March 19, 2004
George Paulos, Sol
Palha & Alan Lunt
Round Table” contributors discuss the ethics
and psychology of bear market investing.
George J. Paulos
Alternatives for Financial Freedom
spectacular year-long rally in the stock market, investors
are exuberant. Stock market bears have become an endangered
species, but reports of their extinction are greatly
exaggerated. Indeed, there are many reasons to believe that
a return to bear market conditions may be imminent. If the
markets turn down again, it won’t be pretty but bearish
investors may be able to harvest impressive profits by
betting on lower prices.
market conditions, most investors are overwhelmingly
bullish. They have been trained to hold stocks through thick
and thin. The bear market of 2000-2003 proved that the
average investor will hold stocks through devastating
declines, much like a deer in the headlights. Few investors
are even aware of techniques such as short selling, put
options, or inverse funds that allow profiting within bear
markets. For savvy traders, a fast moving bear market can
provide stellar profits using these techniques. But a bear
market implies that most investors are losing. Severe losses
can lead to extreme resentment against those traders who
profit from these environments. If you are a profitable bear
trader, you should be sensitive to those who are losing
while you are winning. In a very real sense, the money that
you are making is the money they are losing.
conversations about stocks are typically brag sessions about
being long a stock that went to the moon. When was the last
time you heard someone brag about a spectacular short sale?
The next time you are at a party, try telling your best
short-sale story and see what kind of reaction you get.
Hopefully, your friends will be polite.
popular form of bear market investing is short selling, a
practice where the investor sells borrowed stock from a
broker with the obligation to purchase it back later,
presumably at lower price, with the profit being the
difference between the sale price and the repurchase price.
Even though there is nothing illegal or unethical about
short selling, it is still regarded in popular culture as a
rogue practice. Many people consider it unpatriotic to sell
short the country’s finest firms and profit from their
troubles. Short sellers have always created resentment,
particularly during bear markets when the majority of
investors have lost large sums of money.
investing is fundamentally an optimistic pursuit. Most
people (particularly Americans) have a natural tendency to
be optimistic. Short selling goes contrary to that natural
tendency. This may be why short sellers are mistrusted.
Short sellers are not necessarily pessimistic, they are just
identifying a trend and profiting from it.
One of the
most famous short sellers on Wall Street was Jesse Livermore
who emerged from the 1929 crash with almost $100 million.
Jesse certainly caused a lot of resentment among all of the
ordinary people who had lost fortunes in the crash. Some
even blamed Jesse and other short sellers for the crash. In
response to investor outrage, the stock exchanges enacted
rules to limit short selling that remain to this day. After
the crash, Livermore often received personal threats and was
forced to hire bodyguards. Sadly, Jesse lost his entire
fortune in a mistimed investment strategy a few years later
and eventually committed suicide. The tragic story of Jesse
Livermore has become a parable for the “evils” of short
well-known bears have been teased and ridiculed during bull
markets, then shunned and reviled when their bearish
predictions came true. Bearish analyst Jim Grant endured
years of ribbing by Louis Ruckeyser on the Wall $treet Week
television show during the long bull market. The same Mr.
Ruckeyser fired “permabear” analyst Gail Dudack just months
before the stock market peak in April 2000. The unfortunate
Ms. Dudack disappeared into obscurity just as her bearish
forecasts proved correct. Professional stock analysts know
that a bearish outlook may permanently ruin a promising
career. This may be why bullish analysts vastly outnumber
bearish ones. There is little room on Wall Street for a
bears are always in a battle with a perpetually bullish
“Wall Street Industrial Complex”. These institutions are
designed to sell securities to the public so they are always
promoting stocks as safe and sound places to invest capital.
Trading commissions by short sellers generate little revenue
for the brokerage industry. In fact trading commissions in
general are only a small part of investment industry
profits. Management fees, investment banking, research,
media, and a plethora of related activities make up the big
money the investment industry. These institutions need a
constant inflow of new capital to survive. Only a
continuously bullish marketing message can lure investors to
buy these products and services.
message is reinforced by the financial media who receive the
bulk of their advertising revenue from the same industry
that is after your investment dollars. They have created
24-hour “news” channels that are really nothing more than
non-stop infomercials for stock investing. Most people get
their financial information exclusively from these tainted
sources. Financial media influence is powerful and
pervasive. Most common investors simply reflect the bullish
perspective of the information they receive from the media.
It is not the
purpose of this article to discourage purchasing stocks.
Quite the contrary. Stock investing is an essential part of
a healthy economy. But there is a time to buy and a time to
sell. The media will tell you that anytime is the right time
to buy but will never tell you when to sell. Successful
investors listen to the message of the markets, not the
talking heads on the cable news network. The financial media
will give no comfort or assistance to short sellers or any
other species of the bear family. Short sellers must think
independently and not be influenced by the media-controlled
stock market pop culture.
important to remember that other investors may deeply resent
all of the money you have made selling their favorite stocks
short. You are on the other side of most investor’s trades
and making all of the money that they are losing. Be careful
how you describe your investment success. Be sensitive and
generous to those who are losing. Don’t brag about your
A bear market
usually implies economic distress. Those who profit from
this distress have an obligation to give back to society and
help those who have been hurt by deteriorating economic
conditions. Bear investors in particular should give
generously to charity and work for the public good. This is
not only for good karma, but to diffuse any resentment that
would be generated by profiting from a bear market.
Alternatives for Financial Freedom
Copyright © 2004 George J. Paulos, All rights reserved
While I agree
with almost everything George has to say, especially the
last paragraph, I have a few additional points I would like
to make. Since my favorite topic in the market is the study
of mass Psychology, my answer is going to revolve around it.
problem is not the levels of Euphoria, by any measure this
market is ridiculously over valued and the profits most
corporations are reporting are nothing but statistical lies.
They are all due to the drop in the value of the US dollar.
If one had to adjust those profits to take into account the
drop in the value of the US dollar, all those lovely profits
would disappear immediately. However despite all these lies,
and distortions of the truth, the market still carries on
rallying. What it really comes down is perceptions and
unfortunately the majority of the world is like “Alice
to them illusions are realities and reality appears to be an
The reality is
that the markets should have crashed long ago and this
so-called bull rally should never have ever occurred in the
first place. But reality has never made anyone rich or
wealthy. The illusion however seems to be winning because it
is being driven by another very addictive factor. I call
this “the greed factor” and as the market goes higher this
greed keeps rising to insane levels. Eventually just like
swine’s they will be merciless slaughtered. The average
investor wants to cling onto the illusion that the huge
crash from 2000-2003 was nothing but a buying opportunity,
that all is well now and the bull has re emerged and is all
charged to keep going on forever.
The only way
to win in a market is to be unbiased, there is a time to a
bull, there is a time to be a bear and sometimes one has to
simply be neutral. If you firmly plant your feet in one
camp, start looking for a wheelchair, as they most likely to
get chopped of sooner than later. Currently the market
appears to be in an extremely euphoric mode and I believe
that a lot of this Euphoria is being slowly dampened by the
recent correction. This up down movement will continue for a
while and it appears that this summer has the makings of
being a very cruel time for all traders. I believe we are in
for one more explosive up thrust after which the bear will
viciously bite and destroy all the bulls out there. In the
end the only one left standing will the man who has no bias.
And if you
have made a fortune being a bear or bull, make sure you take
time to donate some of that money to a worthy cause. Since
you actually took that money from someone else and your
fortunes are now many people’s misfortunes.
© 2004 Sol
particularly long winter brr bear wakes up, its his time to
go and rummage for his meal. Typically he is very hungry and
any morsels are accepted with glee. But as the season goes
on he becomes more discerning and begins too pick and choose
his fodder. At this stage in the market he has just had his
first taste and some of the morsels were not that agreeable.
The shorts on the QQQs and Diamonds returned real stomach
cramps, and he regurgitated everything he had from the
futures pit. The time has come to be discerning.
Just like it
is with the bulls, when everyone has thrown in the towel
there is a market turn coming. The bears should have a real
glint in their eyes but instead they are standing back
watching the first honey drip onto the ground. The
perception is that the bears are market pessimists and
really aren't nice people as they want the market to do what
in reality it does nearly half the time, go down. When in
all truth the saying "buy and hold" makes a person a bull
and a bear and they get nowhere, hence "buy and fold". It
sure is helpful if you have a known bias.
The top market
people are those that can recognise when to be a bear
or a bull. They know when to buy and when to
sell. These people are admired by many and in some cases
envied. What they should not be is pilloried for being
correct, yet that seems to be the case for lesser mortals.
If you have entered the market the chances are better than
50/50 you have lost money by forgetting to sell. This is
where the true bear gets wounded by his contemporise if he
has made money in a declining market, he is perceived to be
the vulture picking at the bones of the unfortunates when in
reality all he is doing is stocking up for his coming
Kondratieff is more correct than Alan Greenspan and we are
in the first stages of K-winter then the time of the bear is
coming. He, the bear, knows what it is like to have slim
pickings and I do not see him advertising his gains too
much. He knows he has had to live on the same planet where
the wins of others have been rammed down his throat. He will
not repeat the mistake by gloating too much.
For bears like
me it will be a time to watch and help where we can after
we have pocketed all that lovely spondulie.
"It is less important to redistribute
wealth than it is to redistribute opportunity."
-- Arthur Vandenberg, American journalist and
© 2004 Alan Lunt
Contrarian Round Table Series
The Dow has never been in A true Bear Market
Contrarian Round Table II- Central Bankers
Contrarian Round Table III- Inflation good or bad?