Three Phase Theory

© 2008 Brooke Allen
brooke@brookeallen.com www.BrookeAllen.com

ThreePhaseTheory
The graph depicts four indices for six years on either side of a peak. They are: BLUE : Dow Jones Industrial Average (center: September, 1929), YELLOW: Japanese Nikkei 225 Stock Index (Center: December, 1989), GREEN: Nasdaq 100 Stock Index (Center: March, 2000), and RED: S&P/Case-Shiller Home Price index for Miami (center: May, 2006… ending November, 2007)

Experience has convinced me that there are three phases to the economic cycle:

Phase I – A period when it seems that everything you do succeeds

Phase II – A period when it seems that nothing you do succeeds

Phase III – A period when success depends on what you do

If you’ve studied the Roaring Twenties, Japan in the 1980s, the Dot.com bubble of the ’90s, our current housing market[1] – or even a gravity propelled roller coaster – then you know the slow climb of Phase I deserves to be the scariest for the worst is yet to be.

If what you are doing is working well you then you might convince yourself that you don’t need to learn anything new or do anything differently. You might be seduced into believing that it is wise to mortgage your future for an even more wonderful present. Fact is; these are the best times to save for bad times.

Eventually a hill will be crested that leaves nothing but a cliff in sight and if there is another hill in the distance the fog will be too thick too make it out. Phase II has begun.

During these times people have no trouble feeling fear and remorse but those feelings do them no good. If you’ve lost a job, you might conclude that no equivalent one exists to replace it, and you might be correct. People will switch from mortgaging their future to scrimping to make ends meet. Since no investment seems to pay a return, they stop investing and since nothing they do seems to work, they stop doing anything. These are symptoms of depression, both economic and emotional.

Eventually there comes a time when your investments do begin to pay off and success does depend on what you do. This is the beginning of Phase III.

How well your investments perform in Phase III depends on what you invested in during Phase II. You might object that during Phase II many people no longer have resources to invest. But, they have clear title to a brain and they own their own time. If nothing you do pays a current dividend then there is no opportunity cost to investing effort and time honing old skills and learning new ones.

The degree to which your efforts pay off depends on what you are capable of doing. What you are capable of doing in Phase III depends on what you were doing during Phase II.

Consider the story of how my grandmother and how she found amazing opportunity in the Great Depression that would have never presented themselves during normal times. You can read that story here: https://brookeallen.com/2008/04/01/great-depression-great-grandfather-great-grandmother/ and if you do then what follows will make more sense.

Out of necessity, my grandmother had become a real estate agent in the early 1930’s during a bad time to be one. Homes didn’t begin moving until the economy turned around, but when it did, she had mastered her craft, she had the prospects and she was on the job. Within seven years they owned a spectacular house of their own free-and-clear whereas had they used their meager savings to buy a house in 1928  then by 1937 they would be about 9 years into a 30 year mortgage and my grandmother would still be without a career — assuming, of course, they didn’t lose everything to the bank as did so many of their peers.

My grandfather kept his job at the United Press by volunteering for multiple pay cuts. Things didn’t open up for my Granddad until the environment improved, but when it did, he was there in the office with needed skills while others were still waiting things out.

If, during Phase I, you avoid having too high an opinion of yourself or too much confidence in the future but instead continue to evolve your skills and save for Phase II, then you will be better able to weather and adapt to hard times.

If, during Phase II, you continue to invest in yourself and work for the benefit of others even though your efforts are not immediately rewarded, then you will be in the best position to prosper when Phase III inevitably begins.

If you follow, believe in and espouse this Three Phase Theory, then:

During Phase I you will have been labeled a contrarian and a pessimist.

During Phase II you will have been thought a fool for working so hard without reward.

However, during Phase III, when prosperity seems to shine on you before others, you will be heralded as a genius and visionary.

It is what you do when it seems that nothing matters that determines your success later when you discover that it does.


[1] Note: The Yellow line (Japanese market) is the best illustration of my theory since Phase III doesn’t go down as far and is flatter after it stops rather than “bounces.”

I lived in Japan for Phase II and although the Japanese government tried to manipulate the market. I believe they succeeded in engineering a soft landing but they didn’t manipulate the market for a recovery, which I believe is wise.

In the 1920’s and 30’s (the Blue line) the market ran up just as much in the Roaring 1920’s as it did in Japan in the Roaring 1980’s. But the USA then fell more than Japan in the next few years and then government interventions helped with a recovery.

The Dot-Com bubble of the 1990’s was a bigger bubble than in the 1920’s and the collapse that started from the high in 2000 was more severe. While, in the lingo of so-called analysts, the collapse was a “correction” and the recovery from the low was due to “over-shooting” I believe the truth is that the so-called recovery is the beginning of another Phase I bubble rather than what some people call a “consolidation” and what I call Phase III.

If you want to experience the the the Red Line (Case Schiller Real Estate Index adusted for inflation) as a literal roller coaster ride then look at the Real Estate Roller Coaster video published in April, 2007. You can see it here: https://www.youtube.com/watch?v=kUldGc06S3U

This article was first published in May, 2008 in a publication called International Family Magazine that is now defunct. It is reproduced here with changes made over the years to correct typos and improve readability but the graph and the text describing the theory are unchanged from the original.

I formulated the theory in the 1980s and used it professionally and personally every since. At that time I was employed by Merrill Lynch in NY from 1986-87(Phase I) and kept my job through 1988-90 (Phase 2). Then I moved to Japan with Merrill and worked during Phase II there. I returned to the U. S. A. in 1993 during the depths of recession and bought a house for cash, which turned out to be perfect in retrospect since I timed Phase III within a few months of its beginning.

I was running a hedge fund during the dot-com bubble burst in 2000 and because of this theory we flourished when many peers went belly up. Like my grandparents we own two houses free-and-clear (one for weekday use near a good school and another in the country). There is no way we’d buy real estate during during what is obviously the beginning of Phase II.

Great Grandfather, Great Grandmother, Great Depression

© 2008 Brooke Allen
brooke@brookeallen.com www.BrookeAllen.com
Originally published in International Family Magazine

As I detailed in the story How Grandmother Won Granddad in a Beauty Contest my grandparents met on a blind date in New York City in the 1920’s and decided to marry within a week.

Granddad Tom was sent to Havana to open an office for United Press International. He became El Presidente Local for the U. P. I. in Cuba.

When he returned near the end of the decade he was handed a 40% pay cut even though the cost of living was higher in New York City than in Cuba.

If that wasn’t bad enough, in October of 1929, the Stock Market crashed and the economy began a long slide into what became the Great Depression. Granddad survived multiple rounds of layoffs by accepting further pay cuts.

Grandmother Anne realized that they couldn’t afford rent on Granddad’s dwindling salary, so she took a job as a receptionist with a developer who was building houses on the farm next to their rented home in White Plains. Soon she was managing four salesmen. She received 2 ½ percent in commission on every home sold.

To help care for the children, she found a lovely couple at the unemployment office. The wife was a nurse trained in Canada but without a license to practice in New York. Her husband was a handyman.  She exchanged room and board for childcare and yard work.

Grandmother convinced the developer to build (at cost) a model home for them with an extra room for their tenants. She became a stellar saleswoman in her own right. Before long, her commissions had completely covered the construction costs, and the home was theirs outright.

Granddad wrote to a friend that the Great Depression had been unbelievably good to them. Before the Crash they had had high hopes, but owning a house ‘free and clear’ in just a few years was inconceivable. Where could they have found a trained nurse and groundskeeper simply by letting them live in a spare bedroom and join them for meals? Freed of the burden of paying bills, the young couple soon saved enough money working odd-jobs to buy a gas station and start their own business. Because most of his coworkers had either been laid off (or quit rather than take a pay cut), Granddad had no competition as senior positions became available. His career took off.

In the 1920’s my grandparents had had Great Plans.

During the Great Depression they just tried to survive.

Sometimes just surviving is the winningest strategy of all.

College Thinking

© 2007 Brooke Allen
brooke@brookeallen.com www.BrookeAllen.com
Originally published in International Family Magazine

Colleges have become marketing experts. They work very hard at convincing you to send them your child and your money. You have to do the work yourself to find out why you shouldn’t send them either.

“Admissions.”

“Hello, is this (name of a liberal arts college in the Midwest)?”[1]

“Yes it is.”

“Are you an admissions officer?”

“Yes I am.”

“I am calling regarding my son. He has been admitted to your institution and he’s trying to decide if he wants to go. He isn’t here now so do you mind if I record this conversation for him?”

“Not at all.”

“Great. My son is a very good student but he is not yet ready to narrow his interests. He feels that a liberal arts college might be just the thing for him, at least as an undergraduate.”

“We fit the bill.”

“Personally, there is only one thing that I’m hoping he gets out of college more than anything else.”

“What’s that?”

“I would love it if he learns how to think.”

“Excellent. We’re in agreement. More than anything else, that is what we’re all about.”

“I’d like him to learn how to tackle problems with insight and creativity.”

“We agree.”

“I’d like him to respect authority and yet feel comfortable questioning it.”

“Perfect.”

“I’d like him to develop his people skills and to become responsible.”

“Couldn’t agree more.”

“I’d like him to learn to make his own decisions without requiring the approval of his peers.”

“We teach independence and responsibility by example. The college puts a great deal of trust in its faculty, staff and students to make decisions on their own.”

“I’d hope that he’ll find a place that facilitates this process rather than gets in the way.”

“That describes us to a T.”

“Good. Now, I have a question. Do you require that freshmen live on campus?”

“Actually, we require all students to live on campus their first two years.”

“No exceptions.”

“Well, we do make rare exceptions for hardship.”

“Do you mean, as in a case where we live in town but we don’t have enough money to pay for tuition and room and board? However, we could swing it if he lives at home.”

“We feel very strongly about this. We’ve found it is important for freshmen to develop strong relationships with other freshmen and these relationships are solidified in their second year. So, in the case of financial need we’d give him enough aid so that he could live on campus.”

“Like a grant?”

“Or a loan.”

“Ok, so you feel it is so important you would have him to go into debt. Now, imagine that the fact is that he has inherited a house right in town. It has four bedrooms and it has a market value of $160,000. Your college costs $47,000 a year all in. Since he has clear title, I doubt he’d qualify for a grant based on financial need. Are you saying you’d force him to sell the house and still go into debt so he could give you the money and live on campus when he’d rather take roommates and live in his house?”

“No. That would certainly qualify for an exemption. He could have seven other roommates since the town zones houses that way for students. He could collect enough rent from his roommates to pay all his other expenses.”

“That’s what it seems like. Rather than liquidate the house and give you all his money he could graduate from college with an education and a house free and clear.”

“Correct. And managing a property like that will certainly teach him responsibility. I’m sure I could get an exemption for him.”

“And seven other students.”

“What do you mean?”

“Well, you want him to live with other freshmen. You said so yourself.”

“That could be a challenge, but I’m confident we could do it.”

“Excellent.”

“I’ll form a committee right away.”

“Great. We’ll call a realtor.”

“What!?”

“He doesn’t own the house yet, but there are some excellent properties just steps from your main gate.”

“Wait a minute. This is totally different. What are you trying to do?”

“I’m trying to teach him how to think.”

“What you’re teaching him boarders on the criminal.”

“No, I’m teaching him how to tackle problems with insight and creativity.”

“But we have rules for a reason.”

“Is the reason you have rules to avoid thinking? The only difference between my son and the boy you would exempt from the rules is that my mother has not yet bought my son the house.”

“You’re teaching him how to trick people. If he thinks like you do then he will not be welcome here.”

“That’s what it seems like.”

 

Some colleges don’t want you thinking the way they don’t.


[1] This conversation is completely fictional and any resemblance to any real conversations I might have had with small liberal arts colleges in the Midwest is purely coincidental.

Tricky Economics

© 2006 Brooke Allen
brooke@brookeallen.com www.BrookeAllen.com
Originally published in International Family Magazine

We once attended a “Tricky Tray” fundraiser. It offered some excellent economics lessons. If you haven’t experienced one of these is, I’ll explain.

“Tricky” means what you expect and “Tray” comes from both the French word “très”, which means “very”, and the Spanish “tres” which means “three”.

A Tricky Tray is a very tricky device for separating you from your money three ways.

1) You pay $40 for a meal worth about $7.49.

2) You donate a prize that is supposed to cost about $20 but since it will bear you name, and since you don’t want to appear cheap, you will spend about twice this amount.

3) You must buy at least 10 tickets for $1 apiece that you will use to bid on the prizes. However, everyone else buys five times this number to increase their likelihood of winning something, so you will too just to stay even.

If everyone spends more to increase their chances, then everyone is worse off. The cost to achieve the same chance of winning goes up. This nicely illustrates the relationship between inflation and money supply.

If everyone has the same chance of winning a prize as everyone else, and if the number of prizes exactly equals the number of attendees, and if the average value of a prize is $40, then each participant should expect to win something worth about $40. This nicely illustrates the concept of expected value. As everyone contributes a $40 gift to join the game, they should all break even.

People then spend money for the tickets to underwrite a process that simply keeps people from going home with what they came with; sort of like the way Wall Street charges you a fee to sell one stock and buy another.

The average person paid $40 for their meal, $40 for the gift that they brought, $50 for the tickets with which to win other people’s tickets. Therefore, the average person received $7.49 in certain value and an average expected value of $40 in prizes, but with a large variance in outcomes. You can see how this could lead into a discussion of risk/reward ratios and breakeven analysis. It could lead to that discussion, but it won’t. Not now.

Anyway, it was all for a good cause. At least we assumed that it was.

In our case, we came with prizes that cost us $20 each (though not evidently so). We followed instructions precisely, and did not care who thinks we are cheap.

We bought the minimum number of tickets because: 1) we are not gamblers, 2) since we already had everything that we needed, we did not need anything else, 3) we already had a house stuffed with things we did not need, the only thing that this might suggest is that we could use a bigger house – however we didn’t expect to find a house among the donated gifts), and 4) we had no desire to collect other people’s ideas of things we did not need.

Eve and I separated upon arrival.

With my ten tickets I proceeded to win five prizes. This was more than nearly everyone else. Let me explain how I did it

A ballroom had dozens of tables holding hundreds of gifts. Next to each was a brown paper bag of the size that typically holds a flattened PBJ sandwich under an apple and a milk carton. You were to inspect each prize and decide if you wanted a chance at winning it. If it interested you, you’d drop half of your numbered ticket into the bag. During dinner, each bag would be shaken and winners called out.

Those are the physical and mechanical aspects of the Tricky Tray.

It was worth observing the behavior of participants.

The whole endeavor was clearly a female thing. Men were in tow, but they weren’t digging it. Of a few hundred items, less than a dozen might possibly appeal to someone with a Y chromosome. Even then, they were a woman’s concept of what a man might want.

A typical exchange in front of a variable speed drill:

She (all a titter): “Oh honey, I’m putting a ticket in this bag just for you. You could use it.” It was hard to force the slip into the bag since every woman in the room had used a few percent of her tickets on one of the man-prizes as a gesture of fairness.

He: “I don’t want another drill. I already have one.”

She: “But you can always use another drill.”

He: “How?”

She: “What if the one you have breaks?”

He: “Then I will buy another one.”

She: “But you could have this one.”

He: “If the one I have breaks, then I will want to chose the one I buy to replace it.”

Dinner began at 8:00 P.M. by which time the inspection of the prizes was to be completed.

By 7:45 the room had emptied, but for me.

On a first pass I inspected each bag. Some of the bags were overflowing, many had dozens of tickets, some had fewer than five; a few were empty.

On a second pass, each empty bag got one of my tickets. The remaining tickets went into bags with little competition.

Of course I won lots of prizes. Some folk with over 100 tickets won nothing.

During dinner, half my numbers were called. The women at my dinner table became upset with me. (The men couldn’t care less.)

Was I cheating? Several people suspected as much, until they began to inspect my winnings.

She: “No wonder you won so much; you bid on the stuff nobody wants.”

Me: “I want these things.”

She: “What on earth are you going to do with a shelf of children’s books?”

Me: “I have children.”

She: “Or those reference books?”

Me: “I can use the atlas, the dictionary, the pocket encyclopedia and the almanac. The only thing I have already is the thesaurus and so I’ll give that away.”

She: “OK, but a basket of pet toys? What are you going to do with them? You don’t have any pets.”

Me: “Yes, but I have friends who do. These will make fine presents.”

Priscilla put her finger on it. “None of the things you’ve won are any fun. I saw your bucket with the mop and the cleaning supplies. Are you crazy?”

“I saw that one too.” Suzanne laughed, “Who on earth would donate such crap? There was a really cute pair of earrings nearby. I wanted them so bad. Brooke, why didn’t you try to win those?”

I blushed, “I don’t wear earrings. Besides, that bag was full.”

She: “You could give them away. They would make a better gift than pet toys.” There was obvious contempt in her voice.

Me: “So, if you won those earrings, would you wear them or give them away as a gift?”

A pause.

She: “Well, actually I probably would pawn them off on somebody. They aren’t exactly my style.”

Me: “Good. This will illustrate the point. Let’s look into my cleaning bucket. How much would you normally pay for all this stuff? Bucket, mop, spare mop head, brush, floor cleaner, tile cleaner, window cleaner, pot scrubbers, pumice, natural sponge… the bucket was brimming.”

She: “More than $30.” There was lots of nodding indicated consensus. “But I could buy that stuff any time.”

Me: “Exactly. You have and you will again as you use it up and so will I. So this prize, that not one other person wanted, will save me at least $30.”

She: “Soooo…What’s the point?”

Me: “How much do those earrings cost? They look like costume jewelry.”

She: “I know exactly. I’ve seen them at the drugstore for $19.95. They have a hundreds on display.”

Me: “Now, if I wanted to give you a pair of earrings, I could take you to the store and let you pick exactly the ones you want. If I did this with the money I saved from taking the cleaning supplies that nobody wanted, I’d still have $10 left over.”

Everyone agreed that the real point of the evening was to enjoy oneself. Somehow, for them, my approach didn’t cut it.

Funny, I was having a blast.

The laugher, shaking of heads, and derisive comments lead me to believe I had not trained any competitors for next time.

You need not have fun nor make economic decisions the same way as everyone else.