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Rubes Keep Buyin as Pros Head for Exits

June 21, 1998

The preternatural strength of U.S. stocks these days comes down to one disquieting fact: most investors don't know what else to do with their surplus cash.

The ones I've talked with concede that shares are very pricey now and probably more vulnerable than they have been in years to a bear market.

But none plans to get out of the market -- or even lighten up on stocks.

"What else would I do with my money?" asks a close friend who has seen the value of his portfolio double in just three years. "Besides," he adds, "the taxes would kill me."

This is no small problem for legions of investors. In recent years they've grown so dependent on annual gains of 15 percent or more that you can hardly blame them for turning up their noses at safe, fixed-income vehicles yielding a third as much.

So they continue to invest more or less on autopilot, parking a piece of every paycheck in a 401(k), or in mutual funds, and reinvesting the dividends.

Millions of investors are doing this, a fact that helps to explain why the stock market has remained firm even as fundamentals have grown increasingly shaky.

Indeed, some key stocks have been struggling hard recently. Intel has fallen to the mid-60s since topping last August at 102, and now looks poised for another 30-point dive. Blame intense competition from other semiconductor manufacturers as well as aggressive antitrust scrutiny from the U.S. government.

And Microsoft, the corporate soul of the bull market, is similarly under attack by the Justice Department, its shares unable to make much headway even on days when other technology issues are rallying sharply.

Without the unambiguous leadership of such stalwarts, the bull market is over. I have already assumed as much and am advising clients not only to reduce their exposure to shares, but to short them aggressively on rallies.

This strategy in theory makes it possible to profit from a price decline. Short selling entails selling stock that you have borrowed in hopes of replacing it with shares acquired at a lower cost.

Thus, if you short Microsoft at 97, then later buy, or "cover" it at 82, you have realized a $1500 profit per round lot before commissions.

Once you grasp the rudiments of the short sale, you can begin to comprehend some of the forces that have been levitating stocks even as earnings prospects have dimmed for some of America's corporate bellwethers.

There can be little doubt that short sellers have been providing adrenaline to a market that has grown far too weary to rally on its own. Without such sellers, the Dow Industrial Average would probably be trading 3000 points lower.

The reason is that, while habitual buyers such as my friend can help put a floor under share prices, at least for a while, only panicky buying by bears caught in the ringer can push stocks effortlessly to new heights.

This is known as a "short squeeze," and the mechanism is uncomplicated. As stocks rally against them, bears' losses mount to the point where they must pay up to get out of jeopardy.

Quite often, when the desperation of such buyers becomes apparent, sellers will pull their offers, causing shares or indices to soar on relatively light volume. This is what turbocharges rallies, not run-of-the-mill buying, no matter how enthusiastic.

Because a short squeeze pushes stocks higher without taxing the financial reserves of buyers, bears should be considered the real heroes of bull markets.

They have most certainly been a steady a source of profit and pleasure to shareholders, especially those investment professionals who are able to manipulate the markets to the detriment of bears over short periods of time.

There are of course risks for both sides. But in a bull market, even one that is dying such as this one, the bulls have the edge.

For one, most of the time they can depend on support from individual investors and mutual funds. Even on days when stocks are falling hard there are still sufficient funds from those sources to ensure that at least one or more groups of stocks will remain afloat.

Thus, on a given day, Blue Chips might rally as tech stocks are falling. Or transportation stocks could soar, as they did last week, when the broad market is falling apart.

This shell game is known as "rotation," and its importance to the psychology of the market cannot be overestimated. The movement of funds from one investment sector to another lowers the odds of an across-the-board rout, and the process is therefore crucial to the illusion that the bull market is alive and healthy.

Nothing could be further from the truth, however. The bull is in its endgame, stocks are booby-trapped to entice the unwary, and the con-artists who are doing the manipulating are easing toward the exits.

For reasons explained above, the pros can easily hold the market up when there is little buying enthusiasm. But when there is good news to help them, they are ready to pounce, driving shorts to cover while spring-boarding stock averages to ever-higher plateaus.

This is known as distribution: smart money selling shares to all the rubes. It is what happens before markets collapse, and it is happening now.

It is also why you should view any rallies from here on out with mounting skepticism and suspicion.

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