Bear Market Predictors are Rarely Remembered

October 28, 1999

Time to dip into the mailbag, since it's been a year-and-a-half since Market Directions last fielded questions and comments from readers. I have paraphrased or combined a few of them, but there are others that I have left intact to retain their piquancy.

Q: Your column is an example of the kind of meaningless drivel that has unfortunately saturated the media. When the market continues its upward trend, making new highs in the process, you and your ilk will be long forgotten by the public.

A: I sincerely hope you are right about the trend, since the bull market has been good to us all, but I am unpersuaded that it will last forever. Bear markets are inevitable, and it is just as inevitable that the bear that finally terminates this amazing run of prosperity will be no less stunning than the bull that has preceded it.

It is probably true, though, that the doomsayers will one day be forgotten by the public. For how many of us can recall the names of seers who warned investors to exit stocks before the Crash of 1929? In fact, it is the unapologetic optimists who are most vividly remembered, and not fondly.

Most famously, there is Yale economist Irving Fisher, who on Oct. 17, 1929, declared, "Stocks have reached what looks like a permanently high plateau."

Doubtless some tragically unlucky pundit is going to utter similarly fatuous words on CNBC with the same unfortunate timing. Then will we bears relish our obscurity.

Q: Your column is a real hoot! Bear market? How could anyone be so wrong?

A: It depends which stocks you follow since the bull remains alive only in the narrowest sense of the word. In fact, breadth on the New York Stock Exchange has been declining since April 1998. This means that fewer and fewer stocks have been participating in the rallies since then and that the number of equity investors with losses has been growing. There is similar deterioration in the tally of stocks making new highs each week relative to those making new lows. This has taken its toll on professional investors, most of whom can't even beat the averages. Almost two out of three outperformed the S&Ps in 1993, but more recently, fewer than one in three has done so.

Q: Where do you think stocks will be at the end of 1999?

A: Lower than they are now, even though I expect a Christmas rally to begin in late November. Unfortunately, it will be from much lower levels. The Dow Industrials are currently trading around 10,200, but I would be very surprised if they don't fall to at least 9,200 in the next three to five weeks. If the blue chip index goes any lower than that, the first place it could find traction would be near 8,900.

My bearishness for the near term is not based entirely on technical factors, either. What troubles me most is that Microsoft, the heart and soul of this bull market, has not rallied to new highs following last week's earnings announcement. Also, IBM, another crucial bellwether, has predicted an order slowdown due to Y2K-related factors. If you think these are things the portfolio managers will simply shrug off, you're dreaming.

Microsoft and IBM aside, any investment pro who reads Barron's can see that growth rates have been falling for corporate profits, employment and overall economic activity. You can bet that the fund managers will be selling heavily into whatever fleeting strength this market can muster over the coming weeks.

Q: The whole time I've read your column, you've been saying in effect that millions of investors are wrong and that you are right. What a fool!

A: A bull market with the manic energy of this one gives every fool a vote. A couple of years ago, British rock 'n' roller David Bowie raised $55 million by selling the stream of royalties from his hits to the public. Soul godfather James Brown jumped on the bandwagon thereafter, and I wouldn't be surprised if we hear from Lawrence Welk's estate, The Monkees and the Ink Spots before it's all over.

Concerning the concerted actions of those millions of investors, I fear their confidence is sadly misplaced. As Dr. Marc Faber, economist and author of the "Boom, Doom and Gloom" newsletter, points out, the herd mentality is what increases risk. While few of us would cross a frozen river alone, notes Faber, many would do so where there is already a crowd of people on the ice. "Yet where," he asks, "is the ice more likely to give way?"

Q: Judging from your column, the bull market has passed you by. Do you own any stocks?

A: My kids do, but I have not held shares in a portfolio since the early 1990s. Instead, I have traded equities, options and commodities on a very short-term basis.

As a former floor trader, I came easily to the belief that the rewards of day-trading would greatly exceed anything I could hope to earn using a buy-and-hold strategy, even in a bull market. Turns out I was wrong even though I worked very hard at it.

In retrospect, I must concede that there is probably only a handful of traders in the world who could have matched the performance of the "dumb" investor who simply held on to the shares of Cisco Systems or a few others during the last few years.

Q: You should get yourself a copy of Harry Dent's book and get a life. He says stock prices are going to triple from here.

A: Thanks, but no thanks. Talking up Dow 35,000 is a great sales gimmick, but the thesis is a criminal abuse of fact and logic.

For starters, the consumption orgy that presumably would get us to Dow 35,000 in the 10 years Dent has allowed is already running on fumes.

Household savings growth has fallen to minus 1.5 percent, and we would have to double those dissavings to produce even a feeble 1.5 percent economic growth rate next year. Foreigners have made up the difference by buying our bonds, but I doubt they will long continue to exchange their hard goods for our IOUs.

Bottom line, neither the savings nor the purchasing power exists to capitalize the kind of boom Dent is talking about.

Q: You keep insisting that this bull market is just a mania. What is your logic?

A: Wall Street's biggest fallacy lies in the belief that market share is more important than profits. The idea is that so long as a company is growing by leaps and bounds and capturing market share, it doesn't matter how little it makes or how much it borrows.

Amazon books epitomizes this new religion, but if its shares are trading higher in five years than they are now, nearly everything I've written in this column will have been wrong. There is also Martha Stewart, homemaker extraordinaire, whose IPO last week reportedly made her a billionaire on paper. Old-time investors may be wondering if she is worth a thousand Betty Crockers.

Q: (Fed Chairman Alan) Greenspan wouldn't do anything to kill this bull market. He'll just lower interest rates if stocks starts to fall hard.

A: Not with a weakening dollar, he won't. The chairman's supposed war against inflation is belied by an explosion in credit that has fueled the bull market since 1992. Ultimately, as Greenspan surely knows, it is the specter of deflation that we should fear, with its threat of falling asset values and wages, accompanied by soaring real interest rates.

With the recent surge in oil prices, we are experiencing what analyst Chris Carolan calls a false spring — an inflationary blip that will be overwhelmed within two years by the much more powerful deflationary forces that have squashed Japan's economy for nearly a decade. Let's hope Greenspan is not still fighting inflation when the bear market gets under way.

Q: Are there any defensive stocks you could recommend?

A: I like companies in the water business best. Those who own water at the source, especially the ones generating additional cash flow by contracting with cities to deliver it, are excellent bets. The kicker is that there are many acquisitions being made in this sector, and scores of small, profitable companies are still ripe for takeover.

I also like South Africa's junior gold stocks because some have been beaten down so hard that the downside risk, even if gold prices fall, is minimal. Although deflation would likely keep a lid on gold prices, the metal has historically held its purchasing power in times when other commodity prices have fallen.

The purity of gold is measured in carat weight.

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