Bull!

by Maggie Mahar

  A seasoned market watcher, Acampora realized what this meant. He began setting up for the broadcast that he now knew he had to make. “I was two feet off the ground,” he remembered, “so agitated that, at one point I nearly ran through the wall of my glass office-within-an-office. Everyone around me knew that something was about to happen.”

  Finally, at 11:30, Acampora stepped up to Prudential’s global in-house PA system: “Ladies and gentlemen,” he announced, “I have something very important to say.” He knew he had his audience’s attention: brokers in Prudential offices around the world were listening. Acampora swallowed, then plunged ahead. Flat out, he uttered the words that, in 1998, no one ever used except in the past tense: “bear market.” The Dow, he predicted, would drop 15 to 20 percent from its summer high.

  Acampora half expected the news of his forecast to leak to the media, but it did not. He was glad. “It’s only right to get the news out first to our big institutional clients—the money managers who pay for my research—before the rest of the world gets it for free,” he thought to himself. The institutional clients were scheduled to phone in at one o’clock that afternoon. In the meantime, the Dow continued to slide. At one o’clock, Acampora repeated his forecast. This time the media picked up the news. Ralph Acampora was calling a bear market.

  In fact, Acampora was predicting what economists call a “cyclical bear market,” a short-lived affair that would last a matter of months, rather than a “secular bear market,” which could last for years. The distinction was lost on the media. The Dow fell another 100 points. By day’s end, the benchmark index had plunged 299 points, the third largest one-day decline in Wall Street history. The press blamed Acampora. “Tanks A Lot, Ralph,” read the headline in The New York Post. Even Barron’s ran his nickname: “Ralph Make ’em Poorer.”

  Prudential hired a bodyguard to protect him.18

  That night, Acampora cautioned those who listened to CNN’s Street Sweep: “Forget the averages. Look at your portfolio…everyone should be sitting down and really seriously going through their holdings, and if there are any stocks in there that look vulnerable—and obviously it’s a matter of interpretation—I would sell them.”19 This was not what his audience wanted to hear. Many were outraged. Most still believed that if they just waited—six months, a year, perhaps two years—they would be made whole.

  As it turned out, Acampora’s intuition on that August night in 1998 was at least half right. It was time for investors to think about cutting their losses. On August 31, the Dow Jones Industrial Average plunged 502 points; in the weeks that followed it continued to slide. By October 8 the Dow had lost 1,900 points. Granted, the bull market had another 18 months to run—and by 1999, Acampora himself was once again a bull.

  But in retrospect, it would become clear that the meltdown that began in the summer of 1998 marked a turning point. By the end of that year, the majority of stocks trading on the New York Stock Exchange (NYSE) had peaked, hitting a high that they would not see again for many years. From that point forward, just a handful of stocks would carry the bull market: the broad market lacked support.20

  As for Acampora, he had learned his lesson. After that, he confided, “Instead of saying ‘sell,’ I use terms like ‘rotation.’ I no longer use words like ‘bear.’ I just say, ‘It’s too early to pick a bottom.’”21

  SILENCING DISSENT

  What Acampora had learned is that when a strong cycle is peaking, skeptics are shunned. This is part of the process John Kenneth Galbraith outlined in A Short History of Financial Euphoria—the book that Henry Blodget finally read in 2001. A bubble, Galbraith observed, is always supported by the belief that there is something new in the world. The history of past cycles is dismissed as irrelevant.

  “For practical purposes,” Galbraith wrote, “the financial memory should be assumed to last, at a maximum, no more than twenty years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to come on the scene, impressed, as had been its predecessors, with its own innovative genius.”22

  During the period of delirious forgetfulness, no one wishes to think that his good fortune is fortuitous or undeserved. Everyone prefers to believe that it is the result of his own superior insight into the market.

  No wonder, then, that during such periods, doubters are silenced. Galbraith recalled the fate of Paul M. Warburg, one of the founding parents of the Federal Reserve System, who tried to warn investors in the winter of 1929 that the current orgy of speculation could lead to economic collapse. At the time, “The reaction to his statement was bitter, even vicious…. He was ‘sandbagging American prosperity’; quite possibly, he was himself short in the market. There was more than a shadow of anti-Semitism in the response,” Galbraith noted. “It was a lesson to all to keep quiet and give tacit support to those indulging their euphoric vision.”23

  The story never changes—just the cast of characters. So, in 1999, as the Great Bull Market reached its climax, even Morgan Stanley’s chief domestic strategist, Byron Wien, was beginning to discover what it feels like to be out of step in a parade.

  By 1999, Wien realized that a corporation’s assets, its cash flow, and even its revenues had little relevance to the total value investors were willing to assign to it. On more than one occasion in recent years a younger colleague had come into Wien ’s office and told him: “You just don’t get it, and you’re never going to get it.”24 One scene stuck in Wien ’s mind: an analyst stood in his office recommending a stock that was selling at over 100 times earnings.

  “How do you arrive at your valuation?” Wien asked. “Show me the parameters you’re using.” The young analyst just stared at the 64-year-old market strategist.

  “When you’re an older person, and you’re cautious, while the market is still going up, you’re perceived as out of touch,” Wien later recalled. “You think a stock is worth $20; you say that, at $30, it’s overbought; then it goes to $40. You can begin to doubt yourself.”

  But Wien had a corner office with skyscraper views of Manhattan. The young man standing in the middle of his carpet did not. More important, he did not have the thick skin that comes with trying to outguess the market while working your way up to such an office at Morgan Stanley. If Wien doubted himself, he did not show it. He waited for the answer. “The stock is worth what someone will pay for it,” said the analyst, stating what seemed, to him, obvious.

  The moment crystallized what Wien already suspected: They’re letting the tape tell them what a company is worth. No wonder, when a stock took a dive, the analysts who followed it were just as surprised as everyone else.

  WHAT THE MARKET’S CYCLES MEAN FOR THE 21ST-CENTURY INVESTOR

  “Markets go down because they went up,” James Grant reminded his readers in the late nineties. “Where the free enterprise system shines is in its treatment of failure,” he added. “Individuals as individuals, are always error-prone…[they] also make collective mistakes. They overinvest, then underinvest. The underinvestment portion of the cycle is dealt with constructively, with new business formations, bull markets, and initial public offerings. The overinvestment problem is also dealt with constructively, but with the emphasis on demolition: with bankruptcies, bear markets, consolidations, and liquidations…. Without miscalculation there would be no price action, no capital gains, no losses and no commissions. Determining the ideal price, the market would sit on it, preening.”

  Cycles, then, drive markets: three steps forward, two back. Without the alternating rhythms of expansion and contraction, rising prices and falling prices, there would be no movement. In Grant’s terms, “A boom is just capitalism’s way of setting up the next bust.”25

  This is not to say that booms should be regretted. Often they mark a major technological advance, the discovery of new resources or new lands. But since the limit of the new
discovery is unknown, there is no clear way to measure its value. The prospect for profits is open-ended, and lacking a measuring stick, the human imagination tends to err in the direction of desire, envisioning boundless profits. Promoters further encourage imaginative excess, and so, in the natural course of things, a boom can easily turn into a bubble.

  Meanwhile, the new technology does change the world, transforming entire industries and raising standards of living nationwide, sometimes even globally. But that does not mean that the investors who bought the pioneers at their peak make money. Great technologies do not necessarily make good stocks.

  The great virtue of laissez-faire capitalism, say its staunchest admirers, is that it allows a boom to run its course, and then lets the bubble collapse. With the hissing sound comes a correction: investment mistakes are repriced, and unprofitable companies go bankrupt. “The errors of the up cycle must be sorted out, reorganized or auctioned off,” Grant observed. “Cyclical white elephants must be rounded up and led away.”26 Only then can a capitalist economy resume its progress. The correction clears the way for another cycle.

  This is “part of the genius of capitalism,” declared Treasury Secretary Paul O’Neill following the collapse of Enron in January of 2002. “Companies come and go…people get to make good decisions or bad decisions, and they get to pay the consequence or to enjoy the fruits of their decisions.”27

  O’Neill’s statement must have seemed unfeeling to the many Enron employees whose life savings were wiped out when that particular white elephant was led away. Unwittingly, and some might say witlessly, O’Neill glossed over the human consequences of boom and bust cycles: the losses are never borne equally. Those who get in early during an upturn—and have the luck or presence of mind to get out before someone shouts “fire”—reap huge rewards. But those who come late to the party, often through no fault of their own, are hammered. Markets do not punish the greedy; nor do they necessarily reward the virtuous and frugal saver. Markets are amoral. “Good decisions” and “bad decisions” play a role in the outcome, but much depends on the wanton accidents of timing—when you get in and when you get out.

  Ideally, an investor cashes in his chips when a market peaks. If he holds on, his losses compound. Meanwhile, he loses the opportunity to make money elsewhere, and there is always someplace in the world to make money.

  But in any market cycle, those who find themselves losing the game of musical chairs are bound to resist the inevitable. Even drowning victims do not go straight down. If investors who lived through a bear market are slow to recognize an upturn, those who have become accustomed to a bull market fight a downturn tooth and nail. Denial, anger, desperation…these are just some of the stages that investors pass through before accepting defeat.

  So, even after it became clear to the vast majority of investors that the Great Bull Market of 1982–99 had ended, mutual fund investors stood firm. The mass redemptions from equity funds that many had predicted never took place. As late as March 2003, Gail Dudack observed: “Net redemptions since the beginning of 2002 have been tiny compared with total stock fund assets. The net cash outflow in the 12 months ending March 30, 2003, amounted to 3.6 percent of the sector’s assets. Usually, before a new cycle begins, outflows are much greater—as high as 8 percent a year. You need cash to fuel a new cycle,” Dudack explained. “Until you get the sell-off that creates liquidity, a new cycle can’t begin.”28 (See chart “Mutual Fund Investors Hang On,” Appendix, page 462.)

  “People have talked about how steadfast the individual investor has been. But I think it’s been more paralysis than steadfastness,” added Don Phillips, managing director of Morningstar Inc., the Chicago firm that tracks mutual funds.29 Investors offered various reasons for holding on: “Everything I own has gone down too much—I can’t sell now,” confided one 401(k) investor. “The market is coming back—this is a buying opportunity,” said another.

  Ironically, these are the very responses that fuel bear market rallies, making it dangerously difficult to tell when a market has finally scraped bottom. If investors simply bowed their heads and accepted defeat, bear markets would last no more than a few months. Everyone would sell, and that would be that. But human nature, once again, intervenes. Men resist disaster. This is why even the “Great Crash” of 1929 did not happen in a day, a month, or a year.

  True, in the fall of 1929, the Dow plunged from a September peak of 381 to a low, on November 13, of 199. But the following spring the market seemed to recover. By April of 1930, the Dow had climbed to 294—up 48 percent.

  The bear was playing possum.

  The low of November 1929 was a false bottom, the rally of 1930 a sucker rally. In 1930 the bear trap sprang shut. From April of 1930 through July of 1932, the market lost 86 percent of its value. What is commonly called the “Crash of ’29” was in fact the crash of 1930–32: that is when the wealth of Gatsby’s gilded world was destroyed. It seems that a new market cannot begin until the last bull’s heart has been broken, and typically, it takes more than one crash to do the job.

  The pattern was repeated at the end of the sixties, when the Dow fell to 631 in May of 1970, rallied to over 1050 in January of 1973, and then took a final, fatal nosedive that ended with the crash of 1973–74. Only then did investors learn not to buy on dips.

  It would be another eight years before a new bull market began.

  What precisely does this mean for the years ahead? No one knows. But since both human nature and the laws of supply and demand remain more or less constant, there is good reason to expect that past cycles might forecast, at least in broad brush strokes, the shape of the future.

  What is certain is that an understanding of the market’s cycles is an investor’s only defense against becoming a victim of those cycles.

  —2—

  THE PEOPLE’S MARKET

  Each age has its peculiar folly, some scheme, project or phantasy into which it is plunged, spurred on either by the love of gain, the necessity of excitement, or the mere force of imitation…. Money has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers and risked almost their existence upon the turn of a piece of paper…. Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly and one by one.

  —Charles MacKay, Extraordinary Popular Delusions & the Madness of Crowds, 1852

  Spring 1998. In a neighborhood restaurant, a waitress confides that she likes working nights so that she can watch her favorite characters on daytime TV—Maria Bartiromo and Joe Kernen, the charismatic stars of CNBC’s Squawk Box. Though, she confesses, she surfs back and forth between CNBC and Bloomberg Television “because Bloomberg covers the Nasdaq, and most of my stocks trade there.”

  “Wouldn’t it be fun to set up a pool on when it will cross 9000?” she adds, turning to the regulars at the bar behind her.

  “I thought it crossed today,” a man replies, “did it go back?”

  No one says, “9000 what?”

  As the bull market rolled forward, the financial mania of the nineties came to define the decade. More and more, the stock market had begun to take on the aura of a national lottery: as the pot grew, everyone talked about it. Never before had luck and timing played such a pivotal role in the fortunes of so many Americans. There was a feeling in the air that anyone might get lucky. By the end of the decade, ABC’s Who Wants to Be a Millionaire? had become the signature show of the era. Coast to coast, Americans answered, “I do, I do.”

  A history of the Great Bull Market of 1982–99 is more than a financial story. Ultimately, that breakneck ride would mark an epoch in U.S. cultural history. While share prices spiraled, investing replaced baseball as the national pastime. CNBC’s stars began to edge the soaps off the screen. The New Economy spawned a New Society, and, as the baby boomers aged, even the symbols of success changed: SUVs trumped BMWs. Trophy mansions replaced trophy wives.

  T
he people’s market was telecast as a democracy—though in truth, just over half of all American families owned stocks, either directly or indirectly, through a mutual fund, a 401(k), or some other retirement plan. Still, the share of households with a stake in the market grew from just 19 percent in 1983 to over 49 percent in 1999.1 And those lucky enough to have the price of admission watched their wealth soar. By ’98, the 25 to 30 percent of American families with household incomes north of $75,000 found that since ’89, their net worth had increased by some 20 percent. The wealthiest 5 percent watched their retirement funds grow by a dazzling 176 percent.2 Baby boomers dreamed of retiring at 50 while Gen Xers invented their very own version of the American dream: wealth without working at all.

  Financial euphoria cut a wide swath across generations. At one end “the Beardstown Ladies”—a group of Midwestern matrons that included a retired bank teller, a hog farmer, and an elementary school principal—became cult figures after they pooled their pin money, formed an investment club, and wrote a best-seller claiming that over the 10 years ending in 1993, they had reaped returns averaging 23.4 percent a year. At the other end, Ameritrade’s punked-out hero, “Stewart,” starred in the online broker’s television ads, playing a pierced and tattoed Gen X office boy who showed his pudgy middle-aged boss just how easy it is to trade on the Net: “You’re ridin’ the wave of the future, my man!”

  Somewhere in between the retirees and the Gen X investors, graying baby boomers discovered that they had just enough short-term memory left to learn how to use the Internet. With the bits and bytes of information streaming across their computer screens, anything seemed possible. Online, they tapped into a world of virtual knowledge: Wall Street’s buoyant estimates of what a business might earn, the company’s press release offering its own “pro-forma” version of what it had earned, an analyst’s surmise as to what the quarter’s profits might augur for the future…. It was all there, online, on television, all the time—a beguiling stream of data.