Kass: Why a 25% Drop Isn't Out of the Question

 

So, using historic equity returns, the stock market would have to be down by about 25.4% in order to have a comparable six-sigma event to the one that the Loan Index recorded in July 2007.

According to Yale University's Robert Shiller, there have only been two six-sigma monthly drops in the equity market in the past century. In November 1929, stocks dropped 26.5%, or 7.8 standard deviations away from the average, and in April 1932, stocks fell by 24%, or 6.4 standard deviations. In recent years, the largest monthly loss came in November 1987, when equities had a 12.5% swoon, representing 3.07 standard deviations from the average.

I am not saying that the recent six-sigma event in the Loan Index must necessarily translate into a six-sigma event in equities. Rather, the purpose of today's opening missive is to put the Loan Index's drubbing into an equity context.

What I do know is that the S&P 500 is only about 6% or 7% lower than the six-year high achieved in mid-July. My personal view remains the same: I do not believe that the equity markets' decline is anywhere near over, and I do believe that the recent dip has not incorporated the full impact of the deteriorating credit cycle.

I suspect, in the fullness of time, a cumulative decline of 20%-25% would not be surprising.

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At time of publication, Kass and/or his funds held no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $6 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

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