The Mantra: "Down and Out on Wall St.: Still Bears After All These Years. Ah, the roaring stock market. With averages and indexes setting one record after another, investment profits seem like an American birthright.
Yet at a time when tales of investment coups are as likely to be heard
over family dinners as among high-fiving traders at Wall Street watering
holes, it is easy to overlook the truism that there is a seller for every
buyer -- and that some of those skeptics are deserting the market, not
moving on to the next can't-lose stock.
In fin-de-siecle America, you
don't hear so much from this
dour segment of investors and
seers, this sloth of bears. They
considered the market
expensive when the Dow
Jones industrial average was
half its current level. They
thought buying the dips was a
trap. As 1999 began, they
took comfort in the fact that
the Standard & Poor's
500-stock index had never
risen more than 20 percent for four consecutive years, as it had from
1995 through 1998, and then climbed further.
So miss much of the greatest bull market in history they did. So far, in
1999 alone, the Dow has jumped an additional 24 percent, the Wilshire
5000 has risen 20.6 percent and the S.& P. has gained 18.6 percent.
Most spectacularly, the NASDAQ composite, fueled by technology
issues, has rocketed 81 percent, the most for any major index since
1915.
It is not easy being a bear. As the days have passed, some have suffered
from tarnished reputations and the loss of clients -- even jobs. And
they've had to endure the withering scorn of market evangelists.
"Who could have ever dreamed that this thing would go as far as it did?"
asked Barton Biggs, chairman of Morgan Stanley Dean Witter
Investment Management and the firm's chief global strategist, who turned
wary in mid-1998.
Certainly not David Tice, whose Prudent Bear mutual fund, which sells
stocks short in anticipation that they will fall, has been one of the
worst-performing of more than 3,000 mutual funds the last three years.
Nor Charles Clough, 57, chief investment strategist at Merrill Lynch, who
in August announced his retirement. In recent years, he has advised
investors to allocate more money to bonds and cash -- to the annoyance
of many Merrill brokers.
Then there is market technician Gail Dudack of Warburg Dillon Read,
who was abruptly bounced this autumn as a member of the so-called
Elves Index panel on the "Wall Street Week" television program. Host
Louis Rukeyser explained that Ms. Dudack had simply been bearish too
long and was undermining the Elf consensus of rising prices in the short
term.
All along, the technology-driven stock market has soared with an
irrepressible U.S. economy as its accomplice; economic growth has
persistently exceeded its supposed speed limits, while inflation has
remained at bay.
In February, the uninterrupted expansion that began in March 1991 will
set a longevity record, 107 months. Productivity has also surged. And the
unemployment rate has sunk so low, scarcely above 4 percent, that many
economists are rethinking its longstanding inverse relationship with
inflation.
Indeed, an economy that once looked like a bubble of excessive
exuberance, not unlike Japan's a decade ago, now seems highly resistant
to forces like higher interest rates. And a sage like Lawrence Lindsey, a
former Federal Reserve governor who is the top economic adviser to
George W. Bush, can only regret that he sold his stocks 18 months and
2,800 Dow points ago, believing them overvalued.
Despite their errant predictions, members of the bear contingent of the
1990s remain convinced -- even adamant -- that they will be proved
right. And they have their reasons. Their rationales go far beyond the
structural bias on Wall Street that minimizes expression of the downbeat,
that makes sell recommendations as rare as dinosaurs (as the chief
accountant of the Securities and Exchange Commission observed
recently), and that can mean a loss of underwriting business or, for an
analyst, being cut off from contact with a company's management.
In fact, some bears say their ranks are bigger than is evident -- and
growing with each new breathtaking NASDAQ milestone. "Some of our
biggest clients," said James Chanos, president of Kynikos Associates,
which bets on price declines, "are some of Wall Street's leading
executives." Many other market professionals, secretly worried,
acknowledge privately that they remain fully invested against their better
judgment.
"The problem is that a lot of people increasingly believe that it's a bubble
-- but they're long," said Marc Faber, a onetime Wall Streeter who
works in Hong Kong. "When it changes direction, I think you will get big
selling pressure."
At the latest reading, the Consensus Index of Bullish Market Opinion for
stocks, compiled weekly by Consensus Inc. of Kansas City, stood at 52.
In other words, close to half of the large brokers and investment advisers
the firm monitors are bearish on the overall market. That compares with a
fourth-quarter peak of 60 just before Thanksgiving.
Still, the bears remain outnumbered by the bulls, who see the new
economy as justifying the ebullience. They think the bears are transfixed
by historical analysis. "They're really children of the '70s," said Gail
Fosler, chief economist for the Conference Board, a research group.
"There is just an incredible diffusion of technology" that has raised
productivity and thus economic prospects.
But it is not just the market's relentless climb that makes the bears bears.
They worry about stocks' grounding in economic reality, pointing to
threats like the record American trade deficit and what they see as
unsustainable consumer spending.
Leon Levy
Leon Levy, a founder of Oppenheimer & Co., whose Midas touch is the
stuff of Wall Street legend, says it has been a "humbling experience" to
have been so wrong on two counts: first, badly underestimating investors'
love affair with technology in recent years and, of even greater
consequence, doubting that the economy would get through the decade
without a recession.
But he is not about to change. Levy, relaxing in his capacious midtown
Manhattan apartment, which is filled with his renowned collection of
Greek and Roman antiquities, sees storm clouds thickening in all
directions.
"I would be surprised if it
lasted for more than six to nine
months," he said of the roaring
bull market. When stocks fall,
he added, today's avid
investors are likely to turn into
tomorrow's cautious
consumers.
For Levy, 74, the talk of a
new economic paradigm that
dismisses the idea of recession
-- and underpins the bull
market -- arouses thoughts of
the 1920s. That is when cars became affordable for the average worker
and a flood of inventions promised other previously unimaginable things.
"Were the cheap automobile, which led to the suburbs, the shopping
center and everything else, and the telephone and the radio less
revolutionary than the Internet?" he asked. "It seems to me they were
not."
The Levy analysis -- propounded full time by Levy's nephew, David
Levy, from the family's Levy Institute Forecasting Center in Mount
Kisco, N.Y. -- is based on an observation by Leon Levy's father,
Jerome Levy. Before World War I, he expressed the belief, then
surprising but now conventional wisdom, that profits are what make
employers hire, generating other blessings.
Nowadays, the Levys worry that the reverse will happen: that a market
break will cause consumers with a falling net worth to spend less,
shrinking corporate profits and leaving the economy with a surfeit of
office buildings, plants and machinery from what they contend has been
far too much capital investment.
Leon Levy frets particularly about the rapidly expanding trade deficit,
which reached another record in October, $25.9 billion, signaling a shift
to production abroad. "This is something that shows no sign of reversing,
and it has to come to a bad end," he said. Eventually, he added, it means
fewer American jobs.
For now, though, David Levy said, the United States is short of workers,
not jobs, and wage pressure is likely to push up inflation. "If the economy
doesn't slow down enough to give us disappointing profits, then interest
rates are going to keep rising," he said. "That greatly darkens the outlook
for the stock market continuing this great mania that we've seen."
Plausible as that may be, David Levy stated in December 1995 that there
was a 50 percent probability of a recession in 1996. It has yet to be
sighted, of course. And the Dow industrials have jumped more than
4,000 points since then.
Despite his pessimism, Leon Levy remains heavily invested in stocks,
which he pays other, generally much younger people to manage. His only
hedge is taking short positions in some of the indexes. "I certainly don't
tell them what to do," he said. "But I won't give money to a manager
unless, when I ask him what he does when the market goes south, he has
a well-thought-out answer."
Marc Faber
Marc Faber has been a close witness to bucketsful of economic and
financial distress since moving to Hong Kong from Wall Street in 1973.
Among them were Japan's 1989 stock market crash and the decadelong
recession that ensued and may or may not have ended this year.
But nothing has impressed him as much -- or cost him so dearly -- as the
wave of speculative ardor that has characterized the American stock
market since at least 1996. It has taught this colorful, ponytailed,
motorcycle-riding investor and adviser some painful lessons.
"This is the biggest bubble I've seen," thundered Faber, 53, a Swiss-born
skeptic who writes The Gloom, Boom & Doom Report, a monthly
commentary for subscribers. In a telephone interview from his office,
where, as he commonly does, he was working well past midnight, he
sounded like a true, if chastened, believer.
When assessing this market, he said, just look at the past. "Everything is
depressed compared to Yahoo," he said, "but it's not necessarily
depressed based on historical standards and compared to interest rates
and compared to the earnings outlook."
The "good news," he contended, is that the bubble inevitably will burst --
perhaps as soon as January, a month with more than its share of historic
reversals, including that of the Nikkei 225, Japan's benchmark stock
index, a decade ago.
This implosion of stocks will drag the U.S. economy, which has become
dangerously subservient, along with it, he predicted. "Should U.S. stocks
decline by as much as I believe they will, a U.S. recession will follow," he
said.
While Faber has made many accurate calls (he was one of the few who
predicted the Asian meltdown) being bearish about the United States has
proved expensive. His short positions are losers, and he has made little
or no gain putting money into gold and gold stocks, a strategy he has
followed for years.
"The funny thing," Faber added, "is that you could have actually made
money on the short side in the last two years because a lot of stocks
went down. But if you concentrated on shorting what you perceived to
be the most overvalued, it's that sector that has gone through the roof."
That sector, of course, is high technology.
"I've been wrong about the U.S.," he acknowledged, citing two chief
mistakes. He said he misjudged Federal Reserve Chairman Alan
Greenspan's willingness to allow speculative excesses to build after
cautioning in December 1996 that there were signs of "irrational
exuberance."
He is unnerved by what he considers to be an overly expansionary
monetary policy here. "How come the monetary base has been
expanding at an annual rate of over 22 percent for the last three months?"
he asked.
His second misstep, Faber said, was failing to predict the frenzied
scramble for Internet and other technology stocks. Many sell at
unheard-of multiples of revenues and have no immediate prospect of
earning a profit. "I have underestimated the enthusiasm, the speculative
fever and the greed in the United States and around the world," he said.
"I underestimated the stupidity of the public."
Barton Biggs
Though not the purest of the breed, Barton Biggs, who has been a
relative bear on the American stock market for only 18 months, is as
gloomy as the chief strategist of a major Wall Street house can afford to
be.
"The technology, Internet and telecommunications craze has gone
parabolic in what is one of the great, if not the greatest, manias of all
time," he told Morgan Stanley clients in a recent essay on strategy.
Expanding on that theme in an interview, Biggs, 67 and a former marine,
called stocks overpriced by some 45 to 50 percent, according to the
Morgan Stanley Dean Witter valuation model. The message: the place to
put money is elsewhere.
"I'm convinced that over the next three to four years, the U.S. market is
going to be the worst of the big markets in the world," Biggs said from his
22nd-floor midtown Manhattan office. "I think it's going to underperform
next year by, let's say, 10 to 12 percentage points and over the next five
years by 3 to 5 points a year."
The problem, he said, is that the old economy is "getting crushed" by the
so-called new one, resulting in a bifurcated stock market. The old
category includes consumer icons that have lost pricing power because of
deflation as well as traditional smokestack manufacturers. "Increasingly,
the profitability of the old economy, ranging from Coke to Caterpillar, is
under tremendous pressure," Biggs said. Indeed, many old-economy
stocks have dropped to near-depression levels.
"I miscalculated how fast the Internet was going to impact the world," he
added. "This is a wild thing that's happening here, this destruction of
profitability." Between the third quarters of 1998 and 1999, aggregate
corporate profits of manufacturers slid more than 5 percent, to $163.1
billion.
He, too, said the technology bubble would pop one day. "I'm no longer
convinced that the Internet part of the new economy is going to anywhere
near live up to the expectations embedded in stock prices," he said,
stopping just shy of predicting that the shakeout will bring down the rest
of the market.
But Biggs is sticking to a global allocation of about 65 percent stocks and
35 percent bonds. "I'm scared to death, but it's too painful to
underweight stocks and hold a lot of cash and bonds," he said. "You're
risking your business. They don't like it when you're in cash when the
market goes up."
James Chanos
Running what he believes to be the biggest short-selling operation in the
world, Kynikos Associates, James Chanos is a professional bear.
Kynikos is derived from the Greek word for cynic, and Chanos makes
his living finding stocks that are overvalued, then selling them in hopes of
profiting from their eventual return to earth.
In this market, with the S&P 500 selling at 31.5 times earnings, nearly
twice the historical norm, and with highfliers like eBay going for more
than 1,000 times earnings, Chanos should be in his glory as he goes
about deflating the overblown.
Instead, he has changed his ways.
In 1996, Chanos bowed to the times and created a second hedge fund,
called Beta Hedge, to supplement his older, short-only fund, Ursus
Partners. The new fund really hedges -- that is, it matches short positions
with an equal value of long ones, a market-neutral strategy that translates
into betting only on his picks of individual stocks.
"This came from the realization," said Chanos, whose office in the
Citicorp Center in midtown Manhattan has a seemingly unending view,
"that the market headwinds had been, and were, so strong that it was
masking the high positive returns of short-selling." In other words, the
stock market's rise was fueled by such a powerful force that it was
preventing many overpriced stocks from going down.
The new fund proved a salvation for Kynikos. It does not disclose
results, but it is believed that Beta Hedge has returned about 17 percent
a year since it was formed; its short-only cousin, Ursus Partners, has
been flat.
Chanos, 42, takes no view about the likely direction of the market, but
has not had much trouble these days finding unjustifiably inflated stocks.
He defines inflated stocks as those whose prices reflect discrepancies
between investor perceptions and economic reality.
Corporate earnings provide evidence. Most Internet companies have
none at all, and at many profitable companies this decade, there has been
a substantial decline in the quality of earnings. Increasingly, Chanos said,
they are overstated because of the proliferation of stock options, the
phenomenon of repeated "nonrecurring" charges and the passage of
legislation protecting executives from lawsuits. This so-called safe-harbor
law gives dishonest managements a chance to mislead investors with
impunity, he said.
For all the opportunities to sell short, he must buck more than an
unfavorable bullish trend. Tax treatment of short-sellers is unfavorable, it
is often hard to borrow stocks to sell short and there is a rule against
selling short on downticks. And there is the opprobrium of most of the
investment world and the constant stream of upbeat Wall Street appraisal
and company news.
His advice for ordinary investors is to avoid short-selling. A much better
way to reduce risk, he said, would be to "sell down their longs."
James Grant
The spare, paneled conference room seems to tell a lot: the rolltop desk,
the old Underwood typewriter, the portrait of the losing 1888
Democratic ticket of Grover Cleveland and Allan Thurman. And, yes, a
large picture of William Holbrook Beard's painting, "The Bear Dance."
But James Grant, 53, the editor-entrepreneur whose office sits
cater-cornered to the New York Stock Exchange, is neither a man of the
19th century nor a born pessimist. He has been wrong about the stock
market for a decade, he said, because he is a contrarian. And being
contrary in the 1990s meant playing Chicken Little while other people
became rich.
"I am a skeptical person," said
the 6-foot-5 Grant, a former
columnist for Barron's,
sometime TV commentator
and proprietor of Grant's
Financial Publishing. "I am
forever doubting received
wisdom. It's sometimes a
profitable state of mind -- but
often it's not." Grant, who
once ordered up neckties
depicting a bear wearing only
a barrel, wryly calls himself
"the world's leading authority
on where the stock market is not going."
In the 1980s, Grant was a prominent worrier about the boom in
corporate debt, the thinly financed run-up in real estate, the fragile
balance sheets of banks and the bubble in Japan. He proved largely on
target. But he went wrong in early 1991 as the allied countries were
pushing Iraq out of Kuwait.
"That was my Waterloo," he said. The stock market took off, creating
enough wealth to negate the debt problems. Unfortunately, Grant's kept
on reading footnotes in corporate reports, he said, missing the forest for
the trees.
With a certain regret -- though he says he is not sure he would have done
much better as "another voice in the choir" -- Grant acknowledged that
"we have monumentally missed it on the all-important matter of common
stocks."
Grant's Interest Rate Observer, his main publication, has had some
latter-day on-the-money calls, positive and negative. It was down, for
example, on Coca-Cola, focusing on its accounting practices. Coke,
which has had many setbacks, has indeed seen its stock languish. He was
also on target in 1997, when he saw CMGI, a sort of supertechnology
holding company then selling at about $12, as worth more than the sum
of its parts. It now fetches more than $270.
According to a successful old Wall Streeter, he said, bears always sound
smarter but their thinking can prove a trap. "The truly perceptive person,
knowing that, knows when's the time not to doubt," Grant said.
Now, while a majority of American stocks have fallen from their highs --
and declining stocks have persistently outnumbered advancing ones --
Grant is not ready to return to Wall Street. He finds one of the best
opportunities in Japan, the mirror image of the 1980's and "the beginnings
of something terrific."
This time, he is backing his opinion with cash. He founded a hedge fund
concentrating on the small-capitalization Japanese stocks that he thinks
had sunk to bargain prices (and have risen lately).
"I happen to have been profoundly wrong, negative on this greatest of all
bull markets," he said, referring to his misjudgment in the United States.
"But I've resolved I'm not going to miss the next once-in-a-lifetime
opportunity." |
