These Are Bad News Days for Inveterate Bears

“It seems to me your system is flawed,” an exasperated subscriber recently wrote to Dan Sullivan, editor of the Chartist stock market newsletter in Seal Beach.

Bearish on the market since April, 1994, Sullivan has refused to dive into this year’s spectacular rally, which has now lifted the average blue-chip stock 16.2% since Jan. 1.

For Sullivan, a 26-year market veteran and a nationally known and respected investment newsletter writer, the New York Stock Exchange has become a sort of House of Pain in 1995. Every new high in stock prices reminds his subscribers, whose financial assets are mostly languishing in money market funds, of what they’re missing.

“I feel badly for them,” Sullivan says. But the market signposts that he follows continue to tell him that this bull run is more likely to be a finale than an opening act, he says. So he stays bearish.

Increasingly, however, the resistance of bears such as Sullivan is breaking down as stocks zoom. While many investment professionals--even many bulls--speak cautiously about the market at these levels, the percentage of pros who are outright bearish has been shrinking inexorably all year.

Investors Intelligence newsletter in New Rochelle, N.Y., which tracks about 130 independent investment newsletters nationwide, asks the newsletter editors each week whether they’re bullish, bearish or anticipating a short-term “correction” in stock prices.

Early last December, when soaring bond yields seemed certain to spark a full-fledged bear market decline in stocks--usually defined as a drop of 20% or greater in key indexes such as the Dow Jones industrial average--about 60% of the newsletter editors were, not surprisingly, bearish.

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But as both bond and stock markets have rallied nearly nonstop this year, the bears’ conviction has withered. Only 34.4% of the newsletter editors were outright bearish as of last week.

Interestingly, the percentage of outright bulls hasn’t risen much--from 33.1% in December to 38.3% by last week. What has swelled is the middle ground: respondents who are basically bullish but expect a short-term pullback in stocks.

Any way you look at it, a lot of former bears have capitulated and no longer are warning of stocks’ equivalent of Armageddon. And with each act of capitulation, it’s a reasonable bet that another bushel of formerly sidelined money is freed to enter the stock market. No wonder this rally just streamrolls along.

Howard Freedland, who with partner Bryan Gindoff manages Del Rey Investment Management in Santa Monica, is among the recent market converts. Bearish in 1994, he continued to “short” the market in the first quarter of this year, betting that stock prices would crumble. By April, the two decided they were fighting a losing battle.

Now, Freedland describes himself as a “chicken bull.” He’ll buy a stock he likes if he can also hedge it via “put” option contracts that should protect him if the price collapses. After figuring in the cost of that insurance, he estimates he can pick up 40% of a stock’s actual gain if this rally continues.

Wall Street purists might view Freedland’s strategy as lacking conviction in either direction, bull or bear. But he offers no apologies. Playing the game hedged feels better than not playing at all in a market advance this powerful, he says. Why pretend you’re smarter than the market? he asks. “I’d rather make money than be smart.”

Assuming there are many more Freedlands out there--investors who will continue to play along with this bull market, if for no other reason than that it’s perceived to be too risky to bet against stocks--the surprise could be that Wall Street’s party doesn’t end soon absent a complete catastrophe in the economy, the bond market or on the international front.

The classic definition of a market top, after all, is when nearly every last dollar is invested, and the raging bulls far outnumber the bears and those who keep looking for a correction. If the Investors Intelligence poll means anything, the score still is: Bears and correction-seekers, 61.7%; bulls, 38.3%.

Dan Sullivan promises to still be bearish when that market top arrives, and until then. “I don’t think I’ve ever been out of sync with the market for this long,” he concedes. But with the average stock’s dividend yield at a record low, and other of his time-tested indicators (such as the ratio of rising stocks to falling ones) refusing to confirm that a true bull market is under way, Sullivan says he’s more entrenched with each new market high.

However miserable his subscribers are, to walk away from his investment discipline now runs the extreme risk of buying at the top, Sullivan says. “I would just be compounding my mistake,” he says.

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Capitulation?

The percentage of investment newsletter writers who are bearish on the stock market has been falling gradually since December, as stocks have surged. Bulls and bears in Investor Intelligence’s weekly poll, first week of each month and latest:

May 25, 1995

Bears: 34.4%

Bulls: 38.3%

Note: Newsletter writers who aren’t bullish or bearish expect a near-term correction in stock prices.

Source: Investors Intelligence