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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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A bear is an investor or trader who believes the trend of stock prices is down and trades or invests with that trend by selling his stock and/or selling shortTHE BEAR BACKGROUND Overview Every man takes the limits of his own field of vision for the limits of the world. Arthur Schopenhauer, 1851 In the late 1950s, when I first started serious stock market investment/analysis, it was only necessary to put your assets into blue chips and watch them appreciate year after year. But, by the late 1960s and throughout the 1970s, the key to making money in markets was not just buying sound companies, but understanding Vietnam War-induced inflation, as government tried to supply both guns and butter. (Just as the US is doing today.) By the early 1970s, it was also necessary to have some understanding of foreign markets and international affairs, when OPEC, seeing their pound and dollar assets already eroding because of fiscal irresponsibility in both the US and Britain, temporarily cut off the Wests oil supply using the 1967 ArabIsraeli Six Day War as the excuse. And, as the value of the dollar declined, the value of the Swiss franc and the German mark rose sharply, so it was possible to make a great deal of money simply by moving out of US dollars and into Euro currencies and bonds. THE BEAR AND HIS MARKET Since this book is largely about bear markets, it seems necessary to give a dependable definition of both a bear and bear markets. A bear is an investor or trader who believes the trend of stock prices is down and trades or invests with that trend by selling his stock and/or selling short. A bear market is a depressed or declining market. One can have a bear market in real estate, advertising, automobiles, art, commodities, bonds, or anything elseincluding the stock market. A bear market in stocks is usually defined in ways that equate the mini-bear markets of 1983, 1987, and 1990 with the more prolonged bear markets we saw in the 1970s or even with the great bear market that began in 1929. I prefer to define bear markets in three categories: 1.Baby bears such as those we have seen during the last 20 years, whichwere little more than secondary reactions within a papa bull trend.2.Mama bear markets such as we saw in 1973-74.3.Papa bear markets such as the one from 1929 to 1942 and, in constant dollar terms, from 1966 to 1981. (See Constant Dollar Dow chart in Chapter 19.) Within these major bear markets, it is possible to have mini and medium size bull markets (more on this in the next chapter), but what makes them still a bear market, in spite of huge up-moves, is that the original damage to market and economic infrastructure is not solved until the end of the cycle. For example, it was not until the minibear of 1981 that the problem of inflation was solved, enabling the stock market and business to begin a major new bull market. During the last 20 years, many analysts have forgotten that, although when you buy or sell a stock you are at that moment simply making a bet with another investor on the future direction of that stock, you are not just buying a lottery ticket. You are buying a piece of a company. Therefore, it matters over the medium and longer term whether that company will succeed or fail. Today, it seems fashionable to divorce the value of a stock from its price. That was almost valid during the late great bubble, but may not be so again in our lifetime. New bubbles arise only when the last one is forgotten, usually in a new generation. BE NOT A BULL, NOR A BEAR, BUT A REALIST A bear is not (at least should not be) a permanent pessimist. Nor should a bull always be an optimist if he is wise. Both should try hard to be realists. You should be able to change from a bull to a bear or a bear to a bull, as conditions change, and not be the least inconsistent. Some people are permanent bears, and give the symbol a bad name. Permanent bears often have a puritan ideology that sees prosperity and bullishness as some kind of Original Sin. Likewise, many people are always bullish, obviously without sufficient justification. The almost continual bull market from 1982 to March 2000 has made most people permanent bulls. It has been impossible for them to accept that any downturn is more than a short-term correction. But, in any market, the flexible realist is the winnerthe man or woman who can switch directions overnight. So, let it be crystal clear that a proper bear is someone who used to be a bull but became a bear as conditions changed. SHORT SELLINGITS NOT UNPATRIOTIC Before going further, let me give a definition of short selling because its vital to what follows, and I dont take up the subject in detail until much later. Short selling is the opposite of normal (long) stock positions. If you buy a stock hoping it will go up, you are long of the stock. But if you think the stock will go down, you can sell it first, and buy it anytime you please. This short selling is a simple borrowing-of-stock process that is handled by your broker with no need for you to understand how. Now, let me clear the air on another common fallacy that some people hold with regard to bears. Some think being a bear and/or selling short is in some way unpatriotic or negative. They believe that to invest your money in the industry of your country and lose it is more patriotic than to sell those industries short by selling their stock shortor simply selling out completely because you feel we have entered a bear market. Many TV market commentators, in the aftermath of the September 11, 2001 terrorist attack, urged investors to hold on to their stocks regardless of what the markets would do. At the beginning of G.W. Bushs presidency, when he suggested that there were signs of weakness in the US economy, there was a cry of outrage from those who accused him of talking down the stock market and the economyas if the health of our entire capitalist system is so fragile that it can be talked into changing directions. Even advisors claiming to help you recession-proof your portfolio cite people like Warren Buffet who made his fortune by buying and holding, regardless of short- and medium-term fluctuations. Most advise all nonprofessional investors to do the same, unless they are getting near retirement age, when switching into bonds might be safer. What these advisors fail to mention is that it is only since 1982 that buying and holding has paid off over the longer term. But Joseph Kennedy, father of JFK, for example, made his familys fortune by short selling in the bear market that began in 1929. And many lesser known tycoons of the roaring twenties simply sold all their stocks and took a multi-year vacation, beginning around 1928. Nor did any of these men do the country or the stock market any harm. They stayed solvent and provided the capital for the next economic upturn. THE FACTS OF THE CASE If anyone is still not convinced, the facts are these: (1) If there was anything unethical, immoral, illegal, or un-American about it, the Securities and Exchange Commission wouldnt allow it. (2) The country cannot benefit from having all its investing citizens lose money. Therefore, if some are able to make money in a declining market, this is all to the good. A free society needs solvent citizens, in order to remain free. One might also say its a patriotic duty to stay solvent. And, if short selling does that in a bear market, it can hardly be evil. You cant help your family, country, or self if you lose your money. (3) Stock prices are merely peoples opinions of their value. And, since stocks once sold by the company are no longer the property of the company, the shorting of those shares is not shorting the company but rather shorting the opinion of the company as held by other investors or traders. Microsoft doesnt get your money if you buy its shares, neither does it lose money if you sell its shares short and they drop in price and you make a profit thereby. You merely won a bet with a fellow investor. He thought they would go up. You thought not. You won. Ill have more to say in defense of short selling in Chapter 13. It has been misunderstood for decades. (4) The short seller contributes mightily to the creation of more orderly and stabilized security markets through the demand for and the supply of securities he creates. In bull markets and bear, he is selling short, and he is eventually covering (i.e., buying), which demand puts a cushion under market declines. Without the short seller, our markets would be bottomlessthose times when panic prevails and bulls rush for the exits while the short seller is calmly buying stock to cover his shorts and taking a profit. BEAR MARKETS ARE INEVITABLE Its only reasonable to ask why we have bear markets. Many think we should have progressed far enough in social structure, in government guarantees, floors, and protection that we should have no more depressions, recessions, or bear markets. But to so think is to say we have changed human nature and repealed the law of supply and demand and stopped the pendulum that swings from surplus to insufficiency. Usually when government tries to manipulate prosperity, instead of allowing the business cycle to take its course, they make matters worse. For they destroy the price mechanism that lies at the heart of our free markets system. Its what Nobel Laureate F.A. Hayek refers to as the special information we all have that causes us to buy or sell at certain prices, but to regard products as too expensive or too cheap at others, which causes shortages or surpluses before the system adjusts. The business cycle simply reflects evolving markets. But, except in limited situations where liquidity is needed to prevent panic spreading, most government intervention is of little help and over the long term usually makes a situation worse. There are always unintended consequences to all government interference in an economy or market. For hundreds of years, people have been saying, at certain levels of the business cycle, that they were in a new era of permanent prosperity. Even in ancient Rome, they were under the impression they had a fixed state of affairsan affluent societyas masters of the world. And, during the 1920s, so convinced was everybody that their new technology had ushered in a New Era that, just weeks before the 1929 crash began a decade-long depression, it was publicly stated that America had entered a permanent plateau of prosperity. The more things change, the more they remain the same. No matter what a legislature does, no matter what a President, Prime Minister or Federal Reserve Chairman says, no matter what new concepts are around, the natural cycles of rise and fall take their tollbe it in stock markets, coffee prices, gold, land values, or whatever. GOING TO EXTREMES Simply put, a bear market in stocks comes about because the prices get too high in relation to their value. This is caused by public enthusiasm that gradually becomes excessive, appraising stocks out of proportion to their true earnings. It is the nature of such things to go to extremes in both directions. So, as a bull market often goes too high, so too does a bear market go too low. The excesses are caused by human emotions, about which we have more to say in the chapters on human psychology. THE FALSE PROPHETS One of the aspects of depressions, recessions, and bear markets that is most difficult to understand is the false leadership or false prophets that are prevalent during these times. In part, its intentionally false, as in the case of most political parties when in office. If they suspect (from government data) the business future is grim, they will rarely reveal this if they can avoid it. And what must be revealed to the public is distorted or delayed or colored. This is only human. Nobody wants to lose his or her job, and recessions and depressions usually cause politicians to lose the next election. The talking heads on television have a vested interest in talking markets up to maintain their stations advertising revenue, and their jobs. Vested interest is knee-deep in the TV and mass media worlds. False prophets often speak with great sincerity when they say they foresee great prosperity ahead. Or if that statement seems less than realistic, then its a combination of wishful thinking and self-interest that cause them to announce we will have a soft landing, that we should be looking for new buying opportunities, that weve made a bottom. Most honestly cant see around the corner. This is no crime. But if one wants to preserve his capital (and perhaps even dare to dream of increasing it) during a sick economy or market period, one must try to see around the corner. An important requirement for investment success is to think contra. If the Secretary of the Treasury in any nation says he looks for next year to be better than this year, one should form the habit of automatically being skeptical. It may be meant as a statement of fact, but the odds are that it isnt. And by doubting it, you prepare yourself for preserving your capital. As Diogenes (325 BC) advises: Be a cynic. Likewise, in bad times, the chairman of some board may forecast that software sales will be rather miserable again next year. This should be greeted with the same reaction. Its probably a time to buy shares in software companies. They may be right, but get into the habit of thinking they are wrong, because they probably are. The majority usually are. Even the majority of board chairmen, or Treasury Secretaries and Exchequers! The main focus of this book is help you to think your way to prosperity. Ill offer some formulas, indicators, and strategies. But tools are of limited use if you dont accompany them with logical, nonconformist, contrary thinkingan increasingly lost art in these days of computers and the Internet. Contrary to a computer? Yes, at times. WHAT CAUSES A DEPRESSION? Depressions or recessions are caused by basic economic changes of supply or demand or credit. What leaders say about circumstances cannot in itself help or hurt the situation, except perhaps for a few days. Talk just doesnt matter. If an apple is rotten, the act of saying so will not make it ripe. If its ripe and someone calls it rotten, it will not turn rotten on the spot just because of this characterization. RECOGNIZING THE BEAR The final section of this chapter must deal with the recognition of a bear market. How do you know when you are in one? While we will go into more detail in later chapters, one basic approach was defined by Charles H. Dow in a Wall Street Journal editorial of July 7, 1900. This premise still holds today. He called it: The Great Law of Action and Reaction. Today, it is generally known as the 50% principle. The sum of what Dow said so many years ago was: It is a remarkable fact in speculation that both the average price of a number of stocks and the price of individual stocks show strong tendencies, both in rallies and relapses, to reach one half of all the primary movement. When a stock falls ten points in a comparatively direct move, it is extremely likely to rally as much as five points from the lowest. It often rallies or relapses more than half of the original swing, but it is generally safe to wait for about half. A Comparison of the Averages . . . shows how regularly this movement occurs. When a recovery does not come near being one half of a decline, it generally means that the primary movement has not been completed and that a new low quotation will be made. In Figure 2.1, we see the principle behind Dows words. If the left end of the beam (marked A) is forced up from its resting position, the beam will approach the horizontal position or 50% level (dotted position B). If the upward thrust has been great enough, the beam will swing all the way up to the high position (dotted position C). But if the upward thrust from A was insufficient, the beam may approach or touch the 50% level (B), falter, and then sink back to the original position at A. TO SUM UP Thus we might draw these conclusions, based on Dows idea: . Following a major market advance, if, on the subsequent correction, the (Industrial) Average holds persistently above the halfway (50%) level, the odds favor the highs again being approached (or bettered). 2. Conversely, following a major advance, if the subsequent retracement or correction goes below the 50% level, the primary direction can be considered to have turned down. The preceding lows may then be approached (or passed). . Following a bear market, if a bull move succeeds in retracing 50% or more of the previous bear market decline, the odds then favor a new bull markets approaching or bettering the old bull market high. 4. Following a bull market, if the next bear market succeeds in erasing more than 50% of the total bull market gains, the odds then favor the bear markets testing the old bull market low. This principle applies in many fields, not just the stock market. If what I say in this book applied only to the stock market, it might be valueless because the market is made up of nothing more than peoples opinions. What they think and do makes prices move. So, to understand the market, we must also try to understand people and their motivations. We must also factor in social, political, and cultural aspects of human behavior when making a market decision. One must act contrary to the majority viewat the proper time and in the proper way. A CAUTION This book is necessarily written at one place in time, and looking ahead is still an inexact science, indeed an art more than a science. You, dear reader, must adjust your thinking as I will adjust mine, day by day, using the methods outlined in these pages. |
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