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A Moneychanger
Interview: DAVID W. TICE:
The Worst Bear Market in 100 Years
David W. Tice presides
over David W. Tice & Associates, Inc., an investment research and
management firm in Dallas, Texas. With sixteen years’ experience in
the investment business, Mr. Tice is both a Chartered Financial
Analyst (CFA) and a Certified Public Accountant (CPA).
His firm publishes
investment research “sell” recommendations to more than 200 money
managers who collectively manage more than $2 trillion. Searching for
overvalued common stocks, David W. Tice & Associates’ eleven full-time
analysts serve as a “truth squad” to keep Wall Street honest. The
firm’s work has gained national recognition through several Barron’s
articles as well as Mr. Tice’s appearances on CNBC and Wall Street
Week with Louis Rukeyser. Most recently, the firm’s research moved
Mr. Tice to warn investors about Tyco International last October.
In January, 1996 Mr.
Tice started the Prudent Bear mutual fund to give investors an
alternative to the more than 5,000 equity mutual funds already in the
marketplace. The Prudent Bear Fund was designed with enough
flexibility to make short sales and to be “net short” the market when
the advisor believes it is prudent. Flying in the face of Wall
Street’s entrenched interest groups and big business, Mr. Tice has
chosen to warn individual investors about what he feels certain will
be the worst bear market in the last one hundred years.
After receiving his BBA
in accounting from Texas Christian University (TCU) in 1976 and an MBA
in Finance in 1977, Mr. Tice worked with Atlantic Richfield Company as
an internal auditor for four years. He spent another four years with
ENSERCH Corporation evaluating acquisitions and corporate finance
options and manager of Corporate Budgeting. He also served Concorde
Financial Corporation for four years as Director of Investments and
was responsible for starting a mutual fund. Mr. Tice very kindly made
time for this interview on April 7, 2000.
You can visit the
Prudent Bear web site at
http://www.PrudentBear.com,
or call at (888) PRU-BEAR (778-2327).
MONEYCHANGER
What does the Prudent Bear Fund aim to do?
TICE
To make money in a market decline and to hedge
investors in what we believe will be the biggest bear market in 100
years. We set up the fund to be more short than long, but not
perennially short. After this secular bear market has passed, we
expect to switch back to long positions. Our rough guidelines say we
will be more short than long while the dividend yield on the S&P
remains below three percent.
MONEYCHANGER
Right now stands at about 1.2%
TICE
Something like that.
MONEYCHANGER
Why is it so hard for investors to understand
the concept of shorting? [“Shorting” means selling a stock
before you have bought it. Shorting reverses the usual sequence
of investment – buying first, waiting for a rise, and then selling
becomes selling first, waiting for a drop, and then buying.
Notice that the goal, selling at a price higher than you pay,
is the same. Only the sequence of events differs. – FS]
TICE
Well, it’s an unusual technique that most people
haven’t done before. Once it’s explained, they get it, but because
the sale takes place before the purchase, it’s hard to
understand.
MONEYCHANGER
Do you think that generally you can make more
money shorting than going long?
TICE
No, I don’t agree with that. You can make it
faster, but generally by going long you can increase your investment
five- to tenfold, where you can only double your money going short.
Generally going long is the right path, but shorting offers a great
tool at certain market junctures.
MONEYCHANGER
Don’t markets fall faster than they rise?
TICE
They do drop faster, but the multiple return from
going long generally exceeds in total what you will make going
short. When you face a bear market – I mean a massive bear
market – you can only make money one way, and that’s going short.
MONEYCHANGER
Why do you think we are facing the biggest bear
market in the last 100 years? That’s covering some big bear
territory: 1907, 1929, 1965…
TICE
This super bull market has created greater excesses
than in any super bull market in this century. Super bear
markets follow super bull markets. This super bull market is almost
double what prior super bull markets have been.
MONEYCHANGER
Double, measured by what standard?
TICE
In terms of overall performance over the past 104
years, just three super bull markets have generated all of the
return. One ran from 1921 to 1929, the second from 1948 to 1966, and
third from 1982 to the present. Looking at the other 58 years, and
not including dividends, you actually would have seen negative price
appreciation.
MONEYCHANGER
“Negative price appreciation” … Is that the
same thing as “losing money”?
TICE
Yes. That blows people away. They say, “Well, I
thought the market rises 9% a year on average.” Frankly, however,
when you link all those years together without the super bulls,
the return for 58 years ends up with a negative performance.
What does that mean? If
you invest in one of these super bull markets, you make a lot of
money, but you better invest in the early to middle stages of
those super bull markets. Had you climbed onto the tail end of those
super bull markets, like 1929 or 1966, you would have had to wait 24
and 27 years, respectively, to recoup your initial investment after
inflation.
MONEYCHANGER
What are the “excesses” of this bull market?
TICE
The excesses are the speculation, the leverage, and
allocating capital to businesses that do not make money. Michael
Balkin calls them C.R.A.P.: Companies without Revenue
And Profits.
Most of the excesses
involve debt. Since the end of 1990, the debt to equity ratio on the
S&P 500 has risen from about 85% to 115% today. Household debt used
to be 65% of personal disposable income. Today personal debt has
climbed to more than 100% of personal disposable income. Debt
has increased dramatically. You might even say “excessively.”
MONEYCHANGER
Doesn’t that imply increasing risk? I know
people don’t usually think that way nowadays, but…
TICE
That is exactly right. The bull market has been
premised on increasing debt. We’ve had a great party, but,
unfortunately, people are now swinging from the chandeliers. They’ve
drunk too much tequila and it was time to have gone home about four
hours ago. Unfortunately, they will have quite a hangover.
MONEYCHANGER
You mentioned speculation. How do you measure
that speculation? By margin debt?
TICE
Margin debt would be one…
MONEYCHANGER
Since last November it has grown from $185
billion to $265 billion.
TICE
It is up about 100% from 18 months ago.
MONEYCHANGER
Do these excesses point to a top in the market?
TICE
Yes.
MONEYCHANGER
What about the volatility of the past week?
What does that say?
TICE
Normally, periods of increased volatility mark
market peaks or troughs. We are far from a trough, so we must
be close to a peak. The Federal Reserve has raised interest rates
five times, and they are hinting or signalling that they will have to
raise rates even more. Credit demand stands at record levels because
this party must have higher and higher levels of private debt creation
to keep the lights on and the music playing. Therefore, the Fed needs
to slow down the economy, but that requires higher and higher interest
rates. Meanwhile, inflation is starting to pick up, the oil price has
tripled since February 1999 (even though it has backed off about $7.00
since then), and there are still a great deal of imbalances within the
system.
Just look around. People
are not acting rationally…They are investing in money-losing
companies. Venture capital is investing two-thirds to three-fourths
of their capital in internet companies without any reasonable
business plan or even a shot at making money. People are investing in
a Ponzi scheme, just hoping that a bigger fool will pay a higher price
so they can profit.
MONEYCHANGER
Speaking of Ponzi schemes, I read last night
that Initial Public Offerings (IPOs) from last year have risen 152%
from their initial offering price. Von Mises estimated that the
natural rate of economic growth was about three percent and yet people
expect to make 21 or 25% forever (according to the latest polls).
They’re just not realistic. Whenever market participants imagine they
are going to pull down 25% a year forever, at some point you have to
write them off as lunatics.
How does the Prudent Bear
Fund intend to take advantage of this downtrend in the market? Do you
intend to short individual stocks or indexes or both?
TICE
Both. We are set up to short individual stocks,
but we also short some indices. Sometimes that’s safer in today’s
market because of short squeezes and the irrational behaviour of
individual stocks. We do buy puts on the indices as well as the
individual stocks.
MONEYCHANGER
Today how would you advise individual investors
who are fully invested in the stock market? Would you tell them to
sell it all?
TICE
I would tell them to make their own decision, but I
would say, “Study history. Recognise that Wall Street has a
constituent interest group that wants to keep Main Street invested as
long as possible. Recognise this has been a phenomenal bull market,
but risk has been pushed higher than ever before. Finally, recognise
that it is highly probable this bull market is on its last legs, and
it might take up to two decades to recover their initial
investment.
MONEYCHANGER
The derivatives revolution since 1980, has been
sold as a development that reduces risk. The Bank for International
Settlements recently estimated that derivatives around the world
amount to $100 trillion. I understand that in stable
markets derivatives can reduce risk, but can they reduce risk in this
kind of market?
TICE
No, I disagree completely with Mr. Greenspan’s
comments about risk. Derivatives can reduce the risk for
individual players, but at the same time they increase systemic
risk. Don’t miss this point: Derivatives have actually increased
system-wide risk .
MONEYCHANGER
By system-wide risk, you mean that derivatives
create the possibility for a chain of falling dominoes?
TICE
Exactly. People who
are not willing to bear a risk can transfer it to somebody
else, but they can’t really mitigate or reduce system risk.
In fact, if derivatives seduce some people to perform more
recklessly because they think they have insurance, then they actually
increased systemic risk.
Imagine people building
homes in a flood plain of a river. One fellow might have built his
house on the river but couldn’t replace it if the river flooded. What
does he do? He buys insurance. Risk has not been reduced, because
somebody will have to pay for that house if the river overflows,
but our river-dweller has transferred his risk to someone
else.
Now what happens when
flood insurance becomes cheaper and more readily available? Easy –
one thousand people decide they are willing to buy homes on the
river because now they can afford flood insurance. Systemic
risk has increased, because so many more houses have been built on the
river than ever before.
MONEYCHANGER
Right, and systemic risk is what really worries
Greenspan.
TICE
Well, it should worry him.
MONEYCHANGER
In the past he has mentioned systemic risk very
specifically. In August of ’98 when the failure of Long Term Capital
Management threatened to bring down the whole system because of their
derivative exposure, Greenspan stepped in as maitre d’ for the
LTCM bailout plan. Systemic risk is something he understands.
On April 5, John Crudele
published an article in the New York Post about a very strange
event in the stock market. Just after 1:00 p.m. on Tuesday, April 4,
2000 both the Dow Jones Industrial Average and the Nasdaq were down
over 500 points. Some unknown buyer entered the market buying stock
index futures with both hands. That tempted arbitrageurs to buy the
underlying stocks that make up the index. Then a buying panic broke
out that took both indexes up to close down by only seventy points or
so. This is exactly the same manipulation method that was used to
resurrect the market in 1987. Obviously it was somebody with very deep
pockets. He speculated that it might be the government. Can the
government prevent a stock market crash?
TICE
We don’t believe that a government can prevent a
market crash forever. They can perpetuate an economic and stock
market bubble, but that will backfire. That will only make the
ultimate consequences more extreme. So if the government did
intervene (and I am not saying that it did), it could prevent a
decline for a while. In the long run, however, free markets will
overwhelm intervention.
MONEYCHANGER
Even the ability to manipulate. The numbers
they have to throw at the market become so enormous that they finally
have to throw in the towel.
What will gold look
like in this biggest bear market of the last 104 years?
TICE
I think gold will perform phenomenally well. The
dollar will probably end its reign as the world’s reserve currency and
gold will skyrocket. This bubble psychology has benefited the dollar
as investors have been willing to buy our Yahoo, and Amazon.com
stock. When the bubble bursts, they will be less likely to buy them.
The American economy has operated under fundamentals where foreigners
have been willing to trade their goods for our paper. When that
willingness disappears, gold will do very well.
MONEYCHANGER
In 1929 the Dow topped when it was worth about
16.75 ounces of gold. In 1932, the Dow bottomed when it was worth
about two ounces of gold. It rose to 28 ounces at the top in ’65,
then fell to one ounce at the peak of the gold frenzy in 1980.
In August the Dow measured
by gold topped at almost 45 ounces, its highest level in history. Do
you have any target for the bottom in the relationship between gold
and the DOW or gold and stocks?
TICE
It could easily be in the one ounce area.
MONEYCHANGER
You said you expect the biggest bear market in
history. How long do you expect it to last?
TICE
I think it will require more than 20 years to
recoup your initial investment. That doesn’t mean stocks will decline
for 20 years, but they probably will decline for three to seven
years, and then offer only modest returns for the next 13 to 17 years.
]
MONEYCHANGER
David, thanks very much for your time and
courtesy.
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