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Market's Really, Really Looking Bearish Now

April 10, 2000

HERE'S THE standard put-down of gurus who have been saying for years that the bull market is about to end: Even a broken clock is right two times a day.

Just so: If the hands of a clock are frozen, it will still show the correct time twice each day. Analogously, if some newsletter swami keeps predicting that a bear market is about to start, sooner or later he'll be right.

Until that day arrives, though, expect the broken clock to continue to outperform the gurus.

Outperform me, at least. Although my daily stock and commodity forecasts are purely technical in origin and mostly opinionless, I've been warning in this column since late 1998 that the stock market was in danger of collapse. It still is, only more so.

Shouldn't long-term investors be worried, then, if even opium-snorting bulls are willing to concede that Chicken Little eventually will be right?

You bet. But after last week's impressive trampoline bounce on Wall Street, I somehow doubt that more than a mere handful of shareholders are giving much thought to a possible day of reckoning.

Some of the investors I've talked with seem to think the bear will overlook them when it finally comes bellowing from its lair.

Historically speaking this is delusional, since at least seven out of ten stocks are certain to be decimated during the next bear market, assuming it is no worse than most.

Meanwhile, last Tuesday's volcanic rally was reminiscent of the ones that occurred in the late summer of 1929, just prior to the Great Crash. Then as now, the pundits are eager to explain away the stock market's violent swings with the same words: The economy is fundamentally sound.

And shareholders remain unfazed.

Perhaps each thinks that, when the bear finally comes, his portfolio won't get hit as badly as the next guy's. Or maybe most investors are simply convinced that share prices will not fall very far or for very long, no matter what happens to the economy.

This is the kind of rationalizing that almost cost two of the three little pigs their lives. Let's consider what it could do to investors.

If there is one lesson they have internalized as the bull market has evolved, it is this: Don't panic when equity prices fall, for they will soon bounce back, stronger than ever.

And so they have -- more times in the past few years than anyone can count. The clincher for those who might otherwise doubt the bull's staying power is that the scariest days on Wall Street in recent years have turned out to be the best buying opportunities.

For not only has the bargain hunter been impelled by experience to buy the dips, he has been conditioned by their fleeting nature to do so without hesitation -- when sellers are just a bit freaked -- in order to reap the biggest gains.

So many times has such bravado been rewarded that fear itself has all but vanished from the marketplace. So when equity averages fall 20 to 30 percent in mere days, as they did last week, it is a time for feasting on Wall Street, not fright.

This is scary in a subjective and psychological way for doom-and-gloomers, who are always looking for signs of the endgame. But it nonetheless provides them with a reasonable basis to assert that most investors will be devastated when the bear finally arrives.

Here is how. We already know that the bear can wreak extensive damage without even tipping its hand. Last week, for instance, an estimated $1.7 trillion vanished temporarily when one index alone, the Nasdaq Composite, plummeted almost 30 percent in the space of just seven days. Two thirds of that decline occurred in the final two days of the sell-off.

Yet, when the market whipped around and rose sharply on the seventh day, the talk in CNBC's bullpen was not about the severity of the decline, but the speed and power of the recovery. Americans could breathe a sigh of relief and resume their favorite pastime: adding shares to their 401(k)s.

Someday, however, stocks are going to fall 30 percent and keep on falling. How far could they drop before it dawns on the bullish herd that something important may have changed? My guess is around 40 to 50 percent.

They would not become panicky at that point, just more aware of the possibility that the decline was something other than the accustomed dip.

And this in turn would induce many of them, not necessarily to dump stocks that will come later, when the averages are down 80 to 90 percent, but to offer shares above the market in the hope of selling into a rally.

That will be hoping for too much, since the more fervent those hopes, the bigger will be the supply of shares for sale. Sellers will lower their offers when they go unmet, and this will produce a downward spiral in prices that could last for many months, if not years.

So much for the exit strategy of those who think they will recognize the bear the instant he arrives. Their stock portfolios will be cut in half before they can summon the fortitude to take their losses. By then, there will be panic in the air, and no bids in sight.

Meanwhile, the pundits seem to think the worst that can happen in the near future is that stocks will re-test last week's lows. It will be interesting to see how many true believers buy that dip.

From a psychological standpoint, the most troubling aspect about the market right now is the performance of its two most important bellwethers, Microsoft and Cisco Systems. The latter had to finagle its tax payments last quarter so that it could report a crucial extra penny of earnings per share.

The important thing to note about Cisco is that employee compensation, which includes an extravagant stock options program, is running well ahead of revenue per worker. Most recently, operating expenses were growing 41 percent faster than operating income.

This can't last, and it is a particularly dangerous development for a company whose shares sell at more than a hundred times trailing earnings.

As for Microsoft, the likely outcome of its legal problems is probably too complex to foresee. As a market technician, however, I'll take the easy route and say, simply, that the stock's bull market will be over if and when it touches $75.38. That is 10 points below its recent low, about 14 points under Friday's close and 45 points off its all-time high.

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