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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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The average investor today believes that, provided the Federal Reserve and US government cut interest ratesECONOMIC SETTING FOR BEAR MARKETS Ultimately, in a free society, we cannot protect people from all the consequences of their own errors. We cannot protect people completely without denying them the possibility of achieving their own fulfillment. We cannot completely protect society from the effects of waves of irrational exuberance or irrational pessimismemotional reactions that are themselves part of the human condition. Irrational Exuberance, by Robert J. Shiller, Princeton University Press, 2000 Guideposts for Bear Markets It requires a great deal of boldness and a great deal of caution to make a great fortune, and when you have got it, it requires ten times as much wit to keep it. Ralph Waldo Emerson (1803-82) Lists of data abound, showing signs to look for to tip you off as to whether were heading for business improvement or slump, or for a bull or bear market. During the latter part of the 1990s, these data was used selectively by financial commentators. Analysts fought to get air time or print space for self-serving reasons. And Wall Street became part of the entertainment industry. Thoughtful judgment calls, based on extensive research, were no longer expected of TV or print media analysts. Instead, they were and are expected to entertain viewers and readers, and to put a positive spin on all economic and financial data, no matter how dire it is in reality. Market terminology is being twisted into the new language of Street-Speak, where nothing is ever what it seems, and the need for news has disappeared in favor of the need to be reassured that, no matter what happens, the bull market will resume next week or next month. Symbols have taken over from substance. And after years of the Clintoninduced culture of feeling your pain, a major reaction in the US to the September 11, 2001 attack was to go out and buy a flag and wallow in the emotions of grief, instead of learning about crisis management for their portfolios, responsible citizenship, and for their daily lives. My first book in 1964 was also on bear markets. In it, I published a list of bear market signs for the responsible investor to watch, to alert them when a bear market was imminent. Though many of those signs are still valid for a medium and long-term investor, and I will get to them in a moment, the way many of them now operate has changed drastically in the last 5 years. Until about 1995, technical indicators usually had a few weeks lag time before the data manifested themselves in the markets. And the connection between economic conditions and stock market direction was still accepted as fact. But, from about 1995 on, the media and governments have manipulated all data so much that the average investor today believes that, provided the Federal Reserve and US government cut interest rates or create bail-out packages, it wont be long before the late great bull market of the 1990s resumes. Even the language has changed. In the 1980s, when it was necessary to subsidize the Savings and Loan industry to prevent it from collapsing, it was called a bail-out. And, though it did not cause a full-blown bear market, it was considered bearish enough to create a sizable correction in the DJIA. In late 2001, with the airline industry on the verge of collapse and production at new lows, the bail-out was called an economic stimulus package, and investors reaction to the news has been to push the market back up! In the past, increased government spending and, at the same time, massive increases in the money supply were regarded as fiscally irresponsible and a harbinger of inflation. Today, investors turn to government with the same naive gratitude a small boy might show a parent who replaced the pocket money he lost. The media has created a culture of victim investors: when the news is negative but not our fault. The media admits there are problems but blame it on terrorists or whoever. But when the news is positive it is the government who claims the credit for creating that success. This causes far more volatility in markets than ever before because, when the only factors admitted to be causing a business turndown are claimed to come from outside, markets seem totally unpredictable and people will panic more. But none of this has changed the laws of economics, or stock markets. And companies patriotically and foolishly buying back their own stock or investors watching their retirement accounts diminish while they wave the flag wont change long-term trends, nor do a thing to solve the very real problems that the economy had long before September 11, 2001. During the near vertical fall in 1930, John D. Rockefeller consumed a considerable portion of his enormous fortune buying back his stock in Standard Oil, then a DJIA company. He managed to stall the market fall for a few days. But he was no more able to reverse the laws of economics than todays patriotic investors can. What has been totally forgotten in the last several years is that when Charles Dow created his Average, he saw it, not as a stock market indicator, but as an indicator of economic health. He understood that stocks are no better or worse than the companies they represent. It is the economy that drives the stock market, not the other way round. Yet today, the only time commentators admit the connection between the price of stocks and the companies they represent is when there is a technical rally in stocks, and they remind us that stocks rise before a recession is ended. Ergo, if stocks rise, the economic recovery must be just a few weeks away. SIGNS A BULL MARKET IS ENDING No matter what Washington or the media claim, bull markets cannot be sustained if the economy is faltering. Neither can a bear market suddenly become a new bull market, with a V bottom (media-speak) while economic indicators are getting weaker: 1. The most important indicator that a downturn still has a long way to go is when investor sentiment is still bullish while the underlying economic structure continues to weaken. 2. Price earnings ratios. In recent years, even rational analysts have puzzled over why they no longer seem to work. This is all part of the separation of stocks from the values of the companies they represent. In his book Irrational Exuberance, Yale professor Robert Shiller points out that, since 1870, price earnings ratios for big companies have averaged just under 13 for a yield of 7.75%. In late 2001, that ratio was between 25 and 35, for a yield of about 2-4%, depending which biased source you read. To return to a more traditional price earnings ratio, the DJIA would have to fall to at least 5000. I will discuss that in more detail in a later chapter, but suffice it to say here that it suggests that this bear market has further to fall. 3. The Federal Reserve. Fed action has been the most closely watched indicator in the last 5 years. But, with the most aggressive rate reductions in history, driving US interest rates down to a level not seen since the 1960s and with no result, it is increasingly clear that when the US economy goes south, there is little government can do to stop it. 4. Consumer and Investor Confidence. There is always an abundance of confidence in the future of business and the market, at peaks. Even after markets turn down, as long as that confidence remains high the bear market has further to go. Markets traditionally turn around on low volume in the middle of widespread gloom about the future. Those who buy at the very beginning of major bull markets or sell at the beginning of bear markets are regarded as equally unhinged, as I was regarded in the Spring of 2000 when I suggested, in my newsletter, the Nasdaq was a sell. 5.Gold. In times of uncertainty, the interest in gold and gold shares picksup. 6. Real Estate. It is normal for real estate prices to rise with stock market prices. There is usually a lot of public speculation in real estate at bull market tops. Whether real estate turns down in a bear market depends on how much inflation there is. In inflationary bear markets, real estate is seen as a haven and prices rise. In bear markets where inflation is low and the currency firm, real estate prices will usually stay firm in the early stages, but will decline as the bear market deepens. 7. Stock market action. At tops, there is what is commonly classified as churning (i.e., high volume but not much change in prices, or great irregularity in prices [some up sharply, some down sharply], plus a lot of volatility day to day). 8. Unanimity of bullish forecasts. Business leaders, brokers, advisory services, columnists and broadcasters are, in the main, bullish. Any downturn is dismissed as temporary. 9. Sharp rise in debt. At the top of a bull market, the pervasive mood is that one can make a profit in markets, without risk. Consumer debt, household debt service payments, losses by credit card issuers, bankruptcy filings and mortgage delinquencies all rise sharply. This list is not complete and, with government playing an ever bigger role in our financial and economic lives, this list changes constantly. But I offer this list to stimulate your own thinking, as an antidote to the pap coming from the media and government trying to convince you that if you just buy and hold, consume like crazy, and put your trust in government, the economy will roll as it did in the 1990s. I encourage you to be ever mindful of how free markets work, and that the basis of prosperity is responsible citizens willing to assume risk, who never lose sight of the fact that all monetary decisions involve risk. Our system relies on solvent citizens who are self-reliant, not on governments ability to manipulate interest rates or create stimulus packages. FADS AS A LEADING INDICATOR FOR THE END OF A BULL MARKET All major bull markets of the last 100 years were fueled by new technology. But, in most instances, the genuine advances that the technology created were exaggerated into what became an almost religious belief in technology for its own sake. New Eras and New Economies became fads. Toward the end of bull markets, fads increase and give us a hint of our nearness to the next bear market. Both fads and new technological advances look much the same on the surface. Experience brings the ability to tell the difference between the sizzle and the steak. Thus, in the 17th century, when the big tulip craze hit, a savvy investor with a modicum of common sense should have suspected that, however full of limitless possibilities the new globalization that enabled the Dutch to enjoy this exotic flower was, a single tulip bulb could not possibly be worth the price of an Amsterdam house. But hundreds of experienced investors bought tulips as symbols of the new shipping technology, rather than buying tulips on their own merits. They bought into a fad. So it was in the 1920 Florida land craze. There was nothing wrong with either Hollands tulips or Floridas land. But one needs to look at them as business propositions, instead of getting caught up in an abstract idea. Investment trusts (we call them Mutual Funds now) were a fad before the 1929 crash. In the late 1960s, it was electronics companies, many of which by 1970 had lost 80% of their earlier value, and some had gone out of business entirely. We saw a similar fad in the late 1990s in the form of dot.coms. Both electronics and the Internet have been magnificent technological advances, and we will enjoy their benefits for years to come. But they became fads because they represented such spectacular advances that investors ignored such mundane considerations of whether the companies using the technology were viable businesses. Fads are a major indicator that a bull market is reaching a bubble stage. SIGNS A BEAR MARKET IS ENDING 1. Bad news abundant. The stock market always seems to start up before the bad news (about lower industrial production, unemployment, lack of consumer confidence, etc.) stops. At that point, the market will be acting contrary to the obvious, which is usually a good sign that the market is right in whatever it does. 2. Credit. Still tight. But credit balances in brokerage accounts usually are considerable. Large holdings in bonds and other cash-related investments. This latent buying power is what will give a new bull market its stamina. 3. Stock Market. Volume low, not much interest. Stocks selling at low price earnings ratios, high yields. But then new lows in the DJIA and S&P occur on even lower volumes. Some key stocks begin to show good rally potential. Volume tends to increase on rallies, decrease on dips. Charts are the way to spot this. 4.Confidence. Nil. Pessimistic forecasts made for the market and forbusiness. 36Bear Market Investing Strategies 5.Real Estate. Unless it has been an inflationary bear market, real estateprices will be down. It is hard to sell property. Lots of empty commer-cial buildings. Rents reduced. Foreclosures rise.6.Bonds. Government bond buying is popular. Corporate bonds are high,yields low. THREE BEAR PHASES It may shed further light here to quote from Robert Rhea, who was a hugely successful investment advisor during the 1930s. I will quote a number of market researchers from the 1930s and 1940s in this book because they saw things a lot more clearly than many do today. Government and media spin was not in vogue, then. Today, in our highly complex world, we tend to lose sight of the forest because we are too busy avoiding the trees and the undergrowth. Writers from a simpler time had the luxury of being able to see the big picture with less distractions from clutter. Today, TV sound bites appeal and deceive simultaneously. Said Rhea: Bear markets seem to be divided into three phases: the first being the abandonment of hopes upon which the uprush of the preceding bull market was predicated; the second being the reflection of the decreased earning power and reduction of dividends; and the third representing distress liquidation of securities which must be sold to meet living expenses. Each of these phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market. WATCH YOUR EMOTIONS Logan Pearsal Smith, in 1931, said: Solvency is entirely a matter of temperament and not of income. My greatest caution in this entire signs-of-the-times section is to urge that you hold a strong rein on yourself, otherwise your emotions or prejudices of the moment (be they bullish or bearish) will cause you to read the total situation as bullish or bearish on the basis of selective evidence. Or, you will be too demanding and expect too many signs of the times to be convinced the climate has changed. BE FIRST The great advantage of being aware of these potential signs of coming events is that, when you read or hear data of the changing economy, you are able to interpret it immediately and, if necessary, act on it. You know what to look for and you recognize it before it is fully reflected in stock market prices. If the signs of the times were easily interpreted, the future would be plain for all to see. They arent, and it isnt. Dont expect to see too many signs occur at once. They show up over a period of perhaps many months, as the giant economy slowly rolls over, or yawns and slowly comes back to life. In this respect, we see again that the stock market is non-accommodating. It isnt going to conveniently flash all its red or green lights at once so everyone can see at a glance what direction is next. Remember the old Wall Street adage: Dont confuse brains with a bull market. And dont imagine that markets turn on dimes and change direction overnight, as the mass media would have you believe. BUSINESS INDICATORS Many of the signs given earlier in this chapter are business indicators. But the lists are by no means complete. I encourage you to add new signs to your personal list, things which you feel offer keys to a change in market direction. Many accepted leading indicators are lagging or coincident indicators, so, if you want to stay ahead of the crowd, you need take note of those indicators as soon as the facts are known. The best way to use these indicators is not to create some mathematical model on your computer (though thats OK as a reminder and checklist) but to develop an internal model in your head. Ideally, make lists of the facts as soon as you know them, with a note of what they will do to what economic indicator and when that indicator will be released, and then forget about it. Slowly, a pattern will emerge without you being conscious of it. Suddenly, you will find yourself muttering meaningless when somebody tries to point out the significance of a minor rise in retail sales, or a fall in commodity prices, because of the overall index you keep in your head. To separate wheat from chaff is a vital function amid the signs of the times. It is a fact that no two bear or bull markets are exactly the same in their manifestations. This is why a single investment software package is of limited use. Software, unlike the human mind, can only compare present models to those in the past, usually almost exactly. And, though we may have a future bear market as inflationary as those in the 1970s, or as economically devastating as the 1930s, or any in-between, the only certainty is that any future bear market will not look exactly like any in the past, though it will doubtless have elements of past markets. However, software that records and keeps technical indicators for you can be of tremendous value, and saves you the tedium of having to calculate the indicators on a daily or weekly basis. The type of lateral thinking needed to use the past to construct a plausible future is something that only a human mind can do, and for the foreseeable future no computer can. THE EFFECTS OF GLOBALIZATION Today, the world is so interconnected that the economic problems of any nation spills over to every other nation. Everybody exports to everybody else, so when one economy contracts, all those who do business with the problem economy are affected. You may have no interest in investing outside your own country. But you cannot afford to ignore what is happening in other countries. Economic problems abroad can be a leading indicator of possible problems at home. Even if you never plan to invest in another country, I urge US readers to watch European news on television, and take a subscription to the Financial Times and The Economist. European media give international coverage of the sort that US media do not. Likewise, non-US readers should read the New York Herald Tribune and/or the Wall Street Journal for a US insight. THE HOUSE OF CARDS EFFECT In our interdependent world, its a house of cards no matter how you stack it. We stand together or fall together. For those still not convinced, let me offer an example. Envisage a major city with several thousand businesses. In a depression, can you imagine that the depression would affect only half of them? Would you expect to find 1,000 prospering as never before while the rest were losing business? Or is it more logical that all would feel the pinch, in varying degrees, of the national slowdown in business? Today, the global economy functions much like a major city. Pockets of prosperity amidst adversity, be they cities, neighborhoods or entire nations, have become rare. |
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