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Neuroeconomics (the scientific study of choice) has its origins in two places, in events following the neoclassic economic revolution of the 1930s and in the birth of cognitive neuroscience during the 1990s, (Glimcher, et. al, 2009)

Congratulate yourself. You’ve made it through this part of the bear market courageously. Your courageousness may be a sign of brain damage (not really, but see the next paragraph!). I expect a new bull market to breakout as early as November, although there is some hope it could begin sooner. Of course, much depends on autos, housing and banking. Nevertheless, last month you were rewarded with the best one-month return in the stock market in 18 years. This doesn’t recoup all losses from peak values in 2007, not hardly, but it’s a start. Your tenacity suggests continued trust and confidence in your money management team. Your trust is appreciated. Surely it hasn’t been easy.

Maintaining your trust in the wake of never-before-witnessed volatility and unheard of interventionist policies by the federal government requires great emotional strength and mental control. Give yourself an A+. I encourage you to continue to maintain your mental discipline as research shows it takes emotional control to be an above-average investor. As you may recall, I completed my MBA thesis on neuroeconomics. In the course of my research, I came across a Wall Street Journal report in which researchers found that individuals with brain damage make better investors. When faced with a problem, individuals with brain damage experience less fear. This allows them to view problems objectively and make decisions based on logic and reasoning, as opposed to panic and fear.

To drill down further into the relationship between fear and investing, it is helpful to return to the basics of fear. The human neurological system is built on a neuroplastic substrate (flesh with nerve endings) that responds to certain types of events. The top events stimulating a fear response in human beings are: spiders, snakes, heights, water, enclosed spaces, tunnels and bridges, social rejection, failure and public speaking.

In the brain, one of the internal mechanisms responsible for much of the delivery of fear is the amygdalae. The amygdalae is actually made up of two amygdala, which are walnut-shaped neuron bundles whose primary role is to respond to overwhelming stimulus events by flooding neuropathways with neurotransmitters. High brain regions read these neurotransmitters as fear and danger. As the brain pieces together complex messages, such as the rush of visual and emotional messages brought on by a stock market collapse, an immediate sense of danger is contextualized. The amygdalae also works in coordination with other neurological systems in the brain to form and store memories. Fear enhances long-term memorization. This is why people have such vivid memories of exactly where they were when catastrophic events such as Pearl Harbor, JFK’s assassination, or 9/11, hit the newswire.

Successful problem solvers learn to control fear in order to assess the best solution sets in the midst of chaos. They also make a conscious effort to control memory in order to keep from learning the wrong lessons. Successful investors control their fear in order to keep from making irrational decisions such as buying high and selling low. Columbia University researchers found that the anterior cingulated cortex is the region of the brain which helps control fear. The rostral anterior cingulate cortex activates to dampen activity in amygdala, granting subjects a degree of emotional control.

Day in and day out, the economy and the stock market bombards people with information. Fortunately, human beings naturally participate in pattern recognition strategies through their amazing intellectual ability to draw salient points from overwhelmingly complex sets of stimuli. However, we do not have the capacity to mentally process 100% of the stimuli which we are constantly subjected to. Therefore, the context in which an individual processes and interprets stimuli is extremely important. Pick an accurate economic context and problem solving is easy. Select a false, misleading or gap-filled context and your investment strategies are likely to experience poor returns at best. Decide to opt out of decision-making strategies, in favor of buy-and-hold behavior, especially during a bear market, and get hammered.

The strategies we have employed on your behalf this quarter included significant trading activity. Nimbleness was necessary because the first quarter was so extreme it included the equivalent of a small bear market and bull market all on its own. It is encouraging to report that much progress was made in the month of March. Going forward, we will be engaged in decision making based upon faint glimmers of new hope for an improving economy. Nevertheless, we still need help from the housing, automobile and banking industries this quarter in order to rally beyond 900 on the S&P 500. That’s roughly 13% higher than the 797 level at which we now find the S&P 500 as of this writing. Many analysts expect a flattening out or base-building process this spring and summer. To give you greater perspective on new fundamental and technical data, I close with the following three summarized data sets:

1. Until proven otherwise, we are in a bear market rally. Under this scenario, a long multi-month, tight-trading range can be expected. A trading range somewhere between just under 700 and 800 for several months would do much to build a base from which a year-end rally to 940 could be staged. This rebound could begin as early as June or as late as November. Certainly by November more encouraging news should begin to filter into the markets. On the short term, we are all closer to a turn in the economy than we were before the government initiated the stimulus packages for the banking and auto industries. Of course, longer term, the government must unwind these interventionist policies.

2. This is the first bear-market rally during which lead indicators are turning up. Credit markets are beginning to improve, refinance activity and consumer spending are heating up, and indicators point to valuation statistics which show that equities are still 1.2 standard deviations cheap. Nevertheless, the percentage of stocks trading above their 10-week moving average has risen from just 6.8% of stocks to 67% of stocks since the beginning of this bear market. From the start of this bear market this measure has never risen above 70%.

3. Very high cash levels remain in place, and quarter to quarter panic buying may ensue as mutual fund managers rebalance to keep up with the bench mark S&P 500. This bodes well for either a.) follow-through to the upside and b.) support above the November 2008 bottom.

Contact us to learn more about working with Vaughn Woods Financial Group.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0035

**Marketedge.com, Pershing NetExchange Pro, Bloomberg, Credit Suisse
Context: A Neuroeconomic Solution Set for the Integration of Intelligence Models (Woods, V., 11/2007)
Global Equity Strategy: The Best monthly gain since 1991-can it continue? (Garthwaite, A., Credit Suisse, 3/2009)
Fear, (.Wikipeida.org/wiki/Fear, 3/2009)
A Quarter Defined by Historic Whiplash on Wall Street, (Paradis, T., Yahoo Finance, March 31, 2009).
Wall Street Journal, ( 7/21/2005)
Neuroeconomics, Decision Making and the Brain, (Glimcher, et al., p. 463, 2009).