Updated: May 3, 2013 12:14PM
Originally published: July 11, 2002
Did anyone see this coming? By “this,” I mean not only the bear market, but the accounting scandals, the deception by corporate executives, and the disappearance of billions of dollars in shareholders’ equity?
Yes, indeed. Two longtime stock market experts waved red flags for the last five years. And they were ignored, ridiculed, and even threatened over their warnings of questionable accounting.
So, it’s appropriate to go back and acknowledge their foresight--as well as to ask them where they’d be investing now, and for the future.
Here’s a hint: They’re both still incredibly bearish.
Chuck Allmon has written the twice-monthly Growth Stock Outlook for 37 years--long before most people differentiated between “growth” and “value” stocks. For many years his newsletter was rated No. 1 by Hulbert’s Digest, the rating service that tracks the performance of newsletter recommendations. Even in the latest Hulbert report, which covers the last 20 years, the Growth Stock Outlook ranks No. 3 for risk-adjusted performance.
But about five years ago, Allmon told his subscribers that the market had become “overvalued” based on what he called “real earnings,” not the “pro forma” earnings that companies were reporting. It was an accounting distinction that went unnoticed by most stock market investors. As Allmon explained repeatedly: “Companies have been ‘fudging’ the numbers by not deducting expenses properly, especially when it comes to stock options.”
As the decade ended, Allmon’s list of recommended stocks contracted: only a real estate investment trust and a large gold- mining company, along with a few old-line companies. But most of his model portfolio was in short- to medium-term government securities. Subscribers defected. They wanted the hot technology stocks. Still, in every issue Allmon warned that not only tech stocks but other major companies would see huge losses in market valuation when people woke up the accounting legerdemain.
In mid-1999 Allmon forecast that the S&P 500, the Wilshire 5000 and the Dow Jones industrial average could fall 40 percent to 60 percent by 2001. The former two indices hit his forecast mark; the Dow, so far, is down 27 percent from its highs. And in February of 2000, Allmon forecast the NASDAQ (which he then noted he rarely follows) could drop 60 percent to 80 percent--another forecast that was right on the money.
Today, Allmon isn’t gloating. He says that at his age, 82, he just “takes it as it comes.” And what does he think is coming next? “More of the same,” he responds promptly, adding, “There’s something big out there we haven’t seen in 70 years, and I’m talking about trust. It’s gonna take a long time to get people to regain their trust in corporate America.”
In the meantime, what does he think long-term investors should be doing?
“There’s a dirty four-letter word spelled “c-a-s-h”--and nobody wanted it six or eight months ago. Now they’re changing their tune. I think long-term investors should be holding at least 75 percent in cash.”
And with the remaining 25 percent of their portfolio?
“All stocks don’t go up and down together so there are some buys. I have a few recommendations: Bristol Myers (yielding over 4 percent) and Philip Morris (a 5 percent yield). BMY has paid dividends since 1902, and at its very low debt-to-equity ratio (17 percent) the company is certainly not going to blow away. But overall, this stock market is still very expensive. So even 40l(k) investors should consider putting part of their contribution in the money market alternative.”
And will there be a signal to jump into the market again?
“When they lay off half the stockbrokers.”
There’s one other man who deserves some public credit for seeing this earnings debacle coming. He is David Tice, portfolio manager of The Prudent Bear Fund (www.PrudentBear.com) and perennial gadfly about the veracity of corporate earnings. [Disclosure: I’ve owned shares in this fund for several years.]
Tice was the analyst who first questioned Tyco’s corporate earnings, and his comments and reports helped provoke an SEC review on the subject, which subsequently gave Tyco what was perceived as a clean bill of health. That was back in 1999.
Tice was derided as a short-seller, but he refused to be intimidated. In September 1999 he hosted a conference in New York, entitled “The Credit Bubble and its Aftermath.” I attended that conference, which ranged far beyond accounting issues to a general concern about the overexpansion of credit to both individuals and corporations. And that was before Greenspan flooded the market with credit in anticipation of Y2K.
Do today’s market headlines hold any surprises for Tice?
“No. It’s coming out the way we had envisioned. Corporate accounting shouldn’t shock people. We created an environment of speculation and recklessness, where the most aggressive professionals were promoted--accountants, money managers, analysts and stock brokers. The incentives were to ‘go for it and get rich, baby.’ And as long as executives met their targets, investors continued to buy without caring how the numbers were produced. So this blowup is no surprise.”
What should investors do now?
“We’re only in the third inning of this bear market, and the most important thing to do is protect principal ... We were wrong being bearish early. But I’m confident that we’re still in the early stages of the biggest secular bear market in this century--because the excesses were so great. So I can’t in good conscience advise people to put their money stocks today.”
In remarkable agreement, these two bears advise holding a lot of cash, and avoiding most stocks. Both are shocking suggestions to a generation that has grown up believing that a bull market would guarantee a comfortable retirement. But can you afford to ignore these two Bears again?
Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail to firstname.lastname@example.org. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast.