Managing Risk Is Not a Choice, It Is a Requirement

Everyone needs to manage risk, but that presents obvious problems to normal investors. With a conscious understanding of the limitations normal investors have, I have developed a strategy that anyone can use to gain an edge over institutional investors. I am going to reveal rule-based strategies that can be used today to help manage risk and realize opportunity without sacrificing time or lifestyle. Normal investors will no longer sit at the mercy of their mutual fund or money managers, and take blow after blow from the market. Instead, by leveraging the nimble reflexivity of non-institutional investors, I have produced a strategy that gives normal investors an edge. The playing field has changed, and from this point forward, smaller investors have the upper hand.

However, no one said investing was easy. It is tough sometimes. Thankfully, most of the time it is much harder than it has to be. We have all been brainwashed by big brokerage firms, and it is time that someone stood up and was heard. In fact, most people should be screaming at the top of their lungs. Brokerage firms care more about generating fees than they care about your wealth. Once we all realize that, we will all take the time to learn how to do it ourselves. I am going to lay out the plan, give you specific strategies, and point you in the right direction, but you need to want to move forward. Stop being a pawn in the game immediately and stay ahead of the curve from now on.

This book is a catalyst to financial independence. You cannot rely on your money manager to protect your wealth. This is a responsibility we all must assume for ourselves. The collapse of 2008 has proven that already. Therefore, the next step is to move forward with wealth preservation in mind. That is the reason I have written this book. I want you to know that you can do better than your money managers and make money in a volatile market, and I am going to show you how to do it.

The market, by which I mean the U.S. stock market, offers everyone unique opportunities to make money all the time regardless of market conditions. All we need to do is recognize them. Rationally, sometimes that is easier said than done. However, that overused phrase doesn’t apply all the time, either. In fact, I dispel many similar myths in this book, and I will point you in a direction so that you can embrace the volatile conditions of today, and the oscillating market cycles of tomorrow, with ease. I will introduce you to the Investment Rate model, which is a combination of tools that will help you protect your wealth and realize opportunities for the rest of your life. If you are reading this book as a result of your distress given the market declines of 2008, after my strategies are revealed you may consider the pain of 2008 to be a most valuable blessing. From here, you will find the way to a better lifestyle, something that can be embraced forever. The lasting impact of my strategies will change the way you approach your investments in the market, in real estate, or in private business by allowing you to grow without exposing yourself to the risk of loss such as you may have experienced in 2008.

Rule-Based Strategies Are Integral

For you the investor, it is time to start moving forward. However, forward is not one-directional. Opportunities surface when the market goes up, and when the market goes down. Your prospects are only limited by your own obstacles. Fortunately, those impediments can be overcome, and showing you how is my mission. I am going to offer strategies that work in both up and down markets, that adjust by themselves, and that keep you on the right side of the curve at all times. More important, though, I am also going to reveal a refined approach to market strategy that removes your personal limitations and allows you to take advantage of opportunities whenever they arise. Included here is a model for wealth management, and risk control, too.

This book should be of interest to all investors, whether in the stock market, real estate, or personal business. The investment strategies I offer in this book have kept my clients on the right path through thick and thin, and they can do the same for you. My clients include government officials, businessmen, doctors, lawyers, professors, hedge fund managers, investment advisors, independent investors, managers, retirees, and employees from all industries, from many parts of the world.

My clients have found solace in my process. I make current and ongoing investment decisions easier. This goes a long way in down markets, but the process works when the market trends higher as well. The quantum of solace that I am able to offer to my clients reverberates through their lives. It transcends mere investing and it betters lifestyles. I will provide that same leadership to you. It will impact your quality of life as well.

Do you hesitate to proceed, unwilling to embark on a complex discussion of economic and investment theory? If so, I understand. Therefore, I will also keep it simple. In that way you will have a clear understanding of current and future economic trends. Knowing the direction of the market in advance will aid you with your investment decisions going forward. Most important, you will end with a complete understanding of the proactive investment strategy best suited for you. Everyone can do this. Proactive strategies incorporate risk controls that protect your investments from loss, provide opportunities at all times, and are the direct catalyst to profitability and the preservation of your wealth. These strategies work regardless of market direction and in any economic environment, and I’ll explain how. You just need to take the first step by reading this book. From there, everything else will fall into place.

The Ultimate Goal

My ultimate objective is to bring you to the comfort zone. This is a place where your investments no longer negatively affect your emotional state. This is where market woes no longer stifle your personal life. This is a place where you will be comfortable with yourself, your decisions, and your direction. Ultimately, this will help you live a better life, and that should be your personal goal. This can be achieved when you become secure with your decisions and comfortable with your investment choices. Therefore, my goal is to provide you with that opportunity.

To reach the comfort zone, you will need to embrace change. You will need to extract and employ the innovative ideas and strategies that I will teach you. However, not all of these have been accepted by the mainstream investment community yet. I assume that they will be at some point, but to many my approach will be different than anything they have found before. This may not be easy for you, but important decisions never are. Without a doubt, the market has already told us that we need to make these decisions, and this book makes them much easier. Aspiring to reach the comfort zone is in itself a life-changing decision. Thanks to the declines in 2008, you might also recognize the need to change your investment strategy for the first time too.

Warren Bennis, founding Chairman of the Leadership Institute at the University of Southern California, has noted, “Innovation by definition will not be accepted at first. It takes repeated attempts, endless demonstrations, and monotonous rehearsals before innovation can be accepted and internalized. . . . ” I believe that the disciplined approach associated with the strategies I offer is the cornerstone of investment success. The results of my innovative approach have been extremely rewarding to my clients already.

Peter Drucker may have said it best. This renowned author and professor explained, “Innovation is . . . the act that endows resources with a new capacity to create wealth.” That is exactly what I do. Through this book I will empower your current resources to create wealth going forward and make money in a volatile market.

Think Outside of the Box

Are you still unsure about employing concepts that are not yet widely accepted? Consider then the fame of Deepak Chopra, named recently as one of the top 100 icons of the current era, according to Time magazine.

Deepak Chopra is considered an innovator and a leader in the field of mind-body medicine. He has transformed the meaning of health by incorporating the best of Western medicine with natural healing traditions from the East. In essence, he has changed the art of healing with innovations that were strongly resisted when first introduced in the West, but which are now widely accepted by educated persons across the globe.

Deepak Chopra teaches a system of healing and preventive medicine that dates back 5,000 years. Originating in India, Ayurvedic medicine is now popular in many social circles because it helps balance mind, body, and soul. It is the science of life.

The popularity of this science is based on its ultimate objective. His Perfect Health Course can help free people from disease, aging, and death. This sounds like a far-reaching goal, but he has already indisputably proven that it works. Our elite are believers in his system right now, and the masses are starting to recognize its healing power every day. The root of this power lies within ourselves. In fact, in order to liberate ourselves from sickness or pain, we need to tap into our awareness and bring our lives into balance.

Changing people’s minds about long-held beliefs was necessary for Deepak Chopra to gain Western acceptance of his teaching. I aspire to a similar goal in the field of investment strategy.

In fact, some of these same principles apply to our investments. The Perfect Health of our portfolios also lies within. Emotional balance is required. Liberating ourselves from the sickness and disease that flare up regularly in our portfolios is critical. Poor investment strategies often cause our investments to decline and that in turn troubles our minds and burdens our lifestyle. These losses hurt our pocketbook, and that affects our psychological approach toward new investments in a meaningful way. Eventually, that could also have a negative impact upon investment performance. Understandably, that happened to many people in 2008. It may have happened to you. In this book I will teach you to deal comfortably with the occasional losses that even the best portfolios will suffer. In some cases, I will show you how to avoid these altogether too. This is my goal. I will take you to the comfort zone, and that path starts with recognition.

The Comfort Zone Lies Ahead

You will not be alone. Thus far, many investors have already taken the steps to get there. Many elite investors have been using my system for a long time. My work is regularly published through various media channels, I have been featured in Barron’s, I write an article for MarketWatch every month, and I was nicknamed the Grim Reaper by Erin Burnett on CNBC for predicting the demise of our stock market in the middle of 2007. Reuters provides my Economic and Market Analysis to its institutional clients every day, and I operate a website that serves my broad audience. These and other Tier 1 clients have already realized the value of my simple, yet effective approach and they have embraced my strategies.

Now my path leads to you. In the chapters that follow, you too will learn how to understand current economic and stock market cycles, how to anticipate future economic and stock market cycles, and how to position yourself so that your investments never become a burden again. You will gain a comprehensive understanding of the proactive trading strategies that I use regularly. One or more of these strategies will be immediately actionable for you, too. They integrate both risk control and opportunity in a methodical, structured, and easy-to-follow design that can be used at all times. They will empower you to invest successfully, no matter what the economy or stock market may seem to be suggesting.

Your journey to the comfort zone is about to begin.

Thomas Kee

PO Box 922

La Jolla, CA 92038

Acknowledgments

Economics is all about people. Without knowing that, I would never be in the position I am today. Thank you, Mr. Wingate. Also, in fond memory, thank you, Jack Frager. You and Tom McMullen started me on my path. This book would have never been possible without each of you.

In addition, uniquely, I would like to thank everyone who believes that the current way is always the best way. My innovation would never be possible without you. You have driven me to think outside of the box, you have driven me to believe that the impossible is possible, and you have given me something we like to call Tommyland. Life is a little different here. Believe me, it is possible!

CHAPTER 1

The Investment Rate

The Investment Rate is the core of all of my analysis, and it is the catalyst for all of my trading strategies, too. It influences everything we do. Given the sweeping importance of this tool, I will start our discussion on how to make money in a volatile market by explaining the origins and properties of this tool and then build from that foundation as we move forward. Although proof of the Investment Rate is important, the discovery process itself is equally important as it reveals the simplicity of this model. Therefore, I think it is important to address this first. So, let’s begin.

Economics Is All About People

My empirical journey to the land of economics did not begin with a Harvard MBA, or a doctorate from MIT. My drive to be the economist and independent market strategist I am today started another way. In fact, I confess that economics bored me in college. Although my grades were at the top of my class, I could barely stay awake during lectures. Initially, all of it seemed boring. The study of economics came easily to me, but the thought of applying those tools in the real world cast me from the science at that time. I was extremely social, and crunching numbers in a small office while surrounded by my intellectual peers seemed like the last thing I wanted to do. I was studying the works of Karl Marx, Thomas Malthus, and John Maynard Keynes, to name a few. The chairman of the Federal Reserve was Alan Greenspan, but he was not any different from the rest of them in my eyes. They were all bookworms; they were all number crunchers; and they all seemed to accept a lifestyle that did not interest me. Although I respected these intellects, I also feared the life that awaited me if I chose their path.

Without question, I was not a bookworm. Economics was just second nature to me. The number crunchers who were my peers in school had to work a little harder to achieve the same marks, but they did well and seemed satisfied with their results. Unfortunately, I was not satisfied with mine. Instead, to become satisfied I had to push myself in a different way. I did not need to study as much, but I needed to find motivation somehow. My peers already had it. Grades motivated them. However, because good grades came easily to me, that was not enough. There had to be something more, I thought, but I was not seeing it then. Every day my frustration grew, and I distanced myself from the science that I now find so compelling.

Imagine having a gift and not wanting to use it. What if you were a swimmer of the caliber of Michael Phelps but you decided that swimming was boring? What if you used to beat Kobe Bryant on the court when you were a child, but you stopped playing basketball because you did not like it anymore? What if your name was Tiger Woods, but because playing golf required so much patience, you decided to run track instead? I am not claiming to be in the same league as these athletes, but I did (and still do) have a skill, and I was not pursuing it appropriately. That was a major hurdle. Over time, I have found that everyone has hurdles like this. Helping us overcome them is one of my objectives. Everyone needs motivation—a drive, and a reason to move forward. I too was in desperate need of motivation as I pondered my future in relation to this wonderful science, which bored me before I completely understood it.

Luckily, my abilities and my diverging interests were clear to those who knew me. My economics professor at St. Mary’s College of California, Stanley Wingate, sat down with me one afternoon after observing my disparaging attitude. Economics was already his life and his passion. Gracefully, he wanted to share some of his motivation with me. I cannot thank him enough for that simple half-hour conversation; it changed my life.

During our conversation, Professor Wingate explained that economics is all about people. If you understand people, you can understand economics. If you understand economics, you can understand people. Amazingly, in a blink of an eye, I found a parallel between my social activities and my education. I love interacting with people, and economics came easy, so synergies popped up everywhere. Eventually, I realized that economic theories—such as Random Walk theories—have a much broader range than just identifying opportunity. They apply in explaining many aspects of our social behavior. It is not about numbers; it is about people. Thanks to Professor Wingate, I was able to see this for the first time, and my eyes began to open. Almost immediately, I found correlations. Soon economics compelled me more than I ever thought it could.

Excited, I was motivated to move forward and to apply my new passion to my career. I did this by subtly changing the way I looked at the world. In turn, that opened a series of doors and provided endless opportunities for both inner growth and the expansion of my career. My transition was seamless and empowering at the same time. Eventually, I realized that this same simple revelation could change the perception of economics for many others as well. My drive, my passion, and my motivation have been unyielding ever since. However, I also realize that barriers to entry exist for many people, just as they did for me. Therefore, addressing these will be important to our end goal.

The Relationship Between Market Trends and Economic Cycles

After graduation, I entered the financial industry. Early in my career as a retail stockbroker, Colonial Mutual Funds approached me. Mutual fund companies often woo brokers to sell their funds. This gathers assets for the fund and generates recurring management fees for the firm. This Colonial wholesaler presented me with a sales kit for the funds he was pitching at the time. That kit included a comparative demographic study that pitted birth rates against the stock market. There were interesting correlations in that study. This was an eye opener. It was my first real-life exposure to this type of analysis. It showed me that the actions of people affect not only the economy, but the stock market, too. That broadened my interest even further. More important, it was also my first step toward developing the Investment Rate. Although the Colonial model was clearly flawed, it was on the right track. Over time, with that inspiration in hand, I continued to refine that imperfect model to produce a much more precise measure of current and future investment demand. That is the Investment Rate.

Although the Investment Rate includes variables, growth analysis, and quantum theories, its foundation is the simple study of human nature. It measures consumer demand for investments (demographic demand cycles). This is not a study of GDP. This is a study of investment demand, and it is extremely revealing. I will offer details in the next chapter.

Generally, most people experience similar personal financial cycles throughout their lives. In their early years, they are spenders; in the middle, they are savers; and from there until retirement, they are investors. Because I was looking for demand ratios, I was most interested in the third phase. Specifically, I wanted to know when people became investors. Interestingly, this is a consistent variable. Aside from unique circumstances, this happens at the same time for almost everyone. More specifically, skew is negligible over time, and demand cycles revert to the mean as well. As a result, investment behavior is predictable, and I have exploited that to identify longer-term economic cycles in advance. That is the Investment Rate. But, let me be more specific.

Everyone becomes an investor at some point in his or her life, and our aggregate demand for investments drives the economy. Because this is a demographic study, my references are to the entire population. When the overall demand for investments is increasing over time, the economy grows, and the stock market rises. When net investment decreases over time, the economy comes under pressure and the stock market falls. This is the essence of the Investment Rate. The Investment Rate tells us when this happens.

FIGURE 1.1 The Investment Rate.

Studiously, I compared my theory to the economic history of the United States from 1900 to 2009. The Investment Rate actually extends through 2030, but I was looking for correlations to past economic cycles in this review. My findings were significant. Importantly, my retroactive analysis proved that the Investment Rate has identified every major economic cycle throughout our history in advance. In turn, that past parallel suggests future parallels as a result. That is how my forward model began. This analysis accurately identifies periods of significant weakness, and it precisely identifies the boom periods, too.

Although I will go into more detail in the next chapter, Figure 1.1 offers insight into that relationship. The most revealing may be the first down period. After all, we all know what happened after 1929.

A Leading Indicator

I first offered the Investment Rate to the public in 2002. In early 2002, the market was reeling. Arguably, overall demand for stocks had dried up completely. Investors were scrambling to protect themselves from the Internet debacle, and meltdowns were occurring left and right. On the surface, this was very similar to our experience in 2008, but there are subtle differences. Panic drove the market lower in 2002, and although my proactive strategies were performing extremely well, the selling pressure was unnerving to my clients, too. Unfortunately, I later discovered that this uneasiness also prevented many investors from doing the right thing. Instead of protecting wealth and realizing opportunities within my well-established models, many investors sat idle and watched their wealth dissolve as the stock market declined around them.

Right in the thick of things, I launched the Stock Traders Daily website in January 2000. This was the peak of the Internet bubble and an extremely volatile time. Therefore, I began to offer proactive trading strategies without thinking twice. Longer-term investments were not even a consideration at the time. However, even though we focused on trading strategies, I also recognized the power of the Investment Rate, and I respected its influence on the economy and the stock market over time. Reasonably, this long-term theory of market cycles lingered in my mind, but it was not important to me when I first started. I was only interested in providing solid returns. The Investment Rate did not become important to my clients and me until the market began to fall apart.

Thoughtlessly, at the height of the Internet bubble, major brokerage firms (including Morgan Stanley, Smith Barney, Merrill Lynch, Prudential, A.G. Edwards, Goldman Sachs, J.P. Morgan, and others) had “strong buy” ratings on stocks like Amazon, Yahoo, CMGI, eBay, and others. If it had dotcom in the name, it was on their list. Therefore, if the retail clients of these firms were following the direction of those institutions, they were also holding significant positions in these overvalued Internet stocks when the Internet bubble peaked in 2000. From there, as we know, the resulting declines were detrimental not only to real wealth, but also to investor sentiment as well.

Expectedly, many retail clients were confused, and most investors did not know what to think. If these analysts were indeed superior prognosticators and if they believed those Internet stocks offered significant opportunity, then why not just ride out the storm?

Unfortunately, following the guidance of those analysts pushed some investors over the edge. Between 2000 and 2003, many investors learned the hard way. Major brokerage firms have arthritic reactions to policy changes and analysis for their retail clients. This is especially evident during periods of market weakness. In fact, and more specifically, according to many analysts who offered opinions on Internet stocks for these major brokerage firms between 2000 and 2003, those stocks were “strong buys” in the $100s. Then, sell ratings came when the stocks were in the low single digits. This was a classic case of buying high and selling low. Obviously, they got it wrong.

After the fact, we all know that major brokerage firms provided retail investors with some terrible advice during the Internet bubble. The subsequent freefall in many stock prices resulted in the collapse of many tech-heavy portfolios, too. My focus in 2002, when I developed and introduced the Investment Rate, was to address and quell the fears that resounded so heavily throughout the market as a result. Even though my proactive models were rewarding my clients with exceptional returns, surprisingly, fear still lingered. My clients, like most investors, seemed to be uncomfortable investing in a declining market. Underneath, they really wanted the market to increase, and frankly, so did I. Interestingly, as my knowledge grew, I discovered that this was a mistake.

Understanding and dealing with this emotion has become much more important to me now than it was prior to 2002. In fact, I failed to recognize the consequences of that emotional bias when I first developed my trading strategies. These strategies were essentially short term, and our trading discipline left little room for fear anyway, so I never paid much attention to emotional conditioning on a long-term basis. Reflexivity was part of our models already. At the same time, though, I had not yet applied the strategies stemming from my understanding of the Investment Rate to our longer-term investments. More important, we had not even considered longer-term investments until the going got tough. In 2002 that changed—the focus now is also on longer-term investments as well, and building and protecting wealth accordingly.

However, that does not suggest constant higher moves by any means. Instead, I have grown to recognize that market direction does not matter, even to longer-term investments. Opportunities exist on both sides of the curve, and we must recognize them.

Coincidentally, in 2002, an interesting phenomenon surfaced, and this influenced my study. During a period when the stock market was experiencing significant declines, positive flows of new money into our economy continued virtually unabated. The difference lay in the positioning of that investment money. Money began flowing out of the stock market and into real estate and private business. As a result, the stock market stayed under heavy pressure, and real estate prices began to increase.

Everyone can see that investment shift now, but very few were able to identify that simple transition in 2002. In fact, during periods of weakness in the stock market, almost everyone becomes blind to reason. Therefore, in 2002, investors were more concerned with the value of their mutual funds, managed accounts, and 401ks. If they were holding Internet stocks based on the “strong buy” recommendations offered by the major brokerage firms at that time, those concerns derailed structured and disciplined investment strategies even further.

My nervous clients and other concerned investors everywhere wanted to know if an improving economy would be enough to sustain a recovery in the stock market. I aimed to prove it one way or another. During my pursuit of insight into the future trend of the stock market, the main distinction I identified was that a simple shift in asset classes had taken place, and that was all. Otherwise, demand was still robust, and new money continued to flow into our economy. According to my theory, the Investment Rate, the market would recover swiftly from that decline. I said so in a work I published titled “Will an Improving Economy Be Enough?” That report included a concise understanding of the Investment Rate, a tool I had been developing for quite some time. Until then, I had never dignified this powerful theory with publication.

My report proclaimed that, according to the Investment Rate, there would be a prompt upward retracement in the stock market rooted in an overall increasing demand for investments. The report advised investors that investing in stocks would be intelligent again at some point soon. Therefore, with that evidence in hand, I knew that we should also be looking for precise opportunities to buy when the time was right. From there, I reviewed Fibonacci calculations and technical tools to help me identify the bottom within a few points. The result was not surprising to some of my clients who had already been following my proactive trading models religiously. The result of my preemptive analysis was that I defined the bottom of the market in 2002 almost exactly. More important though, that report also revealed important facts about the long-term health of the economy and the stock market that eventually reshaped the way we approach our long-term investments today.

As we know, in 2002, the market resumed a very strong upward trend that lasted until 2007. The Investment Rate had been a bullish leading economic and stock market indicator in the face of the Internet debacle, and it was virtually exact.

However, there is more. Attempting to defuse the fear of investing during the Internet debacle was initially restricted to proving that the market was still ascending. Inherently, most people held the misconception that they could comfortably buy the dips forever. However, as we have learned over time, it is also every bit as important that investors not fear participating in a declining market either, where opportunities also abound. To that end, the Investment Rate is equally valuable. It assists my clients to understand future economic conditions and market direction whether up or down. This goes a long way to unburdening their fears. With the Investment Rate, they have the tools to take advantage of whatever market opportunities exist. That is the first step toward the comfort zone!

Therefore, the Investment Rate, as I employ it for the benefit of my clients, is not limited to a demographic analysis. It must also include a second component, and that component produces actionable strategies in relation to the findings of the demographic study. The first component is a measurement of the increase or decrease over time of new investment into the economy. This is a predictor of economic trends. The second component is the technical tools I have developed to pinpoint support and resistance levels. These allow us to find turning points in advance. In my opinion, the combination of these components has produced the most accurate leading longer-term stock market and economic indicator ever developed. I will discuss both of these in the next chapter.

The Investment Rate is a long-term fundamental analysis of the economy and the stock market. It is the core of all of my research. It is rooted in all of my investment strategies. A review of the Investment Rate should be conducted before any investment decisions are finalized. This includes investments in stocks, bonds, real estate, businesses, and any other investment class that requires a positive inflow of capital to grow. I advise all of my clients to have a concrete understanding of longer-term trends before they engage any active (short-term) trading strategies, and I use the Investment Rate as a tool to satisfy this objective appropriately. If we can first understand longer-term cycles, we are more readily able to accept change—when change is required.

New Money Drives the Market

In summary, the Investment Rate measures the amount of new money available for investment into the economy over extended periods. In turn, that directly influences the demand for investments throughout that same cycle. Specific investments such as stocks, real estate, and other asset classes within the economy are impacted. The Investment Rate ultimately affects the value of all the investments we make, and that is obviously important to all investors. Nothing is sheltered from this demand-side analysis and that is why everyone should review the Investment Rate before making any investment decisions. Figure 1.2 explains how the Investment Rate affects the investments that are important to us.

The Investment Rate helps us to understand and to predict current and future economic cycles by measuring the demand for new investment, the prime driver of the economy. Simple in concept, it enables us to weed out the noise that clutters so many other economic models unnecessarily. This refined approach then allows us to focus on strategies designed to make us money regardless of market direction. More precisely, the Investment Rate gives us confidence in our strategies, and that is priceless!

The Investment Rate is powerful, it is far reaching, and it influences everyone. It should be used by governments to help them determine long-term economic policies. It should be used by corporations to help them manage business cycles. But most important, it should be used to help individual investors manage their wealth over time as well.

Appropriately, in the chapters that follow this will be a focal point. However, more important, our next step is to prove the theory I introduced here. In the next chapter, I will be specific, and the effectiveness of this demand-side analysis will come to light.

FIGURE 1.2 How the Investment Rate affects our investments.

Summary

Below is a summary of the most important topics in this chapter:

• Economics is all about people.

• The Investment Rate is a demographic study that measures the inflows of new money into our economy annually and over extended periods of time.

• The Investment Rate reveals up and down cycles in advance, and accepting these as opportunities is the first step toward the comfort zone.

CHAPTER 2

Keep It Simple, Sweetheart

The Investment Rate is logical, comprehendible, actionable, and it can work for us to help us protect our wealth and take advantage of longer-term trends throughout fluctuating cycles over time. I have already outlined its origin; now I will illustrate past application and prove its effectiveness. Advancing this tool is integral to understanding our proactive models because it plays an important role in all of them.

Interestingly, though, the simplicity of the model is sometimes overwhelming to new subscribers. Surprising as this may sound, most people want to complicate the already effective contrivance stemming from the Investment Rate, and that usually curbs the effectiveness of this leading indicator with unnecessary variables. Sometimes these observations are sound, and I am always willing to entertain derivations, but not until a person first shows a complete understanding of my current model. In fact, more often than not, those persons who started by questioning the model begin to embrace it after they understand it, too.

Therefore, before I proceed with further explanation, I always challenge my audience. Until they finish the first phase of this lesson, I challenge them to stop listening to the noise. If they can do this, they can also accept the Investment Rate for what it is and see forward applications with ease. With proven effectiveness in hand, I will take that same stand here. Stop listening to the noise surrounding the stock market and the economy day in and day out. Instead, try to refocus on the foundation of economic science, which I described in the last chapter. Think about people, specifically about the people we might encounter every day, and think about the way they live their lives. Incorporate coincidental Random Walk theory into these observations, and draw parallels to the facts described here. As knotty as this may sound, all it really means is that we observe the people we know and take note of their occasional choices.

Specifically, in this case, we are interested in their financial behavior. Going so far as to interview people for discovery is not necessary. Because we all probably know the correct answers to the questions that influence this observation already, we probably do not have to dig any deeper than we already have. For example, think about when they bought their first home, how old they were when their kids started going to college, and when they chose to retire. These and other generalities will develop into specifics as we move forward, and from those specifics will come the action plans we are looking for.

At the same time, however, do not be immediately concerned with the direction of the stock market, or the current health of the global economy. Stop paying attention to interest rates, the housing market, libor, the dollar, oil prices, or anything else that might have investors on the edge of their seats. For the most part, none of these matter to long-term trends. Yes, they all matter to short-term trends, but none of them matter to long-term trends. Our goal is to define long-term cycles first, and then use them as a foundation for further analysis and immediate application afterwards. The only way to do that is to first weed out the noise so we can see the light at the end of the tunnel.

An Example: Interest Rates

Interest rates are a great example of noise. We have all heard the phrase “don’t fight the Fed.” This is often used to suggest higher market levels after Fed rate cuts. Interestingly, the opposite is usually true, and I will prove it. Listening to those prognosticators is usually foolhardy because they are usually wrong. Initial positive market reactions to Fed rate cuts are typically short lived, and the market usually continues to decline after a short honeymoon.

Interestingly, I do agree with that general phrase in a coincidental way. We should not fight the Fed. However, my approach is counterintuitive to traditional doctrine. Initially, it might seem ill founded, but my premise is well rooted and obvious if emotions are removed from the process of observation.

Rather than not fighting the Fed in the traditional sense, if the Federal Reserve is increasing rates, we should be buyers of stocks instead. In addition, on the other hand, if the Federal Reserve is cutting rates, we should seriously consider shorting stocks along with the decline in rates. Logically, save inflation concerns, the Federal Reserve increases interest rates because the economy is too strong. Conversely, the Federal Reserve cuts interest rates because the economy is weakening. However, as we know, during strong economies, the stock market trends higher, and during weak economies the stock market trends lower. Therefore, logically, we can rationalize the moves in the stock market based on the decisions of the FOMC (Federal Open Market Committee) if we can trust that they are acting prudently. Assuming we do, we buy when the FOMC raises rates, and we strongly consider shorting when the FOMC is cutting rates. Instead, most investors listen to the noise, they follow the prognosticators, and it distracts them from obvious reality.

FIGURE 2.1 Interest rates versus the market.

Look at this simple relationship in graphical format (see Figure 2.1).

Clearly, an initial short-lived easing cycle began in September 2008, and the market reacted negatively as expected. However, the relationship between the market and interest rates during that cycle is more difficult to identify because of its short-lived duration. Therefore, the following confirmation begins with the November 1998 tightening cycle. From there, longer-term correlations are clear, and our observations work to prove my theory. Compare the general trend of the market to the direction of the Fed Funds Rate during this ten-year span. The confirmation shown in Table 2.1 proves that the market performs well when the FOMC is in the process of increasing interest rates to curb economic growth, and it performs poorly when the FOMC cuts rates to flatten economic activity instead. This is counterintuitive to widely accepted intuition, and it elevates the value of thinking outside of the box at the same time.

TABLE 2.1 FOMC vs. INDU Confirmation Table

I conducted this analysis in October 2008. The market was near 9000 at that time, and the Fed Funds Rate was 1 percent. However, the FOMC did not stop there. We all know that the FOMC cut interest rates again in December, and they were near 0 percent going into the new year. During that same time, the market continued to decline, and it established a low of 7438 in November 2008. This ongoing association continues to prove the counterintuitive relationship between the Fed Funds Rate and the market over time. Although the cycle arguably could have been considered complete in December, there had not yet been a turn higher in interest rates, and therefore our analysis will be left to October data. However, reasonably, the FOMC could not cut rates any lower after the December cut, and therefore the end of the easing cycle may have already been determined. If that is true, our analysis suggests that the market should increase for at least a short while after the final December cut.

Clearly, buying during rising interest rate cycles has worked over time, and shorting during easing cycles has, too. Since 1998, the market increased by an average of 41.85 percent when the FOMC was raising rates. It fell by an average of 26.85 percent when it was cutting rates. “Don’t fight the Fed” is not all it is cracked up to be. In fact, investors should usually do the exact opposite of what that phrase traditionally implies. Unfortunately, they do not, and unwitting investors become emotionally bound to the influence of unfounded assumptions instead.

Don’t Listen to the Noise

Interest rates are just one example of the noise that burdens investors regularly. Going forward, the next time the FOMC changes interest rates, determine why the FOMC made those decisions. If the purpose is to influence the growth of our economy, and not to combat inflation, we can be sure that history tells us to go with the flow of interest rates instead of against them. With this revelation, those pundits who would have us think otherwise will not be a distraction again, and we will retain the opportunity to realize gains from our advanced knowledge accordingly.

However, as actionable as it may be, this message carries a stronger meaning, and that new meaning will influence our purpose accordingly. More important, do not let other noise variables influence similar distractions as we move immediately forward either. Instead, KISS—Keep It Simple, Sweetheart! Forget about the news facing the market today, unburden those ties, and refocus on people until, at least, we are finished with this discussion. Refocusing on the basics is exactly what empowered my transition in college. It cleared my mind, and it allowed me to see the world in a slightly different way. Since then, I have been using a refined approach every day, and the results have been awesome. The power of simplicity is strong, if we allow it to work. Ultimately, it has put me in the position I am in today, and for many reasons I recommend a simplified approach to everyone. It all started with an evaluation of people.

Originally, I wanted to prove to my clients that demand for stocks would resurface again at some point. We all knew that a bubble was being dissolved in 2002, and we all recognized the turbulence in the market as well, but very few recognized that the demand ratios were still strong within our overall economy as assets shifted to real estate instead. Everyone focused on the crashing stock market and the resulting economic weakness of that era.