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Jeff Saut: Downside Hedging Now an Absolute Necessity


Though we may have traced out reverse head-and-shoulders bottom.

At a recent Bank Credit Analyst (BCA) investment conference entitled "Inflation and Deleveraging: A Turning Point In The Debt Supercycle?", a BCA "Special Report" paraphrased some of the presenters thus:

"Martin Barnes opened the proceedings with the unenviable task of reminding participants just how bad the damage to the financial markets has been, yet just how little we have come in the deleveraging process. In setting the scene, he told of a client who had recently mentioned how annoyed he was becoming on constantly hearing the word 'unprecedented.'

"Many of the guest speakers who followed could not help themselves and used the word repeatedly in their presentations. And with good reason – these have been truly unprecedented times. Every asset class and region has been affected by the process of financial sector deleveraging. From the collapse in equity prices to the blowout in credit spreads and equity premia, there has been no place to hide."

"Unprecedented" indeed. As I've repeatedly said, investing correlations that have worked for years ceased working in June/July of this year, leaving brilliant investors like Marty Whitman and Ken Heebner both down some 43% year-to-date.

While the month of October wasn't entirely unprecedented, it was close - it registered the second-worst stock-market month in history. Said decline also triggered certain indicators close to unprecedented levels, as can be seen in the chart: The one-year price rate of change for the DJIA has only been more severely depressed 3 times in the past 100 years (1974, 1938, and 1932).

Click to enlarge

Interestingly, in past reports, I have likened the current decline to that which began in March 1937 and culminated in March 1938, with the DJIA losing 49% of its value. As now, everything collapsed (stocks, bonds, commodities, etc.) leaving investors nowhere to hide except for cash and Treasuries. Also as now, the government pulled out all the stops and implemented game-changing rules, such as lowering margin requirements and instituting the "uptick rule" for short sellers, but it was all to no avail: Stocks sank, until the sellers were exhausted.

Speaking to downside exhaustion, a fairly unprecedented event took place on October 10, 2008. On that date, 3130 stocks traded on the NYSE. Of those 3130, an unbelievable 2901 (or 92.7%) of them made new yearly lows.

Concurrent with that 92.7% the "new year lows" reading was a near 16-to-1 downside over upside volume reading, causing a rare signal from my firm's Capitulation Indicator, which had not "spoken" since 1966. Accordingly, we deemed October 10th the capitulation-price low and October 24th as the psychological price low, when the S&P 500 failed to break below its October 10th price of 839.80.
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