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COPYRIGHT © 2009 STANFORD WEALTH MANAGEMENT

“DING! DING! DING! THE BELL

ANNOUNCING THE END OF THE BEAR”

December 2002

                      I hasten  to quickly add that the end of the bear doesn’t mean unmitigated boom times with Nasdaq ash and trash roaring ahead 85%.  But my most reliable indicator of undervaluation reached a point in November that confirmed the indicators that led me to tell you to buy on October 7.  The actual low for the bear market was reached on October 9.  From today on, I continue to believe we’ll bump and stumble our way forward rather than backward, mostly up rather than mostly down.   Among the indicators  I use is the ratio between the market value of all US publicly-traded stocks (an earnings- and sentiment-indicator) and the Gross National Product (a measure of all goods and services).  When market cap is low relative to GNP, as it was in the 1940s, you can expect a pretty good market to follow, as happened in the 1950s and 1960s.

ALMOST THERE

 

          (October 2002)                 

                     

                      Every parent who has ever taken a car trip with a child knows all too well the                                 question, “Are we there yet, Mommy?”  (Of course, every parent who has ever taken a car trip with a child knows also that Robert Benchley was right when he said, “In America there are two classes of travel--first class and with children,” but I digress...)

           I can’t help you find a better answer for the kids, but I can tell you that, as far as the stock market is concerned, I believe we’re almost there -- but not quite.  The bear market my proprietary indicators warned us about a couple years ago came in right on schedule.  The rally from the bear market bottom that my indicators forecast then took place, followed by the re-test they indicated.  We’re now nearly finished with that re-test.  I know this because now, unlike two years ago, the exact same fortune tellers, wild guessers, and stopped clocks (also known as: Wall Street analysts, reporters, and academics) that told you the next stop on the Dow would be 36,000, are telling you that the Dow “must” go to 3,000 and the Nasdaq to 300 in order to shake out the excess.  Bull.

           This market will soon go higher.  Why?  Because we shook the tree and the market fell down.  All those people who said that JDS UNIPHASE (JDSU) was a $500 stock and QUALCOMM (QCOM) was a $1000 stock should be embarrassed.  (If they work on Main Street, they are embarrassed.  If they work on Wall Street, it is a condition of employment that the embarrassment, common sense, and ethics genes are removed before being hired.)   All those people who bought QCOM at $180 and JDSU at $130 so fell for the bait that they often bought more as these two, and a hundred like them, fell to $100, then $75, then $50.  Hey, what’s better than $180 to $1000?  $50 to $1000!!!  Only thing is, QCOM is now $28 and viable -- this month -- and JDSU is $2 and may or may not survive.  Where are its advocates today?  Most of them sold in disgust when the stock hit single digits.  And they’re mad as hell. 

           These are the people who have sworn off the market “forever” and are now buying real estate instead.  And there’s enough of them out there. to serve as an early indicator to me that the tide is about to turn.  There is nothing easy about investing.  When the great majority of people believe it’s easy, that is in itself a great contra-indicator. 

           One of the signs I had that we were at a top in 1999-2000 was when a client told me she didn’t need me to manage her money because “If <she’d> just put it in a NASDAQ index fund, it would be up 85% this year.”  Yep.  And down ever since.  She would have turned her $250,000 into $462,500 that year -- and into $146,212 today.  And don’t think she’d have been fine if she’d just sold at the top.  She was greedy.  The 17% a year we were making for her, year in and year out, just wasn’t good enough.  People like that never sell at the top!

           The last vestiges of a bear are always like this.  Bad news abounds.  Good news is discounted.  Volatility rises.  Volume from individuals decreases.  Mutual funds sell en masse as they are faced with redemptions.  Brokerage, mutual fund, and technology stocks languish.  And the smart few -- like Investors Edge subscribers -- start to buy.  There are quality companies that have fallen along with the market whose fortunes are intact.  They are maintaining or increasing their sales, they are gaining market share from competitors who over-reached, they are plowing money into research & development, and they are hiring the best and the brightest that their erstwhile competitors can no longer afford to employ.

           I’ll talk about quite a few of these Survive and Thrive companies on pages 4-9 this month.  In these few paragraphs, let me talk, however, about a larger strategy.

           (1) First, cover your short positions or put buy-stops no more than 15% above their current price.  If the companies you shorted have not gone down in this market, it isn’t likely that they will tumble in a climbing market. 

           (2) Place tight mental trailing sell-stops under your bear mutual fund positions.  If, for instance, you bought PRUDENT BEAR FUND (BEARX) on our recommendation, you have roughly a double right now.  With the price over $8, you might plan to sell if it hits $7.95.  If the market keeps going down and BEARX therefore keeps going up, when it gets to $8.50 resolve to sell at $8.25, and so on.  Only thing tough about this is -- when it reaches your mental stop, sell it.  You have a double; don’t try to nickel and dime the last 10%.

           (3) Decide which sectors will lead the next bull market and skew your investments in this direction.  Absent any news like a war or an oil shortage, etc., it is often the large-cap companies that do best coming out of a trough.  People are burned and they want to stick with quality.  The accounting scandals of the last couple years notwithstanding, people still trust EXXON (XOM) and CREDIT SUISSE (CSR) and ALCOA (AA) and PROCTOR & GAMBLE (PG) more than they trust FlyByWire, Inc (FLUB).

           They also trust companies that make tangible things and provide necessary services in times like these.  That means my old favorites the energy industry, the health care industry, the financial industry (insurance, banking, and, yes, even brokers and mutual fund companies), and water and power firms. 

           (4)   Because no one can predict with certainty which sectors will strike investors’ fancy this time around, we’ll buy exchange-traded funds, market proxies like QQQ, SPY, VII, and DIA (see comments on p 4), and mutual funds that reflect the larger market. 

           When the market was running in the late 1990s, the amount of time most people wasted on stock selection could have been much better spent kayaking, SCUBA diving, or mountain biking (OK, enough about the sports I like -- you can substitute fishing, golfing, bowling, or whatever else you like here.)  The point is, the market was going up and it took most everything along for the ride.  It was the same in this secular decline we’ve been in.  Even the good companies fell to bargain prices.  And even the not-so-great companies will rise in the next upsurge.  It will, of course, be our pleasure to accompany them...   <  >   

           The pattern repeated in the 1970s, followed by the amazing secular bull market of the 1980s and 1990s.  That ratio reached 190% in March of 2000 — when the bell rang announcing the end of the Bull.  It then declined to 133% in 2001 and less than 100% in 2002.    Because the public is now more interested in stocks than in the 1940s or 1970s, it is less likely that we will see the ratio at 50% again.   There is simply way more wealth in publicly-traded firms today than in past periods of our history.  I think anything less than a 1:1 (100%) ratio is more likely a fine entry point these days.  When Fortune complied the chart in October 2001, it stood at 133% -- by October of 2002, it was at 95%.  (By the way, if you are of a mind to track this indicator yourself, it’s pretty easy.  Go to  the Wilshire 5000 Total Market Index website  -- http://www.wilshire.com/Indexes-/Broad/Wilshire5000/Characteristics.html -- to see the market cap of 6500 publicly traded securities that comprise about 99% of all market cap.  Then visit the St. Louis Federal Reserve site at http://research.stlouisfed.org-/fred/data/gdp/gnp for the most recent data.) 

       In concert with my proprietary indicators, this valuation ratio, the seasonality factor, and the fact that we are in the 2nd year of a Presidential administration when politicians pull out the stops to get re-elected, I believe the market will be surprisingly strong for at least another few months.

        I predicted last month that the market would probably dip down below 8000, just because that is a psychological barrier that would bring out The Last Wave of Sellers.  I believed that, once they had sold, the market would chuckle, having fooled most of the people most of the time, and then wend its merry way upward.  I was wrong.  The Market Trickster, like the Yoruba trickster god, fooled me and blasted through 8800.  That breakout confirmed the new Bull upheaval, climbing the proverbial Wall of Worry. 

           There are four great blocks of granite upon which we have always built our foundation of successful investing: 

           (1.)  It is difficult to predict what an individual company will do in the short term. Well-selected baskets of stocks yield greater predictability.  That’s why we always discuss sectors like energy, medicine, financial, etc., then recommend either mutual funds, ETFs, a basket of stocks, or a proxy for the sector. 

           (2.)  We do not know what "the market" will do over the next week, month, or year.  As Ben Graham said many years ago, "Though the stock market functions as a voting machine in the short run, it acts as a weighing machine in the long run."  Short term predictions will be wrong as often as they’re right, but the hawkers selling you their expertise on The Bull Channel will never show you charts of their wrong calls!  With a long-term horizon, we can make serious money.
           (3.)  It is best to invest during periods of low or declining interest rates and to be exiting the market during periods of high and/or steadily rising interest rates.  The high rates of the 1970s killed investment in equities.  Why invest in a company in which you expected to make 12% a year if inflation was 12.5%? 

           (4.)  It is best to invest when the market value of all publicly traded securities as a percentage of GNP is low and to exit the market when it is high.  That is why we are "value" investors.  History is on our side.

            I try to apply common sense, smart asset allocation, a dollop of intelligent market timing, and the best sector and stock selection I can.   To see where this common-sense approach leads, please turn the page...  <  >   

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