It's Rough Out There: How You Can Protect Your Holdings in the Worst Market Since 1974

By Eric Roseman

What a horrendous day.

In case you missed it, this past Black Monday was just awful for investors. And that's after Treasury Secretary Hank Paulson called the day's trading "orderly." Orderly it wasn't.

The S&P 500 and the Dow posted their third-worst point declines in history on Monday, after Lehman announced it was going into Chapter 11. Now, a few days later, they're down more than 22% from their October 2007 all-time highs. The MSCI World Index is now down more than 25% off its high, and the MSCI Emerging Markets Index sits just south of a 40% crash from its peak.

Ugly indeed...

How can you protect your portfolio in an environment like this? In a minute, I'll share my prescription for minimizing risk, but first we need to understand the impact our crisis is having on the markets.

How Far Back Do You Have to Go to Get Some Perspective?

Any way you slice it this is serious bear market territory. In fact, you have to go all the way back to the market carnage of 1974 to find anything like it.

In some ways, this crisis is worse and more on par with the 1930s. It's definitely a fair comparison as central banks, mainly the Fed, launch an all-out assault on falling prices. The aftermath that's still hammering the financial system is highly deflationary as the number of busted credits, failed institutions and unemployed all rise.

Let me just run some incredible market numbers by you. These numbers suggest we're close to either a bear market bottom or we're sitting at the cusp of a bear market rally - the third such suckers' rally since September 2007.

Since 1960, the average bear market has lasted 14 months and has taken stocks down about 31% before bottoming, according to Ned Davis Research. Currently, this is the 11th month of the bear market and stocks are down 23% from their highs.

So there's probably more selling coming our way, but I think we're approaching the low point of this crisis. Many stocks, which have nothing to do with sub-prime debt, credit problems or financing issues have been savagely hit.

Big bargains are out there.

But here's the problem: The market has completely broken down. The NYSE Advance-Decline line has collapsed with just 174 stocks rising versus a whopping 3,096 stocks dropping. On Monday, 792 stocks hit new lows. These are horrid numbers and strongly suggest this market is oversold.

Grim Outlook Breaks the Market

How to Fix Your Portfolio in This Broken Market

If you have a traditional portfolio that invests in stocks and bonds, then you should load up on cash. If you don't buy alternative investments like hedge funds or managed futures, then a reverse-index fund or ETF is a MUST to protect your stock exposure.

Investment portfolios should not have more than 20% invested in common stocks at this point. Despite huge values in many sectors (utilities, oil stocks, gold mining, oil services) investors are being penalized for bargain-hunting because the advance-decline is busted.

The odds of making money in this market are almost impossible if you just buy and hold stocks.

In addition to low market exposure, I'd hold a 10-20% position in a reverse-index fund, depending on your appetite for risk. Essentially, if you really like the stocks you own now and you don't want to sell them then make sure to cover your exposure.

As a rule, if I'm holding 20% in stocks, then my reverse-index exposure is about 20% or market-neutral. I just don't want to lose money.

About the only good thing I can say about 2008 is that we're a little more than three months away from 2009 . I can't remember the last time I was this anxious to end a year.

Comments

[redbaron:]

The 'SS', so much has happened since 'Monday', that I can't remember the details of that day. If you want to be considered relevant, suggest that perhaps you should be posting these thoughts the day you write them.

2008 Sep 19 07:44 AM

[carey_jim:]

I don't know about the market in general, but this week has been a speculator's paradise:

Monday: Sell the Dow at 11,300
Tuesday: Vacation day
Wednesday: Buy at 10,700
Thursday: Vacation day
Friday: Sell at 11,400?

Weekend: Send Thank you letter to Hank and the Fed. Tell them to keep up the good work.

2008 Sep 19 10:51 AM

[gordon:]

No way to gauge this market as gov't intervention dictates all movement, and short-covering gaps in premarket give way to flat to down all day. Dow hit 11,458 50-day brick wall on parabolic move. If in the inverse ETF, you got creamed. I'm in 3-month FDIC CDs and TREASURY-ONLY RESERVE money markets, and sleep well, until the market moves sideways followed by non-short covering investor confirmation moving money back into equities, this isn't for me. The 10-yr back to 3.7% shows money coming out of bonds, but until I see that be the trend, that is, it not falling back to 3.5% next week, now that shorts were burned alive on Quad-Witching Options Expiration, when they needed to tap their cash to buyback stock, I won't be on this corrupt train wreck. Earning 3% FDIC on $500K feels damn good, folks. Enjoy your In'nOut.

2008 Sep 19 01:36 PM