June 8, 2009
THE GREAT MIAMI HURRICANE OF 1926
The value of irrational optimism
When the winds began to howl during the night of September 17th, 1926, there was little reason for Miamians to be concerned. Most people assumed they were hearing the sounds of just another one of those violent S. Florida thunderstorms that seem to kick-up from nowhere and then leave town just as quickly. Floridians pulled up their blankets, rolled over and went back to sleep. While a hurricane warning had been issued a few hours earlier, how many people could have known? There was no Internet and no television and hardly anyone even had radios at that time. By 2 a.m. on the morning of the 18th, buildings and homes had been destroyed and numerous lives had been lost as a result of the violent hurricane winds. The eye of the storm passed directly over Miami about 6 a.m. that same morning. The citizenry, unfamiliar with the calm that a storm’s eye can bring, began to venture outdoors to assess the damage and check on neighbors. The lull in the storm lasted about 35 minutes, and in that time the Miami streets became crowded with people. When the eye completed its pass through, even fiercer hurricane winds, of close to 140 miles per hour, returned. As a result, many more of our unaware and unprepared residents perished unnecessarily, when they were caught by the back end of the storm.
No storm of that magnitude has passed through Miami proper since. In fact, many experts consider the hurricane of 1926 to be the “1 in a 100 years” type of event I have previously written about. Note that while Miami was heavily impacted by the monster, Category 5 Andrew of 1992, that hurricane actually hit south of Miami, passing through Homestead. Hurricane experts claim that a storm of equal magnitude to that of the 1926 hurricane taking an identical path today, would cause $157 billion in damage, twice that of the infamous and destructive Hurricane Katrina. Have our leadership, developers and residents planned for such a “1 in 100’ direct hit? Take a good look at our over-developed, condo saturated coastline for your answer.
Speaking of Katrina, the 2005 New Orleans storm that killed over 2,000 people, was labeled a “1 in a 100 years event” as well. Indeed, politicians, storm planners, and the U.S. Army Corps of Engineers all knew many years in advance that a powerful storm taking a particular pathway could overwhelm the city’s levies and cause massive destruction and deaths. But the chance of that happening was only “1 in a 100”, and who can find the money or take the time to protect the population against such a remote occurrence?
THE (NEAR) GLOBAL FINANCIAL COLLAPSE OF 2009
Yes, the Stock market meltdown and (near) global financial collapse was also called a “ 1 in a 100 years event” and similar to Katrina, the improbable occurred. But why waste the time and economic resources to plan for a “1 in 100” probable event? And of course, as we all know by now, no one took the time or allocated the resources. Regulators, Insurance Companies, Banks, Politicians, Corporations, all were caught with their proverbial pants around their knees. They under-planned, under-reserved, over-lent, under-regulated and over-leveraged. If not for some timely government intervention, arguably, our entire economic system might have collapsed under the weight of corruption, greed and mass hysteria.
In dealing with the fallout from the financial storm, one of the most difficult aspects to grapple with is the effect it had on the portfolios of average investors who played no role in the meltdown. Average investors were shaken to the core when they looked at their savings or retirement portfolios during March of 2009. Portfolios that were heavily weighted in what had been considered good quality stocks may have been down close to 50% from their peak. And even conservative portfolios with heavy concentrations in bonds may have been down by 20-30%. There was virtually no place to safely invest money from mid-2008 until mid-March of 2009. The public’s state of fear and panic was further exacerbated by our 24/7 headline grabbing, “breaking story” style media. As a result, many panic-stricken investors bailed out of their investments, very close to the March market lows.
THE BIG RALLY
Stocks have rallied anywhere from 30-40% since the market lows of March and the public and our clients seem much more confident now than they were only weeks ago. Discussions of economic Armageddon have faded and the focus now seems to be on whether the recovery has, indeed, begun and/or at what pace it will unfurl. Many of our clients have begun to invest again and have resumed talking about and planning for their financial futures. Some of our clients’ businesses are showing incipient signs of recovery, while many continue to hope and wait anxiously for their own signs of a turn around.
A RETURN TO IRRATIONAL OPTIMISM?
There has been a definite transformation in the public’s behavior from a state of fear and panic, to a state ranging from guarded to outright optimism. I have, however, developed some concerns as a result of recent behavioral patterns that I have observed with our own clients. As I have written in the last couple of e-mails, getting back into equities and buying good companies that have seen their share prices pummeled during the meltdown may prove to be an excellent financial decision in the long run. However, after the DOW has now moved from close to 6,500 to the 8,700 range, a few investors who had “thrown in the towel,” selling off stocks close to the market lows, and declaring they were permanently out of the market, have now expressed the desire to go all the way back in. When I reminded them about how fearful they were in March, and their decision to stay out of the market because, “things could go bad again,” it appeared as if they were stricken with “economic amnesia.” Oddly, they seem to barely remember the panic they were experiencing only a few weeks prior.
A VISIT FROM THE ECONOMIC PSYCHOTHERAPIST
I was so concerned about this “economic amnesia,” that I had a psychologist specializing in behavioral economics visit our office to speak to our financial staff. Behavioral Economics is a growing field in our industry and it focuses on cognitive and emotional factors that drive investors and consumers. I asked Mr. Ken Haman, who had a private psychotherapy practice for 20 years in the Washington, D.C. area and now consults with Financial Advisors on investor behavior, to address my concerns about “economic amnesia.”
Haman spoke to us for an hour, mostly about the human brain and evolutionary factors effecting investor behavior. He referred to a dynamic that we are all familiar with, and which makes my business very challenging… that “fear conquers rational thought.” From an evolutionary standpoint, when ancient man was faced with a frightening situation it was safer and more advantageous for the continuation of our species, for him to take off and run, rather than to stop and experiment.
With respect to “economic amnesia,” he also cited evolutionary factors that cause us to forget and revise prior bad memories. He used the example of the childbirth experience, pointing out that, “If a woman would remember the exact level of pain from childbirth, she would only have 1 child.”
I have more examples of how we are programmed, for the most part, to forget or revise bad experiences, and maintain a sense of optimism as we navigate through life---you can call me if you are interested.
MY NEW ROLE AS YOUR FINANCIAL PLANNER
Modern man is programmed, because of evolutionary factors, to be fearful, yet, optimistic, and prone to revisionism when it comes to bad memories.
Over the past 4 years, we have seen 2 “1 in 100 years” events occur, with truly devastating consequences: Hurricane Katrina and the Financial Meltdown of 2008-2009. Even so, we will for the most part, continue to ignore the possibility of the detrimental consequences of a future “1 in 100 years” event. After all, in each year there is a 99% chance that such an event will not happen.
Hurricane Katrina passed directly over my house in Aventura on August 25, 2005 as a Category 1 storm before it strengthened into a monster category 5 storm over the Gulf of Mexico. We were fortunate in South Florida, as it produced only minor damage here. It nearly felled my 2 mango trees, which I am happy to report today are again producing outstandingly delicious mangoes after a 4 year recovery and dormancy period.
Similarly, while not experiencing the devastating effects some of our citizens have suffered as a result of the Financial Meltdown of 2008–2009, I still experienced it in a very real way. I took all your calls, felt all of your pain and frustration, and worked 14-hour days for months to help you navigate through it.
As we move through the recovery, I will keep in mind what has just occurred and what could happen again. I promise not to have amnesia. I will always be cognizant of the fact that “1 in a 100 years” events can happen and will always be prepared to cope rationally and not emotionally with all eventualities.
I will also continue to be cautiously optimistic. Absent a sense of optimism, it is impossible to grow or move forward, or even to get out of bed in the morning.
I remain committed to seeing my clients through this crisis and to helping them work towards achieving economic security for themselves and their families.
Speaking of families…announcing the arrival of Hannah and Eli Frye Sanders born June 3, 2009