Fear, Greed and the End of the Rainbow

Why is it that after making their own fortune on the stock market they write a book preaching gloom and doom to the rest of us! There are several of them out there; however, to Andy Sarlos’ credit he doesn’t appear to have the ulterior motive of wanting to sell us something beyond the cautionary advice contained in the price of this book. He warns that with stocks tracking skyward in a parabolic curve, sooner or later there has to be a bear market of massive dimensions.

Sarlos quotes a stock market rule of thumb that bear markets usually run about one-third of the preceding bull market, and follows this with the bad news rule of thumb that the greater the bull, the greater the subsequent bear. He suggests that the coming bear could wipe out as much as one-third to one-half of the Dow, bringing it down to between 3500 and 4700.

No specific time frame is given for the onset of the bear market, Sarlos is much too astute for that; however, he does sketch out various scenarios and circumstances that could trigger it at any time - also allowing for the totally unpredictable that is always a possibility.

Contrary to the assertions of those who claim that ‘This Time It’s Different,’ Sarlos cautions that there is nothing different about this bull market by comparison with previous bull markets. He details the arguments and reasoning of a number of the TTID people then proceeds to debunk them. In essence, he foresees a regression to the norm, and the norm is for much lower returns and price multiples than at the present euphoric levels.

“... to survive a big bear you must unlearn everything

you’ve learned during your investing career ...”

Apart from the 1987 market correction, this has been an exceptionally long bull market, consequently there are not too many professionals around who experienced the bear market of 1969 to 1974 when stocks dropped nearly 60%, therefore most people selling stocks, and mutual funds in particular, have little knowledge and even less experience with bears, for which a whole new set of skills is required.

Sarlos raises the spectre of a meltdown in mutual funds as the people who bought mutual funds at top prices in the last couple of years rush to cash in as prices decline, thereby triggering a vicious circle as fund managers dump stocks to meet the cash drain brought on by rising redemption rates.

So how do you hang on to what you’ve got and avoid getting clawed when the bear arrives? For one thing, sell too soon, Sarlos says. Heightened activity and price gyrations are typical of the bull’s final stages along with considerable sector rotation, therefore stay in the game by following the sector rotation but take profits without getting greedy or trying to second-guess the turning points.

“Don’t try to buy at the bottom and sell at the top.

This can’t be done - except by liars. (Baruch)”

Start to liquidate equity investments and shift into interest-bearing investments or specialty funds - and, yes, the returns are low for now. You cannot expect to make money in a bear market, the best you can hope for is to preserve capital, earn a modest return, and be ready for the next bull market.

“The first rule is not to lose your capital.

The second rule is not to forget the first rule. (Buffett)”

In the short term Sarlos says there will be opportunities to own stocks in certain industries that will not be affected by the bear, such as biotechnology breakthroughs, or telecommunications, if you can buy at a low price and reasonable multiple. He also bets on real estate for the future, because it is subject to a sixty-year rising cycle that is usually followed by a ten-year down cycle that should bottom in the next two to three years.

How will you know when the bear is losing his viciousness?
· When the dividend rate on the S&P 500 is around but preferably greater than 3.4% 
· When book value to stock price is in the 2.5 range, before inflation.
· When the S&P 500 P/E ratio is about 15.

Macro-style timing is what this book is about, which means one has to become sufficiently well informed so as to be positioned to take advantage of opportunities as they arise, and Sarlos was a living example of this.

Fear, Greed and the End of the Rainbow is not all gloom and doom, fortunately. What attracted me to it were the author’s common sense observations, his insights about the psychology of the stock market, his wide knowledge of economic conditions, and the generous sharing of his sources of information.

Altogether a timely reality check.

I. B.

Fear, Greed and the End of the Rainbow,
Andrew Sarlos with Patricia Best, Key Porter Books

   


Copyright 1998 - Ian Bullock. All rights reserved.

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