Bears like Sams don’t get much sympathy in this stock-happy era. As Delphi Management’s Scott Black says, “only fools try to time” their stock sales and purchases according to the market’s ups and downs.
But being a bear doesn’t have to mean being a loser. Some of the biggest market pessimists have excellent records. Despite last year’s stumble, Sams has delivered an average 16.9 percent per year for the last 15 years (ending March 31), nearly 2 percentage points better than the Standard & Poor’s 500 index. Since he started Robertson Stephens Contrarian in mid-1993, Paul Stephens has racked up a 20.55 percent average yearly return while small-company stocks averaged 13.51.
These guys know how to turn a buck while being cautious. That’s a skill investors should consider learning as the stock market floats into never-never land. People have never paid more for stocks than they are today, says Steve Leuthold, president of Leuthold Asset Allocation Fund in Minneapolis. Ahead is “a very large and very damaging decline.” Here are lessons from the bears that might protect you:
Market-timing isn’t all bad. You won’t read those words anywhere else. Market-timing, which means getting into the market before it goes up and out before it goes down, is more reviled than the Unabomber. What works, experts say, practically in unison, is to stick with the market through thick and thin. There are two flaws in this advice, bears say. First, it’s bull-market gospel. When the market is rising, people believe they’ll happily ride out a major market decline. But they won’t. Investors steadily yanked money out of mutual funds for five years after the 1973-1974 bear market’s trough. After the crash of 1987, they cashed out for nearly all of the 18 months it took before the market recovered its previous peak, according to Leuthold.
The second great deception: you’ll do better staying fully invested than darting out of the market. A University of Michigan study often trotted out as proof shows that if an investor missed the stock market’s 12 best months between 1926 and 1993, his $1 investment would be worth only $65, instead of growing to $637.30. That’s a pretty big penalty for getting out of the market, it’s true. But what’s rarely pointed out is that an investor could massively improve his results by exiting during the worst 12 months. Instead of $637.30, he’d have $7,850.10. Pretty persuasive, but is it realistic for most investors? Let’s say you fumbled and missed the 12 best months as well as the 12 worst. Your portfolio would be worth $810.30, still $173 ahead of the constant investor. You’d have to be a slave to your computer screen to try to do this yourself. But don’t turn up your nose at fund managers who are willing to do a bit of market-timing.
Being a bear doesn’t mean deserting the market. Jean Marie Eveillard, manager of SoGen International, doesn’t shrink from market-timing. But he no longer blows off a country altogether. After a satisfying run-up in his Japanese stocks in 1988, he decided prices were outrageous and sold everything. Big mistake. The market continued to soar. “I looked like an idiot for 18 months,” says Eveillard. Though he thinks U.S. stocks are pricey, he’s still devoting 25 percent of his fund to them. “If you’re feeling bearish, scale back,” advises David Shulman, a strategist at Salomon Brothers in New York City.
Don’t count on your mutual-fund manager to do this for you, particularly in U.S. diversified funds. Most fund companies believe that their shareholders are paying them to stay fully invested and instruct their fund managers accordingly.
Cash isn’t your only alternative. Trying to score with cash during a bull market is like trying to return Pete Sampras’s serve with a flyswatter. Ask Richard Fontaine. He’s parked about 50 percent of Fontaine Capital Appreciation in cash since 1990–and underperformed the market three out of the last five years.
The point of raising cash is to be able to scoop up bargains when the market plummets. But you don’t have to overdo it. There are other places to earn a decent return while you wait. Byron Wien, Morgan Stanley’s U.S. investment strategist, thinks investors should hold 15 percent in cash and look for opportunities in Japan and Mexico. Contrarian Fund’s Stephens searches out nickel, aluminum and gold-mining companies around the globe. “These stocks have been out of favor for 15 years and are the best way to play the emerging markets,” he says. SoGen’s Eveillard has bought high-yield corporate, or junk, bonds and, after staying away for seven years, Japanese stocks.
Global funds, which buy U.S. and foreign stocks, have the latitude to shift gears in this way, but many U.S. diversified funds don’t. Check your fund’s prospectus. To assess your manager’s defensive abilities look at his record in early 1994, when the market fell 14.4 percent, or in June of 1990, when it began a 31.7 percent plunge.
Hedge your hunch. Another bear trick: bet on the market in both directions. About 22 percent of Robertson Stephens’s Contrarian is invested in short sales, which are sales of stocks not owned by the fund in anticipation that their prices will decline. Though these positions cost the fund through much of 1995, they generated gains in December when retail and technology stocks tumbled. Leuthold Asset Allocation Fund hedges more conservatively. Only 60 percent of the fund is invested in the market, but it also buys “calls” on the S&P 500 index, giving the fund the right to buy into the market cheaply if it continues to go up. This is the most aggressive way to be a bear. Don’t fool with such market hedges unless you really know what you’re doing. Instead consider Contrarian, Leuthold or two other funds that actively hedge: Crabbe Huson Special or Caldwell & Orkin Aggressive Growth.
It could be that all these precautions won’t be necessary. If you really can stick with the market through good times and bad, you probably should buy and hold, as the financial gurus keep telling you. But if you’ll need your investment money any time soon, want to take some winnings off the table or simply don’t believe that a feel-good market feels good forever, borrow a move from the bears. Declares Salomon Brothers’ Shulman: “Bear markets have not been repealed.”
History shows that bear markets are preceeded byt these statistical red flags:
In bull markets investor enthusiasm drives up the ratio of companies’ stock prices to their earnings. Today’s P/E of 25.4 is higher even than in 1987, before the market crashed.
What will investors pay for a company? Today: 3.1 times what accountants say it’s worth.
Stocks pay off to their owners. At 2.2, the yield has never been this low for this long.
In peaking bull markets, private companies scramble to go public with initial public offerings.
No one wanted stocks after the 1973-1974 bear market. Today, investors feel putting money in the market is a no-lose proposition.
