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Jeff Saut: Finally Potential for a Correction


The only question is: What shape will it take?

Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

October isn't a four-letter word, but it should be -- especially with the month's hysterical history. And while it's true that statistically, the month of September is the worst month, it should be noted that more than 40% of the Dow's biggest daily declines have come in October.

Unsurprisingly, more than 70% of the Dow's worst "daily dives" have occurred in the September/October two-step. Accordingly, this year investors entered the dreaded month of September with a bearish mindset only to experience one of the best months on record. That wrong-footed, bearish strategy left portfolio managers scrambling for stocks right into quarter's end, causing many folks to think there isn't going to be an October "ouch."

Comes October, and according to my firm's friends at the invaluable Bespoke Investment Group, last Thursday represented the fourth worst opening day (-2.58% basis the S&P 500) of the fourth quarter since the index data began in 1928. It was also a 90% downside day. While I'm clearly not clairvoyant, I did indeed caution that the upside vacuum created by the recent melt-up might get "filled" on the downside once third quarter's window-dressing was over.

Consequently, my firm entered the fourth quarter of 2009 with a cautious, but not bearish, strategy. And while the jury is still out, my confidence level is rising that for the first time since the March "lows," there's potential for a correction of more than 7%. The only questions to me are: What shape will the correction take? Will it resemble the smash of October 1978, which saw the senior index surrender more than 10% in three weeks, or will it lie around and then dribble-down in a slow-motion "melt"?

Think about it: Last November, I was opining that while most participants were waiting for the worst to happen, for the second shoe to fall, I was screaming that the worst had already happened, given Lehman, WaMu, Freddie Mac (FRE), Fannie (FNM), etc. "If the news gets any worse," my firm wrote, "they will have to close the New York Stock Exchange and we will retire!" The environment we have now is the exact opposite. Participants are currently moving up the "risk curve" to invest their oversized cash positions in stocks that have the "right stuff." While in the long-run, I think that will be a rewarding strategy, in the short-run, I believe more caution is warranted; and evidently, I'm not the only one.

Indeed, just last week Richard Russell of the Dow Theory Letters fame, removed the bull picture from the top of his letterhead. To quote him: "I'm removing the bull from the box. With the Industrials, Transports, Utilities and S&P all 'rolling over,' I'm thinking that the counter-trend rally from the March low is in the process of topping out. The Dow has declined six out of the last seven sessions; and, the MACD is on a well-defined sell-signal."
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No positions in stocks mentioned.
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