Spotlight:  July 20, 2001
Contrarian Paradox Turns Hopeful Bears into Duped Bulls
Or why it is hard to "buy low and sell high" when everyone else is doing the same
By Todd Alway & Brady Willett

People used to claim that market bears were overly pessimistic creatures too myopic and risk-averse to take advantage of the blossoming opportunities being created by advances in technology.  They don't claim this anymore.  The popular consensus now is that tech stocks were indeed in a bubble and that the bubble has finally burst. On the surface, then, it would seem that recent events have at least partially vindicated the caution of the stock naysayers.  Having learned of the damages that can be caused by irrational exuberance, so the common-sense opinion goes, it is a more mature investor who now engages in the buying and selling of equities.

However, surface appearances soon take on peculiar textures once one scratches beneath the surface.  To begin with, and to put it most bluntly, the stock market has seen the expiration of bullish effects only in tech, and not the demise of the bull market per se.  In terms of basic valuations, most Dow components are almost as highly priced today as they were at the so-called peak of the bubble.  Ironically, severe drops in the 'overvalued' tech sector have caused severe floods of capital into 'value' areas of the marketplace.  Thus, what little value there once was in isolated segments of the market has all but vanished.  The result of waning tech leadership has been a transformation from a market characterized by isolated areas of insanity (tech and blue chips) to one completely and entirely overvalued.  

The above example of sectoral capitulation is exactly why Bearish commentators are still bearish, while the new breed of "bearish" investor is really bullish.  Newly "alert" investors, who racked up gains in tech orientated mutual funds throughout the mid-1990s only to lose them in the recent downturn, cannot completely leave the market for fear of missing out on the next sectoral bull.  With that in mind, they scour the equity landscape looking for areas that were out of favor during the tech-crazy 1990s, and/or hope to find specific stocks that have seen spectacular drops in share price.  Conversely, the truly Bear-aware have seen attractive dividend yields in REITs and other areas slam lower, and tobacco/utility stocks moon-shot higher.  Needless to say, Bears do not see undervaluation in tech land just yet either. 

In effect, what the bear/bull conundrum boils down to is that one animal still has not reared its grim visage on the street.  The bear may have been spotted in far off tech land, but it has yet to sink its teeth into the fattened valuation levels of the market as a whole. Sharp sectoral movements suggest that there is still an ample amount of implicit bullish sentiment left to contend with.  In contrast to the 1990s, however, this sentiment is focused not on a handful of high-flyers, but on areas of the market thought to have 'bottomed'.  How often have you heard the popular proverbs 'tech is nearing a bottom' or 'blue chips have bottomed'?  Clearly the search for bullishness has become a search for bearishness –  the herd mentality of optimistic momentum that summed up the late 1990s investor has paradoxically become a herd mentality of contrarianism.

Unfortunately, as market participants lean towards contrarian initiatives (buying the most beaten down area of the market) they do not necessarily do so according to corporate fundamentals or astute contrarian perceptions.  Rather, what is fairing most poorly in the market (an example is chip stocks in April, 01) is purchased because aggressive price drops appear to have temporarily abated.  Stock prices become the sole ingredient for contrarian decision.

This change in investor directives has created an entirely different market, but perhaps still not an undervalued one.  The fact of the matter is that even though yesterday's bulls have become more price patient, they have not become more sophisticated.  These supposed 'new bears' are the same people who previously purchased tech stocks and claimed that 'bears were overly pessimistic creatures too frightened to invest in stocks'.  Now they hunt for bottoms while singing such mindless mantra's as 'stocks will (must) rebound by early 2002', 'ticker ABC is a good long-term buy because it has dropped 85%', and 'I am happy that I have learned a new word called diversification'. To be sure, an extremely bullish atmosphere still persists when the common investor is putting their faith on a chip stock turnaround while every conceivable datasheet points to further sectoral woes.