2 Bears, Getting Their Day in the Sun, Say It’s Time to Take Cover

James Stack lives among the bears--the genuine, ursus horribilis kind--in Whitefish, Mont., but he insists it is mere coincidence that he himself has been one of Wall Street’s biggest bears since the summer of 1993.

The publisher of the InvesTech market newsletter has literally been a voice in the wilderness over the last three years, a Cassandra warning that the U.S. stock market was becoming increasingly overvalued and primed for a plunge.

Now, in the wake of this month’s troubling slump in share prices and the rising worry about the longevity of the 5 1/2-year-old bull market, Stack is obviously feeling better about his unwavering bearishness.

But that’s not quite the same as feeling good.

“ ‘Good’ is a relative word,” says Stack, who concedes that he left a lot of money on the table by sitting out the market’s sensational gains of the last 18 months. “I’ve been too cautious too early,” he admits. “But I guess I know too much about history. Anyone who lived through the market of the 1960s and 1970s knows that what we’ve been seeing are symptoms of a frothy, speculative market top.”

For the minority of investment advisors who have been in Stack’s camp in recent years--that is, expecting a steep decline in stocks--history has arguably been on their side. But rather than follow history, this bull market has made its own.

Despite the pullback of recent weeks, the Standard & Poor’s index of 500 blue-chip stocks still hasn’t fallen 10% (on a daily closing basis) from its all-time high reached May 24. At Friday’s close of 635.90, the S&P; is off 6.3% from its peak. That makes it a record 68 months without a 10% drop in the index.

And so what? say the bulls. The prevailing sentiment on Wall Street is that the outlook for stocks is still healthy, as it has been since 1991. We’ve got low inflation, relatively low interest rates, a growing economy, record corporate profitability and an aging, needing-to-invest population. What’s not to like about the stock market?

At most, the recent turmoil is the start of a typical “correction” that might clip 10% to 15% off the S&P; index and the Dow Jones industrials from their highs, the bulls say. Then it’s off to the races again.

That is not at all the view of Geraldine Weiss, editor of Investment Quality Trends newsletter in La Jolla. Weiss, like Stack, has been bearish for several years. Today, the number of blue-chip stocks that she considers undervalued, and thus worth buying, is the lowest in her 30 years of following the market. That’s as powerful a signal as any that the bull is breathing its last, she insists.

Her advice to people who have profits in stocks is to take them now, rather than hold on and be panicked into selling later at much lower prices. She expects the Dow index, now 5,473, to fall at least 27% from its 1996 peak, which would take it down to 4,218. If that level fails to hold, the Dow could ultimately fall as much as 43% from its peak, to 3,293, by sometime next year, Weiss says.

Weiss, Stack and many other such bears aren’t perpetual doomsayers, a distinction that needs to be made because there are plenty of bearish analysts who at heart are flaky, store-the-ammo survivalist types.

Weiss and Stack are happy to participate in bull markets as long as they aren’t being asked to pay what they consider irrational prices for stocks relative to earnings, dividends and assets.

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What their research has told them since at least 1993 is that stocks in general have climbed into extreme overvalued territory, especially compared with the dividends companies are paying to shareholders (i.e., the real cash return on your investment) and compared with the true value of the companies’ assets.

And an overvalued market, Weiss and Stack say, almost always gets fixed in the same way--with a dramatic retreat in prices back down to levels that history would suggest are rational again.

For Weiss, it would take a 27% drop in the Dow just to boost the average annualized Dow stock dividend yield to 3% from the current near-record-low of 2.3%. And 3% would still be a low yield relative to what investors can earn on bonds, she notes.

Bullish investors argue that the problem with analysts like Weiss and Stack is that they spend too much time looking at their charts, waiting for history to replay itself. Dividends don’t matter to people the way they used to, the bulls say. And anyway, investors buy stocks looking forward, not backward, they say.

The counter-argument from Weiss and Stack is that precisely because the new generation of investors has never bothered to look at the historical market patterns, it fails to understand that periods of overvaluation come and go. This period may be longer than all the others, but it too will go, the bears say.

More specifically, it is going, Weiss says. With the tumble in stocks so far this month, she smells blood. “I think what the market is telling us is that it is strenuously overvalued now,” she says.

Investor psychology is turning, Weiss says, and people will soon be more interested in protecting 5 1/2 years of bull-market profits than making more. Thus, the selling will increase, she says. The decline she foresees will be a slow one, with intermittent rallies. Nonetheless, she says, “once a trend is in place, it tends to stay in place,” a market maxim that works in both directions.

Stack, meanwhile, concedes he isn’t sure that a severe bear market is already underway, although he notes that the traditional harbingers of market tops--slowing corporate earnings growth and fear of a credit-tightening move by the Federal Reserve Board--are present.

“Investors haven’t been pushed to the edge of their chairs yet,” Stack says. But if the market rallies from here, he says, the eventual bear-market decline will be that much worse.

“The big danger is that we haven’t had a real correction in the market” since 1990, he says. “It becomes like a pressure cooker without a release valve. When the lid blows . . . “

Stack points to two recent trends that he says bolster the bear case. One is the shift by some longtime bearish market gurus, including Joseph Granville and Dan Sullivan, to a partially bullish stance--a sign of 11th-hour capitulation (i.e., “I can’t take the pain of staying out of this market anymore”).

The other trend is the sharp decline in the highest-flying growth stocks of the spring, especially Internet-related issues. They remind Stack of the “go-go” growth stocks of the late 1960s. Between 1968 and 1970, many of those stocks (Control Data, Fairchild Camera, Optical Scanning) lost more than 80% of their value.

The Dow index also finally succumbed, losing a stunning 35% of its value by the time that bear market bottomed in 1970.

In retrospect, of course, it wasn’t the end of the world. But it probably felt like it to investors who had paid peak prices for overvalued stocks. To Weiss and Stack, this is simply a time to remember history and prepare for the worst--not pretend that the worst can never happen again.

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Deja Vu?

The recent slump in many high-flying growth stocks--especially technology issues--reminds some veteran analysts of the early stages of the devastation suffered by the growth stocks of the late 1960s, a group that also included the leading tech stocks of the day. How those stocks plummeted from their peaks in 1967-68 to their lows in 1970:

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1967-68 1970 Pct. Stock high low loss Optical Scanning $146 $16 -89% Litton Industries 104 15 -86% Mohawk Data 111 18 -84% Control Data 163 28 -83% Fairchild Camera 102 18 -82% Kidde 87 15 -82% Textron 57 15 -74% Sperry Rand 65 18 -72% Natl. Cash Register 81 29 -64% Texas Instruments 140 61 -57% Xerox 115 65 -43%

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Note: The above are actual prices from those years, not adjusted for any stock splits since.

Source: Dun’s magazine