Former Bear Warming to Bullish Possibilities

Jim Stack was a bear on the stock market--an angry, snarling bear--for much of the 1990s, and particularly in the technology-bubble era of 1999 and early 2000.

Today, he is rightly considered a hero for warning subscribers of his InvestTech market newsletter, and anyone else who would listen, away from stocks as they climbed toward their peaks and then careened into the worst decline in a generation.

But that was then, and this is now. Stack the once unrepentant bear now is bullish on the market--”conservatively, cautiously, watchfully bullish,” in his words. He is telling his followers that the stock market today presents “a viable profit opportunity that will likely extend well into next year.”

At a time when many investors view the market’s powerful advance since the Sept. 11 terrorist attacks with a mixture of relief and disbelief, support from former bears such as Stack provides an important underpinning for the bullish case.

“In all probability, it is a new bull market,” he writes in his latest newsletter, penned before stocks surged anew last week. The Dow Jones industrials rose 2% for the week, to 10,049.46, while the Nasdaq composite jumped 4.7% to 2,021.26.

The 50-year-old Stack, who writes his newsletter from Whitefish, Mont., but whose name and market opinions have reached far beyond that tiny hamlet over the years, takes his cues in large part from history. Because every classically overvalued market in the last century or more ended in disaster, that had to be the fate of the late-1990s market, he maintained--and he was right.

But if bear markets are inevitable, so is their demise, Stack says. And though he concedes that there are plenty of reasons to be nervous about stocks, he says the magnitude of Wall Street’s decline between March 2000 and September suggests that enough is enough already.

The drop in the blue-chip Standard & Poor’s 500 index from its peak of 1,527 in March 2000 to its closing low of 965 on Sept. 21 was 36.8%. That was larger than the 32.6% average bear-market loss of the last 70 years, Stack says.

The 18-month duration of this bear market was a bit longer than the 17-month average duration of declines in the last 70 years, he says.

Many investors’ losses have been catastrophic--the Nasdaq index is down 60% from its 2000 peak--but Stack says that reality also offers hope that the market overall has seen its worst. He believes most major stock indexes reached their bear-market lows in September, though he says he isn’t sure that’s true of the technology-dominated Nasdaq.

Stack has been warming to the market for much of the last nine months. In March he declared that the economy already was in recession, taking his cue from the collapse of consumer confidence and from the plunge in the manufacturing sector.

But that was the good news, he told investors, because recession headlines in the media would help precipitate a final washout of stock prices, paving the way for a new bull market.

(Understandably, Stack was delighted when the National Bureau of Economic Research, the official arbiter of recessions and expansions, announced in late November that a recession was in fact in process, and that it began in March.)

Stack’s growing confidence in the market also may stem from his past successes in calling critical turns. He largely exited stocks just before the October 1987 market crash. And he turned positive ahead of the market’s rally early in 1991.

Still, he was far too early in bailing out on the 1990s bull market. He turned bearish in 1993, and was warning of collapse by 1996. Investors who sat out 1996-1999 would have left a lot of money on the table. Even with the bear market’s losses, the total return on the S&P; 500 index from Dec. 31, 1996, to now amounts to 10.7% a year. It was better to be getting in than out in 1996 and 1997.

But that was then, and this is now. Based on the fundamental and technical indicators he tracks, Stack says, the case for a new bull market is very strong as investors anticipate an economic recovery in 2002.

He notes that some analysts point to a lack of “doom-and-gloom pessimism” in surveys of investor confidence. At the start of a bull market, doubt about stocks should be high--far higher than it is today, the argument goes. Where there is doubt, there is money on the sidelines that eventually may be lured into the market, driving prices higher.

Stack admits that he, too, is bothered by many investors’ seemingly high confidence in the market. But he offers an interesting explanation.

“Rather than call it confidence, we’d prefer the label of ‘complacency’--and we might even be a tad off-target there,” he says. “It might best be called ‘resignation,’ as discouraged investors accept the fact that their bubble has popped and the U.S. is in recession.”

But what follows recession is recovery. And when investors expect an economic recovery they naturally look to the stock market, Stack and other bulls note.

None of these arguments gives much comfort to Richard Bernstein, however. He is the newly named chief U.S. investment strategist for brokerage giant Merrill Lynch & Co., and he is more than a little worried about what he sees in the stock market today.

Bernstein, who for years has been Merrill’s chief market number-cruncher as head of “quantitative” strategy, now is charged with making broad market calls for the firm’s millions of institutional and individual-investor clients.

He is advising investors to be very cautious. His recommended asset allocation is 60% stocks, 20% bonds and 20% cash. For a brokerage strategist, a 60% stock weighting is a minimal bet.

Bernstein considers the market to be “highly speculative” in the wake of the rally since Sept. 21.

Investors have total belief in the ability of Federal Reserve interest rate cuts (another of which is expected Tuesday) and higher federal spending to fix what’s wrong with the economy, Bernstein says.

“Everyone is certain that the policies will be effective. That has set up expectations that are very high--and [stock] valuations for that matter--with not much room for error,” he argues.

A major concern of Bernstein’s is that credit risk in the economy--the potential for many more borrowers to go belly-up, a la Enron Corp.--is being “underestimated and unpriced,” in his words.

“You can now buy a big-screen TV for no money down, no payment until January 2003, and 0% financing on those payments,” Bernstein says. “Guess what? They’re selling TVs like crazy. Of course they are! If you underprice credit risk, things look great.

“However, what the analysts aren’t paying attention to is the accounts-receivable buildup for these companies. The companies’ sales and earnings will look great, but the risk profile of the companies is changing significantly” because they have extended more credit in an economy that is already highly leveraged, he says.

The bottom line for Bernstein is that the stock market is ahead of itself. “I think this is another false rally like those of January and April,” he says. “If one jumps on board this train, they are jumping on board a rather speculative one.”

For his part, Stack agrees with Bernstein that high price-to-earnings ratios on many stocks are a significant risk. “No one can argue that stocks, in general, are on the bargain counter,” he says.

But that isn’t enough for him to simply deny the possibility that the market is in a sustained mode of recovery after the worst losses in 30 years, he says. For now, he argues, the weight of the evidence supports his position of “conservatively, cautiously, watchfully bullish.”

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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to www.latimes.com/petruno