some pain, suffering and the loss of youthful innocence?

The experience of Vietnam made an indelible impression on me; how I think, make decisions, what I value. I had no idea when I returned from the war just how much it had influenced me - particularly how I would approach the practice of my future profession as an investor and money manager. But one thing I knew for sure; security and safety are at best illusions. Life is a perpetual war; a series of skirmishes, ambushes and full-pitched battles where the stakes are always the same - your physical, mental and spiritual survival.

Understanding how to invest successfully is part of the life strategy you must master if you are to fight your own personal war successfully and survive well.

A short list of the investment lessons I learned in Vietnam follows:

1. Do not forget the lessons of history. Imagine having worked from 1900, saved and invested, having bought and held a diversified stock portfolio until 1929. When the October crash hit, the broad market lost 90 percent of its value. It did not recover from those losses until 1954.

More recently, we had the bear market of 1968 to 1982 where the broad market lost almost 50 percent of its value. Can your investment and retirement strategy sustain you through that type of 14-year investment drought?

2. Develop a well defined investment plan with clear goals and objectives based on a thorough understanding of the dangers and opportunities confronting you.

3. Be ever vigilant - expect the unexpected, especially when it seems nothing can go wrong. Remember, nothing very good or bad lasts forever.

4. Be flexible and alert. No single tactic or strategy works under all circumstances. Consider beating inflation. In the last 202 years of the New York Stock Exchange history, during at least five multi-year periods totaling more than 86 years or 43 percent of the time, owning the average stock was a losing investment idea after factoring out inflation: 1807-1813, 1837-1859, 1907-1921, 1929-1949 and 1968-1982.

What about diversification to eliminate risk? Since 1920, there have been at least seven periods when none of the usual investment vehicles have beaten inflation - stocks, bonds, real estate or precious metals: 1920-1921, 1929-1932, 1941-1942, 1946-1949, 1968-1970, 1980-1981 and 1983-1984.

Often diversification guarantees failure because the unprofitable investment segments drag down results from the profitable segments.

In reality, sometimes putting all of your investment eggs in one basket is the only safe and profitable thing to do. Sometimes simply holding cash is the best, most profitable, safest investment decision.

Sometimes it is best to buy and hold, digging in to take a defensive hold- your-ground position. At other times, you must invest aggressively and charge ahead, attacking directly into the danger that you perceive, seizing the opportunity changing circumstances provide. Success requires proper timing.

5. Do not risk assets and resources frivolously or speculatively - especially for poorly defined goals and objectives. For example, owning gold funds or stocks has been a losing investment for most of the last eight years, but has any gold fund manager suggested that investors sell? No!

6. Investing, like other forms of warfare, is full of paradoxes. Often the strategy or tactic that emotionally seems the safest virtually guarantees disaster.

7. Preparation for battle is continuous. Constantly upgrade your investment knowledge and skills.

8. Trust only information that you can personally confirm before acting on it.

9. You are always responsible for the results in your life, even when your problems may have been caused by something or someone else, like some adviser's or broker's inept investment plan.

There is a continued tendency of the non-professional investing public to have unrealistic expectations of the sustainability of the current bull market. A recent investment industry survey found that most non-professional investors believe 30 to 40 percent returns on investment are normal. This is the most dangerous form of investor naivete.

Please understand, I do not enjoy being a maverick within my profession. However, I am also continually troubled by the tendency of many, though not all, in my profession to prey on this naivete.

Among institutional investment professionals, you non-professionals are called "publics" - sort for non-professional public investors. it is an investment synonym for "sheep" to be sheared, clipped and generally exploited by the Wall Street institutional professionals.

The current "runaway" United States stock market has been fueled, in large part, by brokerage and mutual fund industry spokespeople encouraging the illusion that you are living in a new economic and investment era, the beneficiaries of a new economic paradigm where the laws of "economic gravity" have ceased to exist. Their fee and commission income goes up as you forget Newton's Law of Gravity has its counterpart in the economic laws driving market cycles - including the global stock and bond markets.

You are encouraged to forget that the return OF your money can be as uncertain as the return ON your money.

Many investment industry leaders want you to follow their investment advice without questioning their underlying assumptions. They offer simplistic approaches to gain financial security that should insult your intelligence.

You hear constantly that risk free economic security will result from simply buying and holding a diversified portfolio of stocks, bonds or mutual funds or purchasing the same through dollar-cost-averaging; i.e., equal periodic investment of the same dollar amount.

They tell you that over the long term these approaches to investing will allow you to defeat the major threats to your money. Those threats are inflation, market fluctuations and other general economic risks such as war and acts of God.

This is a fool's paradise. They tell you, "Simply diversify your investments and then you go to sleep. You can wake up 20 years to a safe and secure retirement."

The effects of these risks when they occur have often lasted so long that you would have died before your investments recovered from the damaging effects. The risks to your money can be managed and reduced but not eliminated.

The best way to manage the risks to your invested money is by learning how the various economic risks provide profitable investment opportunities. You must be prepared to move your assets as the economic cycle and other events like war and natural disasters dictate.

Failure to obtain that understanding will doom you to suffer from the ignorance of our economic history over the last 300 years.

Remember, "For everything there is a season." And in human affairs, nothing very good or very bad lasts forever.

Clifton Maclin is an SEC-registered financial services representative in Carson City.


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