The Optimistic Bear
Adam Hamilton November 1, 2002 2979 Words
The emotionally-charged financial markets are an exceedingly fertile breeding ground for myths.
Capital, which should be a useful tool and nothing more, tends to evoke incredibly strong emotions. All kinds of crucial human needs and desires are somehow symbolized in capital. Foundationally, capital represents the ability to easily purchase lifeís necessities like food, shelter, and education free from worry.
More mystically, capital has become a proxy for higher-level human desires. Virtually everyone seeks freedom, fulfillment, happiness, comfort, and status, and somehow capital has come to characterize each of these powerful life goals.
There is probably nothing else on Earth that is as powerful of emotional lightning-rod across entire populations as capital, or its most liquid form, money.
Emotions are the mortal enemy of rationality. Whenever greed or fear squeezes the hearts of investors and speculators with an iron fist, all of a sudden there is no room left for reason and it is unceremoniously evicted. Emotions cause investors and speculators to act impulsively without carefully considering all their potential courses of action, and the results of this shooting-from-the-hip style of capital management are universally disastrous.
All the powerful emotions that capital generates inevitably focus on the financial markets like an industrial laser. Because the emotionally-heavy concept of capital floods investorsí souls and drives out rationality, a complex mythology has arisen surrounding the markets.
One key myth in the capital markets encompasses bulls and bears. Bulls, of course, believe the markets are heading higher. Bears, the other side of the coin, believe the markets are heading lower.
Bulls and bears can both be rational at times, and they can both be emotional at other times. The emotionally-charged myth that has arisen, however, states that bulls are optimistic and bears are pessimistic. I would like to address the popular misconception that all bears are pessimists in this essay.
It is not too difficult to understand the developments that have spawned the pessimistic-bear myth.
Over the long run, history has unambiguously shown that stock markets have a strong upward bias. Two major strategic factors contribute to this phenomenon.
First, general prosperity for the fraction of humanity fortunate enough to live in the First World continuously increases over time. We humans, deep down, are an optimistic hard-working lot and we constantly strive to improve the standard of living for our own families. When countless centuries, diligent work, advancing technology, and greater general knowledge are all mixed together, the result is an overall higher standard of living.
In many ways, todayís American middle class is blessed with a higher standard of living and far more creature comforts than even powerful kings of a few centuries ago. The relentless upward progress of technology and standards of living allow greater specialization of labor, which frees people to pursue their passions in business. Broad specialization of labor leads to vastly more general wealth created. This newly created wealth eventually seeks a home in the capital markets, bidding up stock prices over the long-term.
Second, the stock markets have a strong upward bias over long periods of time because of inflation. Unfortunately, all the national currencies on Earth today are ultimately nothing more than worthless paper. Without any link to anything tangible of intrinsic value like gold, todayís paper money is just that, ultimately worth nothing more than the paper it is printed on.
Governments love paper money because it grants them the opportunity to levy a stealth tax on their hard-working citizens trying to save. Like counterfeiters the governments print ever more new paper money and then quickly spend it on whatever pet program the politicians are fawning over at the time.
As the overall supply of paper money relentlessly increases, relatively more money chases relatively fewer goods and services, bidding up general price levels. Through this inflation of the paper money supply, every dollar saved today is worth less and less tomorrow in terms of the real goods and services it will purchase. Inflation is the bane of the existence of hard-working savers everywhere, their true nemesis.
Less than a century ago, US$20 would purchase a fine manís suit. Today, thanks to relentless inflation in the United States perpetrated by the ultimate inflation machine of the unconstitutional Federal Reserve, finding a $20 bill sitting on a sidewalk is hardly even worth bending over to pick up anymore. Inflation destroys purchasing power.
Stock market index prices are always quoted in nominal terms, not adjusted for inflation. This means that they will always tend to rise over long periods of time in inflationary regimes such as the ones that exist in every major country on Earth today.
Together the general advancement of technology and progress coupled with fiat-currency inflation lead to a relentless upward march in stock index prices over the long-term.
Because the markets tend to ultimately rise, bulls command the loving attention of the big media. Media companies are in the business of selling advertisements to earn profits, so they seek to advance opinions with the broadest popular appeal. In the markets, the bulls always spark greater popular enthusiasm than the bears. Popular enthusiasm leads to more viewers which lead to higher advertising revenue for the media companies.
Like all good capitalists, the media companies simply advance the market views that earn them the highest profits.
The bears, effectively shut out of the mainstream media, have always had to rely on alternative means of advancing their ideas. For much of the last few decades, the only forum available for bearish thought was the newsletter industry. Today, at the glorious dawn of the Information Age, a vast new forum is rocketing up in importance however, the Internet.
I have been an avid newsletter reader and fan for the better part of two decades. Newsletters have thankfully exposed me to brilliant men and women who understand the markets infinitely deeper than the usual short sound-bite blurbs the mainstream media reports. Always very thankful for an alternative view of the markets, now I find myself in the newsletter business today, publishing Zeal Intelligence.
Just like the mainstream media, newsletter publishers also strive to maximize their profits. Iíve observed that newsletter editors, often bearish, tend to grow their circulation by advancing what I call Doomsday Theories. The newsletter industry has always been rife with talk of The-End-of-the-World-As-We-Know-It scenarios (TEOTWAWKI).
In the early 1980s, many newsletters voiced concerns about a nuclear war or Russian invasion of the States. In the late 1980s, after the Great Crash of 1987, many newsletters advanced a Great Depression of the 1990s scenario. In the mid-1990s, the vogue TEOTWAWKI talk focused on an immediately imminent crash. In the late 1990s, fear-laden accounts of the coming Y2k computer catastrophe sold letters.
Now I donít know about you, but I lived through the last two decades and I canít remember a Russian invasion of the US, nor a second Great Depression in the 1990s, nor a horrific equity crash in the mid-1990s, and I am certainly not penning this essay from a candlelit cave on a computer powered by hamsters thanks to Y2k. While the End of the World will no doubt arrive someday, it will most likely be a very low probability surprise event that virtually no one sees coming, not a well-publicized TEOTWAWKI scenario.
Can you see the links of the causal chain here?
Bulls dominate the mainstream media, because bullish thoughts sell ads. That leaves the bears to languish in the backwoods of the alternative media, which in the last two decades was the newsletter industry. Newsletter editors, bless their souls, seek to grow their own businesses so they tend to latch onto grand TEOTWAWKI theories to drive letter sales.
The net result of this progression is that bears are generally believed to be raging mega-pessimists because equity bears are often associated with countless discredited TEOTWAWKI scenarios dredged up from the ghosts of newsletters past.
Now please understand that my intent is certainly not to attack newsletter editors! Many newsletter editors, even the most legendary pessimists of the last two decades, are my personal financial heroes. Their hard work and detailed analysis has been an enormous blessing for me. They have taught me to search beyond the surface of the markets and to always dig deeper, never accepting the status-quo paradigm at face value. I will be forever grateful for them and their great wisdom.
The ultimate personal praise I can heap on the newsletter editors is that I respect them so deeply that I became one!
The bulls would certainly consider me to be a bear, and they are right based on my public writings. Way back in the summer of 2000 I was on the record stating that I believed the NASDAQ would trade under 500 before this supercycle bust ends. I still believe it will be so. I have penned countless essays and newsletters explaining in depth based on hard data and painstaking analysis why I believe this will be the case.
Does my current bearish outlook make me a pessimist? Heck no!
I strongly believe that bears can be Optimistic Bears!
An optimistic bear?!? Isnít that an oxymoron? No way my dear friends!
The markets travel in great cycles through history. Over the long run valuations drive stock prices. In history markets roar up from undervalued levels and languish from overvalued levels. Valuations are based off the amount of profits that publicly-traded corporations can earn for their shareholders.
In addition to the long-term great cycles based on the perpetual sine-wave like swing from undervalued to overvalued back to undervalued levels, there are also short-term market cycles. Short-term market movements are based almost exclusively on general emotional sentiment, popular greed and fear.
The legendary contrarian investor Warren Buffett, quoting his mentor Benjamin Graham, perfectly explains the forces that drive these waves. Over the long run, Buffett says the markets are a weighing machine, valuing stocks based on their fundamental worth relative to the earnings they can spin off for their owners.
Over the short run however, Buffett says the markets are a voting machine. It doesnít matter which stock is the best candidate to win based on fundamentals, all that matters is which stock is most popular and likely to be chased by short-term capital bids (votes) in the marketplace.
Understanding valuation, greed and fear, and long and short cycles is the essence of contrarian investing. Contrarian theory is the only form of investing and speculation that has consistently proven immensely profitable over decades and centuries, so the lessons and wisdom it imparts are truly priceless.
The whole goal of investing can be summarized in four simple words. Buy Low Sell High. While others give lip service to this key truth, only the contrarians actually walk the walk.
Sometimes stocks are generally expensive relative to earnings, like the late 1920s, and sometimes they are cheap relative to earnings, like the early 1930s.
Now as prudent investors and speculators, we all need to constantly strive to buy low and sell high. Imagine if you could be miraculously transported back in time to the late 1920s. Would you buy or sell knowing what you now know about the Great Crash of 1929 and the resulting Great Depression? Itís a dumb question, as only a fool would buy at the top (buy high?) or sell at the bottom (sell low?!?), yet that is exactly what most investors at the time did!
With perfect 20/20 hindsight it is obviously easy to make the right decisions looking back in time, but the real game unfolds everyday in real-time with imperfect information, making it extremely challenging.
Most investors and speculators today choose to run around the markets blind, frantically trading based on pure emotion like a chicken with its head chopped off. There is a relatively small band of folks who reject emotional trading however, the contrarians. They seek to diligently learn the hard lessons of market history from the people who already suffered through them rather than learning the hard way by making the same mistakes again themselves.
The contrarians, through their historical studies, realize that markets move in cycles through history and the cycles endlessly repeat themselves. Overvaluation inevitably gives way to undervaluation over the long-term, and vice versa as the wave rolls on. Greed inevitably gives way to fear over the short-term, and vice versa on the opposite slope of the wave.
If markets move in cycles, and the cycles, while not exactly the same over time, are predictable enough to rhyme with history, why not use them to Buy Low and Sell High?
Right now the markets remain far overvalued by all fundamental measures!
If you wish to understand how I can be so brazen as to make such a bold statement, please skim ďLong Valuation WavesĒ and ďValuation Wave ReversionĒ to dig deeper. If the markets are involved in a classic long-term slide decaying from an overvalued to an undervalued state right now, why buy today?
If all the weight of history suggests that the stock markets will be lower a year or two from now, wouldnít it make infinitely more sense to wait for true undervalued prices rather than buying today at overvalued levels? How can an investor or speculator Buy Low today if huge amounts of hard empirical evidence suggest much lower stock prices ahead?
My colleagues and I, and countless other bears, are bearish today not because we believe a TEOTWAWKI scenario is approaching, but because we are on the down-wave of a great valuation cycle. History suggests that the best stock bargains in many decades, maybe in 70 years, are going to show up on our doorsteps gift-wrapped sometime in the next couple years!
Personally I am absolutely giddy with excitement about buying general US equities again at rock-bottom prices in the not-too-distant future. My heart would jump for joy at the historic opportunity to buy elite survivor companies like General Electric or Microsoft at 7x earnings, half historical fair value of 14x earnings!
In July 1932, the last supercycle bust bottom marking the end of a Great Bear, one of the greatest stock market rallies in history exploded off the depths of fear and bearish despair. The Dow 30 rocketed from 41.2 in July 1932 to 108.7 one year later in July 1933!
This breathtaking 164% annual gain off the bottom in the Dow 30 makes the NASDAQ bubble explosion of 86% in calendar 1999 look like childís play! And, unlike buying the NASDAQ at 100x earnings in 1999, an immensely dangerous and reckless speculation, the end of bust Dow mega-rally in the early 1930s launched from a very safe undervalued level of only 6x earnings!
You could have bought near the ultimate bust bottom in July 1932 and made huge profits almost regardless of how long you held elite blue-chip US stocks. All the research we have done at Zeal as well as the work that countless other brilliant contrarian researchers have undertaken leads me to believe with all my heart that such a fantastic opportunity is approaching again.
Please understand that the Optimistic Bear is not cheering-on the horrific carnage in the US equity markets today. On the contrary, the Optimistic Bear weeps when families lose their livesí savings in the bubble bust and people are laid off in droves and canít feed their families without resorting to the curse of debt.
The Optimistic Bear simply wants to Buy Low and Sell High. It makes no sense buying now before the ongoing Long Valuation Wave mean reversion has even passed fair value on the downside. The legendary profits will be made off the ultimate bottom when no one even wants to hear about the stock markets anymore, not today while general enthusiasm for stocks still waxes ecstatic.
While some bears embrace TEOTWAWKI theories, back them with powerful arguments, and will no doubt be right some day, not every bear is a pessimistic bear. Some bears, like us at Zeal, are raging optimists at heart who can hardly wait for the legendary buying opportunities to come.
The NASDAQ is going under 400? Fantastic, we canít wait to buy Microsoft, Cisco, and Dell at 7x earnings each! The real-estate bubble will burst? Awesome, as we would love to pay $50k cash to gain full debt-free fee-simple titles on houses that sold for $500k two years earlier! Perhaps a Depression is approaching in the States? Well, since we canít change the future we will be ready with the cash to buy great businesses for mere pennies on the dollar at the depths of despair!
The Optimistic Bear does the prudent thing, zealously preserving his or her precious capital until the rare real blood-in-the-streets buying opportunities present themselves.
Buy Low Sell High. This is the whole capital game! Nothing else matters in investment and speculation.
So my dear friends, please donít let myopic bulls with little minds label you as a pessimist just because you are bearish and believe superior buying opportunities are approaching in the not-too-distant future. Donít let someone get under your skin and impugn your optimism because you have studied history and they havenít. If tormenting bulls refuse to seek wisdom and understand market history, let Ďem eat cake.
The world has never seen anything before even remotely like the Information Age. The future is so dazzlingly bright that it defies description. The wealth created in the last century, the Industrial Age, will probably be a drop in the bucket compared to the wealth created in the next century, the Information Age.
I strongly urge you to diligently study history, seek out the legendary wisdom of the contrarians, and prepare yourself intellectually, psychologically, and financially to carve out your own piece of the greatest wealth pie the world has ever seen.
Contrary to popular bullish mythology, there is no inherent contradiction in being bearish on stocks today but ragingly optimistic in general.
Long live the Optimistic Bears!
Adam Hamilton, CPA November 1, 2002 Subscribe at www.zealllc.com/subscribe.htm