Bull!

by Maggie Mahar

  With that in mind, in 2002 Buffett had waded into the foreign currency market for the first time in his life, hedging against the dollar’s decline. In 2003, he reported that he had enlarged his position as he “grew increasingly bearish on the dollar.”25

  Buffett was not alone. Chairman Greenspan’s critics argued that by flooding the world with dollars the Fed had been trying, quite literally, to “paper over” a financial crisis, and in the process had only postponed what Jim Grant called the stock market’s inevitable “rendezvous with fair value.”26 The artificial stimulus of easy money might keep the economy going through 2004, they acknowledged. But, below the surface, risk built.

  Gazing at Washington’s twin deficits, Peter Bernstein did not try to conceal his alarm: “Of one thing we are certain: current trends are not sustainable,” he told his clients. “The imbalances are now enormous, far more glaring than at any point in the past…. A hitch here or a tuck there has little chance of success. When it hits, and whichever sector takes the first blows, the restoration of balance will be a compelling force roaring through the entire economy—globally in all likelihood. The breeze will not be gentle. Hurricane may be the more appropriate metaphor.”27

  GMO’s Jeremy Grantham shared his fears. Nevertheless, at the beginning of 2004, Grantham advised his clients that the market might well remain “relatively stable” for another twelve months. It was, after all, an election year: “The lesson learned from 2003 is very clear,” Grantham observed, “never, ever underestimate the desire of an administration to be reelected, or the substantial cooperation that the Fed will typically provide [emphasis his].” Looking ahead, however, Grantham believed “potentially dangerous levels of debt” would ultimately catch up with an overpriced market, leading the United States into “a financial black hole.” His warning was blunt: “The outlook for 2005 and 2006 looks about as bad as it could get.”28

  The odds of financial catastrophe over the next two years might be low, but the sheer magnitude of the risk remained far too great to ignore. For this reason seasoned investors, including Dudack, Bernstein, Grantham, Leuthold, Russell, Jim Grant, Bill Gross, and Marc Faber, continued to emphasize alternative investments: commodities, oil, natural gas, foreign currencies, and emerging markets topped many lists. Some recommended gold as protection against a falling dollar. Others bought commodities as a hedge against inflation: “We now have about 10 percent of our equity portfolio invested in oil, and 15 percent in industrial metals,” Steve Leuthold reported in April of 2004. “Over the next five years, global demand will outstrip the means of production in these sectors, and so we’re betting on inflation.”29

  Logically, TIPS should offer the best buffer against inflation—and in the spring of 2003, they had seemed a safe haven. A year later, however, TIPS were losing favor with investors such as Steve Leuthold and Jim Grant. “TIPS are a trap because the government has been keeping the consumer price index artificially low,” Leuthold warned.30 “Of course the government has an interest in keeping the CPI [consumer price index] as low as possible: the higher the CPI, the higher the cost-of-living adjustments for programs like Social Security,” he added. “But, the CPI is also used to calculate the extra dividends that TIPS investors receive if inflation rises. If the CPI continues to understate inflation, investors won’t receive the full protection that they’ve been promised.”31

  Meanwhile, global cycles continued to turn, offering new opportunities in other parts of the world. By the end of the first quarter of 2004, some had begun to suggest that the bear that had been haunting Japan for more than a decade was, at long last, ready to retire. “Bearish sentiment about [Japan’s] economy and equities…reached an extreme last June,” Marc Faber observed. Looking back, he believed that Japanese shares had finally scraped bottom in the summer of 2003.32

  As for the United States, in the summer of 2004, many investors sensed that much hinged on the upcoming presidential election. They knew that whoever took office in January of 2005 would face enormous economic problems: a half-trillion-dollar budget deficit, a trade deficit approaching another half trillion, plus roughly a trillion dollars in consumer debt. At the time, just one thing was certain: if Washington’s policy makers wanted to avoid pushing the nation into a “financial black hole,” they would have to stop digging.

  NOTES

  PROLOGUE

  1. The story that follows is based on interviews with the author. All interviews with Blodget were completed early in 2002, and all quotations are from the interviews unless otherwise noted.

  2. David Rynecki, “Internet Stock Analyst Takes Unorthodox Approach,” USA Today, 10 May 1999, 4B; Brenda L. Moore, “Some Savvy Pros Had an Early Line on This Year’s Biggest Winners,” The Wall Street Journal, 23 December 1998, CA2.

  3. Goldman’s stock had risen 53 percent since the firm went public in May, Morgan’s was up 85 percent for the year. The Times made it clear that the reason for hiring Blodget was to try to boost Merrill’s investment banking business: “As much as one-quarter of the revenue generated by investment banking departments these days comes from advising technology companies on mergers and public stock offerings,” the Times observed. “So why has Merrill largely missed out on technology bankers’ big bull market?…Merrill’s total of $2.2 billion in technology underwriting this year, as calculated by Thomson, gave the firm…only about half the market share of more influential rivals like Morgan Stanley, Credit Suisse First Boston and Goldman Sachs…. Investors in Goldman and Morgan have been handsomely rewarded this year, in part, because of their prowess in the technology sector.

  “‘It is not clear to me that they are going to make strides quickly enough,’ Steven Galbraith, an analyst at Sanford C. Bernstein & Company, said of Merrill…. ‘What is more, Merrill has not been a believer in the star system,’ Mr. Galbraith said. Having a name-brand stock picker, like Mary Meeker, the celebrated Morgan Stanley analyst who helped put that Internet practice on the map, is essential, he argues. On that count, though, Merrill may now be trying to cultivate a rising star. In February, it hired a 33-year-old CIBC Oppenheimer analyst, Henry Blodget, who went way out on a limb last year by predicting that Amazon.com would hit $400 a share…. Hiring Mr. Blod get,…is simply one indication of the way Merrill Lynch has expanded its technology research effort, said Steve Milunovich, the firm’s global team coordinator for technology research.” Laura M. Holson, “Market Place; Technology Bankers Work to Give Merrill a Silicon Shine,” The New York Times, 27 December 1999.

  4. David Barboza, “Market Place; Anything.com Likely to Be Hottest Issue in Class of ’99,” The New York Times, 18 January 1999.

  5. The original e-mail from the disgusted broker was sent by Martin C. Brown (Grand Rapids) on November 30, 2000, and was addressed to Andrew Melnick, one of the analysts’ supervisors. It was headlined “Enough Already.” Melnick passed it on to Blodget, urging analysts to use the next rally as an opportunity to downgrade technology stocks. Blodget then sent the e-mail to colleagues in research on December 1, 2000. Blodget sent the message regarding Infospace on October 20, 2000. Blodget received the query on GoTo.com from John D. Faig at Aexp.com.

  6. In March of 1999, Crain’s New York Business noted, “Blodget is not as unabashedly bullish as some might think. True, he is a big believer in the Internet’s business potential, and at CIBC maintained ‘buy’ ratings on most of the firms he followed. However, his observations on the rise in Internet stocks are peppered with descriptives such as ‘bubble,’ ‘euphoria’ and ‘tulip bulbs’—language usually associated with Internet skeptics.” Jon Birger, “New Executive: Henry Blodget, Merrill Lynch’s Top Pick: Internet Analyst Lured from CIBC, On-Target Research Should Attract IPO’s,” Crain’s New York Business, 22 March 1999, 11.

  7. Spitzer’s remark to USA Today (“Merrill Analyst Pitched Stock He Called ‘Junk,’ Spitzer Says”) on April 15, 2002, was quoted in the class action complaint of Jon M. Rosenbaum v. Merrill Lynch & Co., Henry Blodget.

>   8. See Chapter 20 (“Winners, Losers, and Scapegoats [2000–03]”).

  9. John Kenneth Galbraith, A Short History of Financial Euphoria (New York: Whittle Books, in association with Penguin Books, 1990), 17, 22–23.

  CHAPTER 1

  1. William G. Shepherd, “The Size of the Bear,” Business Week, 3 August 1974; William Gordon, “Poppa Bear Market,” Barron’s, 26 August 1974.

  2. Despite his reservations about valuations, Russell acknowledged that the bull dominated the market throughout much of the late nineties. But in August of 1998, he began to warn readers that they were in the first phase of a bear market. (See Richard Russell’s Dow Theory Letter, 4 August 1998, and 26 August 1998). By October of 1999, his advice to readers was unequivocal: “Get OUT of stocks and get into T-bills or T-notes or the highest-rated munis bonds” ( Richard Russell’s Dow Theory Letter, 6 October 1999). See Chapter 18 (“The Last Bear Is Gored”).

  3. Russell quotes Dow in Richard Russell’s Dow Theory Letter, 8 August 2001, 3.

  4. Interview by the author. For Dudack’s chart of the market’s cycles, see page xix. Returns are calculated on a calendar year basis (January 1 through December 31) as of the beginning of 1882, the first full cycle for which total return data is available. Dudack cites Global Financial Data as the source for total returns on the S&P 500. Global Financial also provided data for inflation adjustment, which is based on the Bureau of Labor Statistics Consumer Price Index (CPI), dating back to 1913 (the first year for which the CPI is available), and an index used by the Federal Reserve to show changes in prices of consumer goods prior to 1913. As Dudack’s table shows, in the past dividends have played a critical role, buffering investors’ losses during the weak cycles and boosting their returns during the strong cycles.

  5. James Grant, The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New York: Times Books, 1996), 216–17.

  6. For an extended discussion of economic and psychological factors driving financial cycles, as well as cycle theories, see Marc Faber, Tomorrow’s Gold, Asia’s Age of Discovery (Hong Kong: CLSA Books, 2002), chapters 6 and 7. Also, see Chapter 21 (“Looking Ahead, What Financial Cycles Mean for the 21st-Century Investor”) for information on the complementary economic and psychological factors that drove the bull market of the nineties to an unhappy end.

  7. By the 1990s, “market timing” was out of fashion—most investors had forgotten about long-term cycles and thought that market timing meant trying to predict six-month moves. But Mark Hulbert, editor of the Hulbert Financial Digest—a financial newsletter that tracks the performance of other financial newsletters—points out that over long periods of time investors who have followed Dow Theory have beaten a buy-and-hold strategy. A columnist for Forbes and, later, for The New York Times, Hulbert has written about Russell’s success in his columns. (See, for example, “The Dow Theory Still Lives,” Forbes, 6 April 1998, 153.)

  In an interview with the author, Hulbert updated his report on Russell’s progress: “A reader who followed Russell’s ‘buy’ and ‘sell’ signals from June 1980 to December 31, 2001, would have earned 11.9 percent a year. We measure Russell’s returns by keeping his subscriber in an index fund throughout those periods when Russell’s theory signals buy or hold, then putting him into T bills when Russell’s Dow Theory sends a ‘sell’ signal,” Hulbert explained, “and that’s how we arrive at an average return of 11.9 percent.”

  On paper, a theoretical investor who bought and held the S&P 500 throughout that period would have done even better—earning 14.1 percent annually—though very, very few investors actually got into the market of June 1980 and held, without wavering, over the next 21 years. Moreover, the success of the buy-and-hold strategy depended on making a correct guess as to how long the bull market would continue. “Russell’s market timing lagged behind a buy-and-hold system over 18 years of those 21 years largely because, in 16 of those years, a bull market insured that a buy-and-hold philosophy would trump any other strategy,” Hulbert explained. “But at the time, no one could be certain how long the bull market would continue. Making one big bet that this would prove to be the longest-running bull market in U.S. history was 42 percent riskier than Russell’s strategy of trying to buy when the market was low, and sell when it was high. This is why,” Hulbert explained, “after adjusting for the risk involved in betting on the market’s long-term direction, Russell’s less risky advice actually beat a buy-and-hold strategy, on a risk-adjusted basis.”

  8. Russell recalled the response in an interview with the author. All further quotations are from interviews unless otherwise noted.

  9. Ken Smilen, interview with the author. See Maggie Mahar, “The Case of the Vanishing Investor,” Barron’s, 10 October 1988.

  10. Andrew Tobias, foreword to Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay (New York: Three Rivers Press, 1980), xi.

  11. Acampora as quoted in Lauren Rublin, “Yes, the Dow Had an Impressive Quarter, but What’s This Talk of Dow 7000?” Barron’s, 3 July 1995, MW3.

  12. Ralph Acampora, interview with author.

  13. Bethany McLean, “A Vision of Dow 18,500: This Guru Gives New Meaning to the Word Bullish,” Fortune, August 1997.

  14. Acampora reported Bartiromo’s remark to the author in a September 2001 interview. See also Mark Yos, “Ralph Acampora: The Reluctant Guru,” Dow Jones News Service, 14 September 1998, for a reference to the media calling Acampora Wall Street’s king, and Abby Cohen its queen.

  15. Ralph Acampora, interview with the author.

  16. Acampora recalled the conversation that follows as well as the events of August 4 and 5 in an interview with the author.

  17. On Prudential’s position in the investment banking business, see Brian O’Keefe, “How Do You Restore Integrity to Wall Street Research—and Make Money Too? Prudential Has an Answer,” Fortune, 11 June 2001, 195: “For years, the Rock had tried to break into the upper tier of investment banking, with little to show for it…. With the new strategy Strangfield hoped to land more individual investors, and generate a larger share of trading commission from investors grateful for unbiased research.”

  18. Acampora reported that Prudential sent a bodyguard with him when he made his next public appearance. The Post headline ran on August 5, 1998. For the Barron’s reference to Acampora’s nickname, see Jonathan R. Laing, “High Anxiety: As Market Gurus Debate, Investors Watch Nervously after Last Week’s Slide,” Barron’s, 10 August 1998, 17.

  19. CNN, Street Sweep, 4 August 1998.

  20. While many investors would believe that the bull market did not reach its climax until the spring of 2000, the summer of ’98 marked a major turning point. Both the S&P 500 and the Dow continued to advance following the 1998 meltdown, but only a small group of stocks were carrying the market forward. When they cracked, the indices collapsed.

  There is an argument to be made that the summer of 1998 was not only a turning point but an optimal time for an investor to cut his losses by selling stocks and buying bonds. See Chapter 16 (“Fully Deluded Earnings”).

  21. Ralph Acampora, interview with author, fall of 2001.

  22. John Kenneth Galbraith, A Short History of Financial Euphoria (New York: Whittle Books, in association with Penguin Books, 1990), 87.

  23. Galbraith, Financial Euphoria, 7. In the same context, Galbraith told the story of Roger Babson, an economist who predicted the 1929 crash only to be roundly denounced by everyone from Barron’s to the New York Stock Exchange.

  24. Wien told the story that follows in an interview with the author.

  25. James Grant, The Trouble with Prosperity, 250; James Grant, “The Downside of an Upturn,” The New York Times, 9 October 1996.

  26. James Grant, The Trouble with Prosperity, xi, 246.

  27. Treasury Secretary O’Neill made the statement on Fox News. His remark was quoted in Jeanne Cummings et al., “Enron Lessons: Big Political Giving Wins Firms a
Hearing,” The Wall Street Journal, 15 January 2002.

  28. Gail Dudack, interview with the author.

  29. Tom Petruno, “Review & Outlook: Mutual Funds: After 3 Years of Losses, Stock Funds’ Biggest Challenge May Lie Ahead,” The Los Angeles Times, 6 January 2003, C-1.

  CHAPTER 2

  1. Investment Company Institute and Securities Industry Association, “Equity Ownership in America,” fall 1999, 14.