With everything that is going on let’s take a look at the most overlooked, but what may be the most important aspect of our economic model.  What is it?  The Fed?  Wall Street?  Inflation?  Nah…it’s psychology.

Right now you are thinking, “This guy has lost it.  Companies are going bankrupt left and right, thousands of jobs are being cut everyday, and he thinks our state of mind matters!”  All of this is true, and it all matters, but it all pales in comparison to the underlying psychology of the markets and economy.  I was reminded of this by a recent article on the 4-Hour Workweek, by Tim Ferris, titled Harnessing Entrepreneurial Manic-Depression: Making the Rollercoaster Work for You.  Read the article, as it provides an interesting look into the entrepreneurial ride and some background for my post.

The interesting thing is that the entrepreneurial transition curve (see figure above) applies to everyone in the U.S. (to a lesser extent everyone in a capitalist country).  Why?  Because, the entire reason behind the founding of the U.S. was entrepreneurial.  People afraid of risk didn’t come to the ” New World “, and they didn’t come here to keep the lives they were leaving behind.  They came to start fresh and risk it all on a better life.  There is a reason Italians made the spaghetti westerns.  The movies represented the ultimate entrepreneur. 

Essentially, the U.S. is one giant entrepreneurial start-up, and we are experiencing the pains outlined in the above graph.  We seem invincible one day and on the verge of complete destruction the next.  Unfortunately, we are becoming an older country, so we are developing less risk takers, and more people who want the status quo to be maintained.  This change results in “corrective” actions like the $700 billion bailout. Too many people are panicking, because they don’t realize the drop is a natural part of our economy.

We need to understand that capitalism and our underlying culture is based on this entrepreneurial transition curve.  As a result, there is nothing we can do to stop it.  We need to sit back, enjoy the ride and take advantage of this curve.

How do we do this?  First, we need to determine where we are at on the curve.  Obviously, we aren’t in the Uninformed Optimism or Informed Optimism areas of the curve.  That leaves us in either Informed Pessimism, Crisis of Meaning or, the big one, Crash and Burn. 

The vast majority of us aren’t collecting unemployment or standing in soup lines, so it’s safe to say we aren’t in the Crash and Burn phase.

That only leaves informed Pessimism and Crisis of Meaning.  If we look at how Mr. Ferris defines these two sections it’s easy to see that we are in the Crisis of Meaning.  All we have to do is look at the first two sentences to determine this:

This is a scary stage and can feel like you’re standing on the edge of a building needing to jump. It will feel like all the odds are stacked against you and that everything is going wrong.

That description could not be more accurate right now.  Time just came out with a cover showing soup lines in the Great Depression, but we are nowhere near soup lines.  Could we be more panicky right now?  I doubt it.

Now that we know where we are at on the curve how do we cope.  Here are few suggestions pulled from the previously quoted post:

Realizing that many others have been in this exact same place and usually turn the corner, just like you will.

Don’t talk to others who are “half empty” types

Don’t take any “all-in” Vegas poker type risks where you put everything on the line hoping for a big win

Realizing that this is not the first, nor the last, time a massive economic downturn will occur should be comforting.  If it’s not the first then others have survived this type of event before, and if it’s not the last, then we have to assume prosperity ensues again or we couldn’t have a future downturn.  Either way just relax and know it could get bad, but it’s not the end…no where near the end.

The second bit of advice about not talking to “half empty” types is good, but hard to do, as they are everywhere.  They are friends, family, co-workers, etc.  Even a friendly cabbie for a trip to the airport, which I personally experienced, can be considered a “half empty” type.  None of these people mean any harm, but most have no idea what is really transpiring or how it is occurring, thus they are panicking.

However, “Half empty” types are good for one thing.  When enough of these types pop-up, especially ones that never pay attention to the market, like my cabbie, they can be good contrary indicators (see bottom for definition).  The most famous example of this was Joe Kennedy pulling his money out of the market before the 1929 crash, because a shoe shine boy gave him a stock tip.  Joe figured if someone this far removed from the market was excited about the market; it had to be nearing a high.  This can be used at the bottom too.

For me the final bit of advice from Mr. Ferris’s post is the hardest to do.  I want to run out and put all of my cash on a couple stocks that have been housed by this brutal market and watch my wealth explode over the next few years.  The problem with this strategy is we might not be the true bottom and/or I might be picking a company that will fail.  So, to lower my risk, I will be slowly getting in as the market goes down, but not all in one company.  I will probably invest in 5-10 companies leaning towards the low end.  I might even end up putting money in as it goes up, if I don’t get it all in at the bottom.  My current plan is to put small chunks of cash (5-10%) in at good investment points.  This week might be a good place to start. Especially, after the market fell below 8,600 today.

Everyone needs to take a deep breath and realize there will be a bottom.  Now is not the time to do anything foolish.  Markets swing way too high with euphoria and way too low with panic.  Pay attention and look for opportunities.  Fortunes have just been destroyed, but fortunes are waiting to be made.

Contrary Indicators - Contrary indicators are events whose significance to the market is the opposite of what their most apparent interpretation suggests.  A good example is Jim Cramer’s call this week to sell or Time’s Great Depression cover.