Bear markets, the experts say, are all about heartbreak and failure: failed rallies, failed declines, failed trends and worse, perhaps, a failure of confidence.

Even bears have trouble making money in bear markets because, if they've been around awhile, they fear the sharp advances that appear from nowhere. They forever find themselves covering their shorts -- or bets against stocks -- too quickly in weeks like this when a comet auguring good news flashes across the sky. If bull markets are all about euphoria and invincibility, then bear markets are about paranoia and vulnerability.

One of the surprises of the past few months is that there are so few tales of fortunes being made on the short side during the

Nasdaq Composite's

35% decline from its high in mid-March. (And by the way, despite my bullish outlook for the full year, a decline of such swiftness and size in a major index has to be defined as the start of a bear period of some duration.) As a columnist who has run a

public portfolio that's flat for the year after being up as much as 42%, I've held out hope that there was someone else out there whose brilliant moves could be memorialized, quantified and turned into a future SuperModel. I've imagined that there's some swashbuckling pirate at the helm of an offshore hedge fund who's made a killing by blowing out all of my stocks at the top, then cackled hysterically as he watched them plunge into the sea.

But so far, the tally of winners amid the rout is, well, short. And there may be a lesson there, which I'll get to in a moment.

Shorting Started Too Early

Many prominent market skeptics were simply too early; they started shorting tech stocks in 1998 and 1999, and blew up as the Nasdaq rallied to heights beyond even bulls' expectations. James Debevec, an analyst at a Bahamas-based firm that invests in hedge funds on behalf of wealthy investors, says he can name only a single fund that is up over 50% this year on the basis of timely short sales. "Most of the bears who were shorting the market a year ago had already been wiped out when the decline finally hit," he said. "There were not too many survivors."

Presuming that Debevec just didn't know the right people, I called on a gentleman who now runs a large public technology mutual fund but had formerly worked for a couple of the world's top hedge funds. He declined to be identified, but said he could name only one other hedge fund that was known to be up sharply for the year -- about 35% -- on the basis of bets on the short side. The reason, he said: "The funds today are geared not to hedge risk, but to take risk. It's a complete myth that the people who run those funds have been smarter than the average investor over the past few years. Many were late to buy tech stocks during the 1990s, and when they finally did buy them last year, they were not capable of holding with conviction once they began to decline in March. Instead, they held these stocks too long and then blew them out. They certainly weren't short and they certainly didn't make a fortune. Quite the opposite."

Scratching the hedgies off my list, I next recalled that several of the establishment money managers who gathered for the annual

Barron's

magazine roundtable on stocks in January expressed strong reservations about the bull's longevity. So I dove into the archives to learn if any of them had made a killing on their prescience. The results here also surprised me: Even the ones who suggested that readers sell short stocks or indices had failed to clean up -- at least in their prognostications in the public record.

Swiss banker Felix Zulauf panned the

S&P 500

and the Nasdaq in the magazine on Jan. 31, but those ideas resulted in less than a 2% gain through May 15. Meryl Buchanan, a value manager and partner at

Buchanan Parker Asset Management,

timidly proposed shorting

JAKKS Pacific

(JAKK) - Get Report

in the same issue, but that stock is only down 1% since. No brave rips on one-time darlings like

Sycamore Networks

(SCMR)

or

Celera Genomics

(CRA)

, which are down 125 points and 196 points, respectively, from their highs for the year.

Bert Dohmen, a trader and newsletter writer in Honolulu who's been a good market timer over the years, said that the decline from the top was the first plunge in the past three decades that he had failed to capitalize on. Despite clues like light volume on the secondary top of the Nasdaq, at 4963 on March 24, he said, "it came too fast."

$2 Trillion to 'Money Heaven'

Dohmen says he believes that more than $2 trillion worth of mostly borrowed dollars went to "money heaven" during the Nasdaq decline, and those unspeakable losses would keep the broad averages from advancing much the rest of the year. Since the peak, he believes that many top traders who were highly leveraged lost 60% to 70% of their funds, and would not be borrowing again to put funds back in circulation.

The lesson, perhaps, is that because no one made a killing, there may be very little spare cash around to boost the markets back to the old highs until confidence is restored -- something that could happen before summer if the

Federal Reserve

definitively declares it has finished draining the liquidity it pumped into the U.S. monetary system over the Y2K scare.

In the meantime, we may have to get used to living in an "Alice in Wonderland" world of opposites. From 1995 to 1999, we learned that all dips could be bought, and most of our charts stair-stepped up. Now we've learned that in a bear phase rallies are sold, and most of our charts stair-step down.

The best tactic for most private investors who are investing for retirement may be the hardest, and that is to do nothing until the coast is clear. It is hoped this will end soon; perhaps it already has. Active traders, to be sure, have the capacity to change their habits and adapt to this new environment. But long-term investors are probably still best served by holding firm to strategies that have been tested over many market cycles.

Over the next few months, I'll propose some trading strategies built on screens that should work well even if the bear phase persists. But if you haven't got the time, stomach or instincts for trading, then history suggests that Year-Trader and Quarter-Trader portfolios (down 1% and up 1%, respectively, this year through May 15) purchased at the end of last year should continue to match the broad market benchmarks. And if stocks perk up in the fall as usual, patient Year-Traders could still have a very pleasant surprise in their stockings by Christmas.

On Margin For Grandma

I received a flood of mail expressing sympathy and advice for the young man about whom I wrote last month regarding his unfortunate experience with margin and momentum. The reader said he had lost a couple of hundred thousand dollars amassed by his grandparents for their old age, first by buying fast-advancing stocks that got stuck in reverse during the Nasdaq's big decline in early April, and then by borrowing against them to "average down" on more shares.

Some excerpts from my inbox:

  • "I bought on margin for the first and last time in the early 70s and got caught in the oil embargo. Margins are like playing Russian roulette. That loaded chamber will come up; it's just a matter of when."
  • "Your story about the young man who lost big was very sad. If 1987, and to a lesser extent 1999, taught me anything, it's one, don't buy on margin and two, stay the course with solid players and don't get rattled about the corrections."
  • "My message to the young man is, first, don't give up: $100,000 is not a negligible nut to start over with. Second, you're not alone in your experience with margin. There's a solution, however: Leverage has to be treated like gasoline, powerful for good and evil alike. One can't invest leverage. One has to regard it as a trading vehicle only. The portfolio has to be divided into levered and unlevered halves, and the positions in the levered half must be entered and exited on the basis of a short-term trading strategy. The important thing is to get comfortable with selling. A levered position can't be held for the long haul through declines. If it declines, it's sold. I have learned my lessons the hard way."
  • "It takes a good, sound character to wash your 'dirty laundry' in public. Go and sin no more. Any idiot can make money in a bull-market mania. It takes system and method to hold onto it. As a professional trader who has made every mistake in the book, I realized that without a system, you're at the mercy of emotion and Wall Street propaganda. Most traders and investors have no system and will lose a lot of money. Nasdaq has become a commodity market with a stock-market mentality."

Here's another bit of wisdom on this subject that I snagged on a ricochet from Su Keenan, a friend who co-anchors

Bloomberg TV

in the afternoon. She attributes the following quote to billionaire

Viacom

(VIA) - Get Report

chairman Sumner Redstone: "Big success is not built on success. It's built on failure, disaster and catastrophe. It's about learning to turn it around."

Personally, I believe that a large part of the recent selloff has stemmed from the irresponsible extension of credit by brokerages to inexperienced investors like my correspondent. Margin loans are hugely profitable to brokerages, so we can't expect them to halt the practice without a fight. Legislators and regulators would serve the public well by passing rules restricting margin to investors with at least three years of experience, and then looking into sharply limiting the lending threshold to less than 50% of a stock portfolio's value.

Fine Print

The notion that a bear market could develop during good times for our economy may seem irrational to those investors who only came into the market in the late 1990s. But a framework for thinking about this unexpected event was summed up well, I thought, in an email sent by New York reader Leonard Kreicas to our new contributors, Laurel Kenner and Vic Niederhoffer. In response to their Friday column "5 Rules to Ace the Market Game," which described rules from a chess and checkers grandmaster that were equally applicable to stocks, the reader wrote: "Grandmasters rely on illogical thinking, but they call it the element of surprise. Generally they start the game according to the rulebook, but then they make a move which is unexpected: It is illogical. This causes the game to go into uncharted waters. The winner is the one who navigates the new terrain the best. The more illogical a master's move seems, the bigger advantage he has, because his opponent becomes totally confused. The weak opponent thinks only inside the box. By the time the confused victim figures out what has happened, he is history ... Likewise, the markets prey on the confused trader who plays only by the established rules. The more unpredictable and chaotic a market is, the more a true master wins. He is able to transcend rules and logic to another level of understanding."

So far Meryl Buchanan is leading her peers in the

Barron's

Roundtable sweepstakes, according to my math. She's up 14%. Close behind her is wizened retired value manager John Neff, up 12%.

Goldman Sachs

partner

Abby Joseph Cohen

is up just 1%. ...

Three-Five Systems

(TFS)

,

Adept Technologies

(ADTK)

and

Keithley Instruments

(KEI)

-- three tech stocks that I've mentioned in the past month as being unfazed by the Nasdaq decline -- all continue to bust new highs. Three-Five on Tuesday rallied sharply after unveiling a new light engine that

Nikon

has built on its LCoS microdisplay technology. Keithley announced a 2-for-1 split.

At the time of publication, Jon Markman owned or controlled shares in the following equities named in this column or listed in the SuperModels portfolios: BroadVision, Cisco Systems, Digital Lightwave, Emulex, Kopin, Maxygen, Microsoft, Nokia, Nortel, Oracle, PMC Sierra, Qualcomm, Siebel Systems, SDL, Superconductor Technologies and Xcelera.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He welcomes your feedback at

mctsc@microsoft.com.

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