Essays and Commentary


The Bearish Contrarian's Psychological First Aid Kit


Some would say I'm a lost man in a lost world. You could say I've lost my faith In the people on TV. You could say I've lost my faith in the politicians. They all seem like game show hosts to me.

"If I Ever Lose My Faith in You" - Sting


Contrarian? Bearish? God forbid you're both... You don't need us to tell you that it has been tough to be contrarian over the past few years. Likewise being bearish has only bought you a ticket to becoming a "cocktail party outcast". (Contrary to popular opinion, being a contrarian and being bearish are two different things. Every so often, the two embrace. At the moment we have our arms wrapped around ourselves. How about you?) You know it's getting really bad when CNBC only allows bearish strategists/investors to be interviewed simply to poke fun at them. We've stopped counting how many times we have watched Mark Haines say "didn't you say that same thing six months ago?" to a guest bold enough to make negative comments. At some point you just don't argue anymore with the "new era" crowd. Ned Davis has described the dilemma many of us face as the difference between "being right and making money". We're sure you've heard the old adage, "Wall Street's graveyards are littered with those who were exactly correct - too early. Starting in 1928, Charles Merrill (that's right, of Merrill Lynch) implored clients to "get the hell out". By mid-1929 his closest friends suggested he seek psychiatric help. No one can impose their will on the collective market. Clearly the market is going to do what the market is going to do over the short run. Nonetheless, sometimes the waiting is the hardest part.

No one has the magic bullet. We often hear even the most strident of bears cry out in anger as "dark side" guru's just can't seem to come up with the definitive event or absolute sign in which they can place certainty that this bull-of-all-bulls is ending. We have news for you. No one will ever be able to call it with certainty. Being human, we can sympathize with the bearish frustration. We live through it constantly. We see most people doing zero thinking and even less due diligence. Unfortunately these are also the same maniacs that are participating in today's common stock skyrockets quite successfully (for now). In today's tech obsessed market, some of the most successful investors (on paper) we have seen over the recent past wouldn't know a balance sheet, P&L or cash flow statement if it kicked them in the ASCII.

What's a contrarian bear to do? Again, we have no answers regarding timing, events, values, etc. Only guesses. For ourselves, we focus on and try to remember the following:

1. In the current environment relative performance is a suckers game. Stop focusing on the maniacs investing in bubbles. In the long run you are competing against yourself, not your neighbors. The relative concept of wealth can be very emotionally destructive. We guarantee that if you get caught up in this type of thinking, you will not be thinking (clearly). At this point in the mania, human emotion and crowd behavior is the key. Controlling yours is also a key. It's not going to be valuation that stops this. We have already had plenty of real world reasons for a change of direction (Asia, Russia, So. America, Clinton, Iraq, Kosovo, and yes even earnings). Watch for a change in crowd behavior and human emotion. Stay focused on the facts. Stop watching too much TV (you know who we mean). Unless we haven't kept up with biotech news, we're pretty certain that greed, fear, and panic are still "active" sequences in the human DNA chain. Put your long term faith in the double helix. Nothing lasts forever (it just seems that way).

2. A true bear market is a process of confidence destruction. The key word here is process. One of the things we believe a lot of contrarians and bears are fretting about is missing the first big down leg in this market. We've had this pang run up our spine a million times. Keep in mind that very few markets ever go straight down. 1987 was really the anomaly. Hopefully, the following table puts it into perspective:

Insert table here.


For what it's worth, we're not double counting in the table. We'll be the first to admit that the initial plunge in each of these periods was mean. All occurred over a 1-3 month period. We're talking about the first 20-30% smack. There were a good number of rallies in each of these market declines. The rallies may not seem like much singularly, but you can see the total decline numbers. There were plenty of opportunities. In each case, peak to trough was a rather lengthy experience. We stopped counting the number of 5% rallies that occurred. The bears will have plenty of time to make money on the down side. We believe this is true now possibly more than in any other market in US history. The public is more fully invested than ever before and institutions are loaded. The best part of all is that (and this is a very broad statement, so take it for what it is worth) they all own the "same stocks". Institutional and individual holdings in the nifty-fifty are at the bursting point. Our question is "who's left that doesn't own these stocks?". Maybe it's only ourselves. Believe us, if the gods so deem, there is potential liquidation to come like never before. Be patient. There could be a whole lot of stock for sale at some point.

3. The public has been conditioned to "hold the dips". So often we hear it said that the public has been conditioned to buy the dips. We're sure this is true with many individual daredevils, but as documented by mutual fund inflows, the larger public clearly does not buy the dips. Mutual fund inflows increase only after the markets have recovered. Although the masses don't buy the dips, they do hold them. We saw virtually no fund liquidation during the downturns in 1997 and 1998. Who can blame them? After the experience of this decade, it's Pavlovian. (Do we hear music playing? Just a minute, let us get something to eat first and then we'll check it out.) In like thought with the previous paragraph, we believe the bulk of public common stock exposure may begin to be liquidated after the market has already fallen 20-30%. That will ultimately drive it down maybe 30-50% (or more). No one can predict how a market will change. No one can predict how perceptions will change. One thing we absolutely can guarantee is that change will occur. The market could experience an initial crash of 20-30% and not recover for a year or more. Maybe the market trickles down over 6-12 months and slowly destroys investor confidence. Maybe Y2K causes a massive disruption and triggers a quick and substantial negative event. No one really knows. Regardless of when or how it begins, we remain extremely confident that the endgame will be bloody simply because we cannot identify the "next buyer". Main Street has poured $1 trillion into stock oriented mutual funds this decade. It represents roughly 90% of all contributions ever made to these funds. Since the public is in the drivers seat and mutual fund cash levels are hovering between 4-5%, when the public wants their money back there will most definitely be forced selling. Although, the funds could put moratoriums on distributions. (Don't think this could happen? Check your history books. It has happened in the past. That's OK, it's a real confidence builder in long term investing. Trust us.) Maybe we are deluding ourselves, but we believe we will have time to participate as we follow in the dust of the hoofbeats of the black horsemen.

4. In the meantime, limit your investment risk during the mania. We know plenty of invested bears. We believe the important point is to limit risk. Don't be afraid to sell, even at a nice loss, if you believe it is necessary. We strongly believe the public is wrongly focused on not wanting to realize capital gains. We hear it all the time. The irony is that by the time they do sell, they could have been far ahead by paying the taxes long ago. Shorting is a very dangerous proposition here. Options aren't much better, but at least you can strictly identify your ultimate downside. We've personally cut back extensively on our use of options a while back. (We now have a loss carryforward we expect to be made good on our final estate tax return. The way things are going in this market, this may happen sooner than we think.) Although it's tough even for us to resist, try not to chase "bear market lottery tickets". Don't short favorites or lunatic bubbles like the internets. Again, we believe the public will allow us to make very reasonable profits on the "dark side". We believe our greatest challenge of the moment is to remain unemotional and stay focused on both macro and company specific fundamental and factual information. In this extraordinary market supercharged with public greed, no one knows how high is high. Take comfort in the fact that also no one knows how low is low. It may be that somewhere over the next few years we receive an answer to both of these questions. Try your best to protect your family's assets so you have enough marbles to play the next game.

5. Watch perceptions regarding Greenspan. We won't go into our thoughts regarding the actions of Greenspan now (we'll save that for your next 300 Market Observation pieces). We believe there is a real perception out there that Greenspan will "save the marker" under almost any circumstance. Talk about the ultimate "moral hazard". You know and we know, Greenspan will be able to save nada at some point. Every time the monetary trigger is pulled, itís shooting smaller caliber rounds. Japan is a direct example that interest rate cuts are no guarantee of a revived market/economy under all economic circumstances. The recent (and significant) interest rate cuts in Europe have met with a muted response at best. Nonetheless, we fear US investors have been conditioned to "react" with an immediate positive bias to monetary cheerleading routines. This is another reason why we're pretty confident this won't be a completely straight down experience. Greenspan may give us a perfect opportunity to bet against the house. (Not that he has not already given us what appeared at other times to be "perfect opportunities".) We don't know how the Greenspan hand will ultimately be played out, but we suggest vigilance regarding short term perceptual fallout concerning monetary policy. If this market starts to blow, expect the last droplets of "liquidity" to spew forth from the Fed firehose. Itís junior firemarshal Greenspan's sworn solemn duty.

Itís no fun being contrarian in this market. Itís no fun being bearish. Itís no fun being wrong. The fools are dancing, but the greater fools are watching. (At least this was the saying in Japan in 1989.) We guarantee change will occur. Keep the faith in yourself. Remember, your neighbors buying the internet stocks are your future source of profits.

Copyright 1999,