What to Do In Case of Liquidation

The Dow Jones Industrial Average tumbled 172 points last Friday – punctuating another thoroughly forgettable week for American capitalism. Friday’s loss submerged the Dow back below the 12,000 mark, while also producing a sixth straight losing week for the US stock market.

How rare is a six-week losing streak?

During the last twelve years, the US stock market has suffered only five losing streaks of six weeks or more – the last of which occurred in the summer of 2004. In three of those five rare losing streaks, gold and commodities also fell. In the first two such instances – September-October of 2000 and February-March of 2001 – the S&P 500 Index fell 20% or more over the ensuing year…and was still showing losses three years later.

The third of these three instances is underway at the very moment…and that’s probably not good news.

Most of the time, when stocks go zig, gold (and commodities) go zag. That’s called “inverse correlation” or “non-correlation.”…and it is one of the many reasons gold is a nice thing to own. You can usually count on it to shine when almost every other investible asset is losing its luster.

Lately, however, gold is doing very little zagging to the upside, even though stocks are zigging to the downside. In fact, there isn’t a lot of non-correlation going on anywhere in the financial markets. Many assets are correlating with stocks much more than usual. When all asset classes begin falling together, even worse declines are usually on the way. Professional investors call this a “liquidation event.”

The recent min-selloff on Wall Street hardly qualifies as a liquidation event…yet. But one thing is very clear: during the last few weeks it has been much easier to lose money than to make it…no matter what you owned.

During the last six weeks, the S&P 500 has dropped nearly 7%. During that same timeframe, gold is down 2%, oil is down 13% and silver is down 25%. Even Inflation-protected Treasury bonds [TIPs] are down. In short, there have been very few places to hide for the last month and a half.

This simultaneous selloff in stocks and commodities is not comforting. But lest we be accused of “data snooping,” allow us to advance a theory to validate the apparent connection between the six-week losing streaks of the past and the present.

The theory is pretty basic: when everything starts falling at the same time, a liquidation event is underway. Investors simply want out…of everything. In such circumstances, risk avoidance takes the place of risk-taking…and this attitude tends to persist for a while, as the examples of 2000 and 2001 illustrate.

A liquidation event may or may not be underway, but investors do not lack for solid reasons to head to higher ground…or to any ground that doesn’t act like quicksand. Past is not necessarily prologue, dear reader. But when investors become eager sellers of all assets, caution is in order.

It’s time to do one of the following things:

1) Panic and reduce your exposure to equities, just in case.
2) Think long-term and don’t worry about it.
3) Buy the stuff that holds its value long-term, no matter what the short-term noise might be.
4) Both #1 and #3.

Our vote would be #4.

Eric Fry
for The Daily Reckoning