An Unabashed Bear, and Betting on It

By RUSS WILES

Dec. 8, 1998 12 AM PT

Russ Wiles is a mutual funds columnist for the Times

It doesn’t take long to realize that David Tice sees a pretty awful future for the stock market.

The first clue is the name of his nearly 3-year-old mutual fund: Prudent Bear. Then, if you check out his firm’s Web site, https://www.prudentbear.com, you’ll discover that Tice describes himself as “the big bear.” He even wangled a highly appropriate ticker symbol for the fund: BEARX.

Tice is a member of a decided minority in investment circles today: He believes U.S. stocks will head south in dramatic fashion in the foreseeable future.

What about the pullback of late summer and early fall, which saw blue-chip stock indexes fall nearly 20%, before rebounding recently? It helped Tice look good. Prudent Bear was the best-performing equity mutual fund in the third quarter, rising 22% at a time when most funds fell. That performance was thanks to Tice’s “short” positions, which are bets that individual stocks will decline in price.

But Tice, 44, believes there’s much worse to come for the market, which he says is a speculative “bubble” that will burst.

Tice was born in Iowa City, Iowa, and grew up in Independence, Mo. He first learned about the stock market at Texas Christian University while participating in the management of a student-run portfolio. His first jobs were as an internal auditor and an acquisitions evaluator.

Near the end of 1987, he founded David W. Tice & Associates, which now counts eight investment professionals. The Dallas-based firm has two lines of business: the Prudent Bear Fund and providing short-selling investment research to professional money managers.

Tice was interviewed by Russ Wiles, a mutual funds columnist for The Times.

Times: You’ve been bearish on the market overall for quite a long time. But don’t you think the dramatic drop during the summer and fall counts for anything, in terms of releasing speculative pressure and bringing stock valuations more into line?

Tice: No. It was really nothing. Investors recouped their losses in three months. That’s certainly not painful. We believe strongly that people ought to be concerned about this market. There has been such a mania. It has become mainstream for people to assume that the market will keep going up.

Because the market has been rising at a compounded annual rate of 19% over the past 16 years, investors think they should stay in it. But whenever you have a mania like this, it’s always followed by a secular bear market. It’s really like stretching a rubber band. The further you stretch it in one direction, the further it will eventually snap back in the other direction. We’re not talking about a short-term bear market but one that could require as many as 20 years to recoup your initial investment on an inflation-adjusted basis.

Times: You’re predicting a 40% to 50% decline in the major market indexes from here--the worst since 1973-74?

Tice: Yes.

Times: By when?

Tice: The timing is difficult to say because this is a bubble. It’s difficult to determine by just how much investors will blow up the bubble.

Unfortunately, the bigger the bubble gets, the greater will be the eventual burst. [Federal Reserve Chairman Alan] Greenspan is essentially prolonging the process by cutting interest rates in an effort to save the global economy. That seemed like the smart thing to do, but unfortunately it has caused even more recklessness and greed to enter the picture. And that will cause even greater pain because it will simply prolong the decline.

Times: What’s the basic premise behind the Prudent Bear fund?

Tice: We didn’t set up the fund to be negative perennially, but we do believe we’re in the midst of a mania. Alan Greenspan even called it a bubble back when the Dow Jones industrial average was at 6,500 [two years ago], so we have company.

We think it makes sense over the long term to be more short than long in today’s market. We think there will be times to be long again, and we’ll adjust. But we aim to be more short than long when the average dividend yield on the stocks in the Standard & Poor’s 500 is below 3%.

That sounds ridiculous today, because the dividend yield is under 1.5%. Obviously, we’ve been early [being bearish], and the dividend yield doesn’t necessarily work well at the end of bubbles like this. But the indicator provides a basis for us to tell people why we will be investing negatively, with more short positions than long. We’re highly confident that the S&P; dividend yield will return to a level greater than 3% in the future.

Times: But federal tax rates encourage investors to prefer capital gains over dividends, and corporations have incentives to use cash for investments or to buy back shares rather than to increase dividend payouts. Aren’t dividend yields less important than they had been?

Tice: No. That’s merely a justification people make. It was the same justification used in the 1920s. Although we may think about people from the 1920s as being fuddy-duddies, they were exactly the same as we are today--they were buying hot growth stocks without worrying about dividends. People were quitting their jobs, going out and trading the market. It’s very similar to today. At the end of manias, people don’t care what stocks yield because the capital gains are so great. But eventually the pendulum will swing back and dividends will mean something again.

Times: What about other classic measures of stock market valuation, such as price-to-book-value or price-to-earnings ratios?

Tice: We’re [at records] . . . anywhere from 50% to 100% above the second-highest levels ever in terms of all of those measures.

We focus on dividend yields because price-to-earnings ratios, for example, don’t let you see how ridiculously the market is valued. At the end of booms, corporate earnings are very strong. Some people might look at a market selling at a 22 P/E multiple, assume it should be selling at, say, 17, and count on earnings that will keep growing next year. So they conclude the market isn’t that overvalued.

But corporate managements realize their earnings are at the high end of the cycle, so they don’t raise dividends to keep up with earnings. That’s why we use dividend yields rather than the P/E ratio.

Times: You said you aren’t a permanent bear. What would it take for you to become more optimistic about stocks’ outlook?

Tice: It would take a 40% to 50% decline in the market. We think we’re in a bubble, and, frankly, the bubble has gotten so big that there’s virtually no way that we can let the air out slowly. . . .

Corporate earnings are heading lower--we’re quite confident of that. Therefore, P/E ratios on 1999 earnings are even higher than they are on 1998 earnings. We think economic conditions are awful around the world, and we see them continuing to deteriorate.

Times: What’s the Prudent Bear fund’s current asset allocation?

Tice: Currently, we have about 75% of our assets in short sales, 12% in long positions, 2% in index puts. [A stock index put, similar to a short sale, is a bet on a falling market.]

Times: What are some traits that make a stock a good short-sale candidate?

Tice: We look for stocks that are wildly overvalued and companies that are likely to produce results that will disappoint investors in the future. We focus on expectations and what a company is likely to deliver.

There are also some tactical measures that we use to control risk. For example, we wouldn’t have wanted to short Amazon.com [ticker symbol: AMZN, $191 on Monday on Nasdaq] back when it was at $50 a share because we would have been run over. Even though Amazon.com was among our top five [shorts] as of Sept. 30, we traded out of it. We happen to be in it today [as a short], but we might not be tomorrow.

Times: What’s a current example of a stock that exemplifies what you’re looking for as a short-sale candidate?

Tice: Applied Materials [AMAT, $44.25, Nasdaq] is one. This is a semiconductor equipment maker. Its . . . [earnings] are dramatically below where they were last year, yet there’s an expectation that conditions are turning favorable for semiconductors. We don’t believe that’s the case. . . .

Another example is MBNA Corp. [KRB, $23.44, NYSE]. We think U.S. consumers have been beneficiaries--or victims--of a credit bubble. There has been an extreme amount of credit created by various institutions such as MBNA [a major credit card issuer] that have sold securities, allowing them to grow very quickly and provide too much credit to individuals.

This growth rate won’t continue because consumers eventually will be strapped by the downturn in the economy. We believe the home equity boom that we’ve had, in which companies have been lending 125% of home values, is going to end up as a disaster for the country. Right now, all of this leverage is allowing consumers to throw a big party while the economy has boomed. But when the music stops, a lot of people will be stuck with way too much debt. Then they’ll quit going to the movies as often, they’ll eat out at restaurants less, they’ll take fewer fancy vacations, and the economy will slow.

The economy has benefited from a favorable upward spiral, with jobs being created and new credit being made available. Even people who are being laid off at Boeing, for example, could use a credit card to start a business. When the economy slows down, some of these businesses that have been financed by credit cards are going to be in trouble.

Times: Jumping to the other side of the fence, what’s an example of a stock that you currently own--one of your long positions?

Tice: Opta Food Ingredients [OPTS, $4.38, Nasdaq]. It’s a small company that trades at only about 1.1 times book value. This company makes products that are used to improve the nutritional content, texture and even taste of foods. It has contracts with fast-food companies and doubled sales in the past quarter. The company isn’t profitable yet, but we expect it to be.

Times: Why don’t you make more use of stock index put contracts, such as on the S&P; 500, rather than research individual stocks?

Tice: We already have the research organization for short sales in place. One of the key advantages we have is our research expertise and ability to find stocks that will do better or worse than the market.

Times: Your fund’s 3% expense ratio is high.

Tice: We charge a higher-than-normal management fee because we think there are few investment managers like us with short-selling expertise who are willing to run a fund like ours.

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Prudent Bear Fund

Strategy: Seeks capital appreciation through “short” positions (bets on declining stock prices) or conventional investment in promising stocks. The fund has primarily been short--a losing proposition in a rising market.

VITAL STATISTICS

Total return, 12 months through Dec. 4

Prudent Bear--25.4%

S&P; 500 stock index+22.8

Dow Jones industrial average+14.0

Two-year annualized return, through Dec. 4

Prudent Bear:--15.7%

S&P; 500 index: +28.3

Dow industrials: +21.1

Five biggest positions as of Sept. 30, all short:

1. Centocor

2. RealNetworks