It's comforting, I suppose, to imagine that harsh experience is always an effective teacher. If so, then the bear market, which in the past two years has lopped 25% from the Standard & Poor's 500-stock index and no less than 64% from the Nasdaq Composite Index, should be awarding investors PhDs in Lossology. Yet precisely what has this bear market taught? The other day, someone asked me for my thoughts on that, and through some innately hopeful reflex I set out to enumerate the lessons: 1) Diversify. 2) Understand the risks in your portfolio. 3) Don't get greedy. 4) Never, ever invest on a hot tip. But all the while, one annoying thought kept creeping up on me: We knew all of this already.
| Robert Barker
Or we should have. Even those too young to recall the last truly vicious bear market--the Nixon-OPEC collapse of 1973-74, a 48% plunge--had every chance to get smart. Back in December, 1996, when Federal Reserve Chairman Alan Greenspan mused about "irrational exuberance," he flashed a yellow light. He was early, but he was right. Three years later, an analyst's loony forecast sent shares in Qualcomm Inc. (QCOM
) flying to 185 from 89 in 21 trading days. Common sense was all anyone needed to see the truth: The market in many leading stocks had come unhinged. Qualcomm now trades near 43.
Lessons of the bear market? To me, it's more honest to see them as mistakes that anyone could have avoided. Many people did, putting their money in such stodgy mutual funds as Dodge & Cox Stock Fund. While fools chased Qualcomm, Amazon.com (AMZN
), and Cisco Systems (CSCO
), Dodge & Cox's investment committee felt compelled by the much more certain investment calculus offered by shares in Whirlpool (WHR
), Deere (DE
), and Phillips Petroleum (P
). By focusing on unloved stocks, the fund has beaten the market over the past 1, 3, 5, 10, 15 and 20 years--always at below-market risk. Not every dowdy stock pays off. Dodge & Cox also owned Kmart Corp. (KM
) But buy a glamour stock, and prepare to pay for it long after the glamour is gone.
That is no secret. None of the Qualcomms, nor the shenanigans by shameless insiders at Enron Corp., nor even one bit of the human frailty behind the bear market would have surprised Jesse Livermore. He is best known as the street-smart trader profiled in Reminiscences of a Stock Operator, the 1923 investment classic that was republished in 1994. Livermore knew well--and freely shared--what has only dawned recently on legions of today's investors. "The public always wants to be told," the book says. "But while the insider might tell the big plunger the right time to buy, you can bet he will never tell when is the time to sell." After many years of experience, and several fortunes won and lost, Livermore concluded: "No man can consistently and continuously beat the stock market."
Livermore assiduously studied his blunders, a habit that the serious investors among us today also are cultivating. One of them is Xiaolin Wu, a 44-year-old native of China who immigrated to Canada in 1984, lives in New Jersey, and works as a consultant and computer-science professor at Polytechnic University in Brooklyn, N.Y.
Wu is much chagrined. First, he lost big betting on Asian stock funds in 1997, right before the region's economic meltdown. More recently, after downdrafts in such stocks as Enron, he plunged in, figuring he was grabbing shares in solid companies at bargain prices. Another bundle gone. Wu is galled by the deceitful accounting, but mostly he just feels humiliated for getting suckered. "It's hard to be objective," he said. "When everyone talks about a V-shaped recovery, you want to believe" stocks will rebound.
Livermore would have advised Wu instead to expect more trouble. Unhappily, that's a lesson many of us have had to swallow from harsh experience. "Once you are humbled," Wu told me, "the next time you will believe in the worst case."
APRIL 2, 2002