Think of the moment in the original Star Wars when the bad guys destroy Princess Leia's home planet of Alderaan with a single blast from the Death Star. Just then, back on Tatooine, Obi-Wan Kenobi shudders and says "I felt a great disturbance in the Force, as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened."
We've had a similar sensation here over the last few days as the latest data on mutual fund outflows reveal a time-honored pattern: When individual investors (and, yes, their panicky advisors) simply can't take the pain any longer, they dump stocks very late in the game.* Now, we want to be very clear here. These data alone don't imply a bottom any more than any other single indicator can. Especially when forced selling seems dominant and the credit markets remain broken.
But with the VIX setting daily records, put-call ratios pushing higher, and other measures of bearishness breaking out all over the place (this magazine cover is a classic contrarian item, but daunting and a little scary nonetheless), we could be reaching a point where the rubber band is stretched too tight--at least for the short term.
This morning's (for now very short-lived) hoot-and-holler reversal** off of the first half-hour's plunging lows notwithstanding, this market remains deeply damaged. Whatever current technical-psychological extremes might do to the broad averages in the short run, we continue to be concerned about the prospects for corporate earnings. Now, a loss of 40% or more in market capitalization certainly does imply an adjustment for expected weakness in earnings. But here's the thought experiment: What if the next few quarter's results are flat-out ugly? Is a steady drip of corporate weakness (and thus retrenched spending and hiring) adequately "priced in"?
At some point, when investors have shed their fear in favor of indifference, we'll have reached a real, lasting bottom, one that will have created some truly spectacular investment opportunities. As we've been arguing for months now, the name of the game is still risk management. Capital preservation is a virtue, as those who lives to fight another day will benefit enormously from the wreckage on Wall Street.
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* The bigger question is when those who have just bailed out of stocks will have the wherewithal to return. If they wait too long, they will have perfected the disastrous sell-low, buy-high sequence that impairs the results of so many individual investors. What people need here is discipline. If you go to cash now, start buying back in whether the market go higher or lower. If it goes lower, great...you'll pick up the merchandise at even better prices. If it bottoms at or near these levels and heads higher (even if slowly and unevenly), you won't wait too long to participate. We could be more specific about this, and maybe next week we will be.
** Which brought back memories of a time when CNBC's Maria Bartiromo actually squealed--there's no other word for it--her approval of the day's trading action. In keeping with the Star Wars theme, and given that stocks were trading roughly 40% higher then than they are now...that moment feels like it took place long ago, in a galaxy far, far away.
Source
Jennifer Ablan, "Flight to quality as money funds rise, stocks dive," Reuters, October 10, 2008
Jeff Kearns, "VIX Options Index Advances to Record Above 60 on Credit Freeze," Bloomberg, October 9, 2008
