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Is This the October 1987 Sequel?


Some hedgies bet that a crash is coming, but not everyone agrees.

The stock market has gone nowhere year-to-date, but perhaps, if some hedge fund managers are to be believed, it's really just setting up for something a lot more dramatic.

The SPDR S&P 500 ETF (SPY), which includes holdings like Apple (AAPL), AT&T (T), Chevron (CVX), Exxon (XOM), JPMorgan (JPM), Johnson & Johnson (JNJ), and Microsoft (MSFT) is up, year-to-date, a lifeless 0.8%.

Jon Markman of Markman Capital Insight writes this morning on the Buzz and Banter that he's not looking to spook anybody, but he's been chatting with some top hedge fund managers who think the market is setting up now much as it did in early October 1987, right before the largest single-day crash in the post-Depression era.

Check out the following chart of the S&P 500 in the fall of 1987:

Click to enlarge

The managers Markman is talking to see today as the equivalent of around October 3. They speculate that the August top equates to the recent January top. The decline to the 100-day average in September is the equivalent of the recent decline to the 200-day average in early February. The advance to the lower high in October is equivalent to the recent advance to 1,123 on Wednesday.

"Now these managers think the next set of steps would be a sharp decline on Thursday or Friday, a series of 0.5% to 1% single-day declines next week, followed by a plunge, let's say, next Friday and a crash around March 15," Markman writes.

The professional money-makers Markman is kibitzing with argue that there are many fundamental, structural, and economic factors today that parallel those seen in 1987 -- not just the chart analog.

Markman rattles off the list: legislation that could cause investors to dramatically lower their estimates of stock values, a lack of liquidity, a sense of overvaluation after a steady recent advance, revelations of a massive budget deficit, and expectations of a sharp fall in the value of the dollar and an expectation of higher interest rates.

As for what he himself personally makes of all this, Markman tells his clients that, for now, he wouldn't give this scenario more than a 40% chance of playing out, however.

"Valuations are not extreme, interest rates are low, sentiment is still largely poor and governments are much more highly attuned to, and experienced in, dealing quickly with markets that threaten to unravel," he emphasizes.

We also checked in with Mike O'Rourke, BTIG's chief market strategist, for his views on what these well-heeled hedgies are preaching.

Are conditions now, in fact, similar to those in October 1987?

O'Rourke's answer: no. He doesn't see any indications that this stock market is ready to take such an awesome tumble.

"I see the market as in a recovery rally," the strategist tells us. "Liquidity has slowed down and dried up, but that's because we had a nice rally and now we're consolidating and building a base."

He adds, "I would view this as a market rest rather than some ominous sign out there that we will see a crash."

Right now, in terms of sectors, O'Rourke favors Technology.

"Valuation is attractive," he says. "We know the leaders in the sector are performing, and many of them put up record revenue numbers in the fourth quarter. And this is all during the great recession so imagine what happens when some economic strength emerges."

In contrast, O'Rourke says he's steering clear of Energy and Materials.

"There is a lot of speculative activity out there," he says. "In 2009, China was restocking and getting ready for this stimulus spend-out and probably purchasing at above-trend rate. This year, that takes a breather. I wouldn't want to take the risk of being there."

Sam Stovall, chief investment strategist at S&P Equity Research, notes that, since World War II, there have been 70 times that the stock market has fallen by 20% or less.

It takes, on average, two months to recoup losses from a pullback (5% to 10% decline); four months from a correction (10% to 20% decline); and 12 months from a bear market.

"This is why investors have stuck with stocks," Stovall says. "They know that these are usually good buying opportunities. Unfortunately, most people know when to get out, but not when to get back in."

But what about a crash during a secular bear market?

"We're not exactly sure what would happen next," Markman says. "There isn't enough data."
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