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Dan Dorfman

Dan Dorfman

Posted: September 30, 2010 06:33 PM

With Halloween just around the corner, many of us will soon be shaking as we confront the usual array of ghosts, ghouls and goblins. Adding to our jitters will be a TV bombardment of such time-worn horror films as Frankenstein, Dracula and Night of the Living Dead.

Equally significant from an investment standpoint, Wall Street will undoubtedly be shaking, as well, since October is notorious for having produced one of the bloodiest one-day showings in the history of the stock market. That was October 19, 1987, or "Black Monday," as it's called, a day that saw the Dow Jones Industrials dive a wicked 508 points or 22.6% and shed some $500 billion of market value.

The reason: computer and insurance programs all flashed sell signals at the same time, which touched off a selling panic.

What's more, October has savaged investors with a series of additional hefty declines, namely, 20% in 1929, 17% in 2008, 14% in 1932 and 10% in 1937, I'm told by Standard & Poor's chief investment strategist, Sam Stovall.

October is a spooky month, says Stovall, pointing to such events as: the two biggest monthly declines in the stock market both occurred in October, five of the last 10 bear markets (declines of 20% or more) bottomed in October and four of 17 corrections (losses of from 10% to 20%) also ended in October.

On the other hand, some market pros pooh-pooh any October fears, noting that the market is on a roll, what with the Dow -- largely reflecting expectations of a zippier economy -- having ballooned more than 700 points since late July. What's more, the Dow posted a 7.7% gain in September, which is traditionally the market's worst month of the year.

A money manager at Baltimore-based investment biggie also plays down October worries, telling me "unless you're blind, you can't help but see the market wants to go higher, and it looks like that's where it's going."

Stovall agrees, arguing it's pretty likely that the correction of 2010 bottomed in July. Further, he believes technically that the S&P 500 has undergone a bullish reversal and the bull market that started in March 2009 is likely to resume, albeit at a slower pace than the initial surge.

Further, he points out, dating back to 1945, October has displayed a lot more vigor, averaging an 0.8% annual gain and rising in six out of every 10 years.

Still, this October is saddled with a number of concerns. Among them on the investment front are a couple of closely tracked contrary market indicators which invariably signal lower stock prices.

One of them is a report from Investors Intelligence that a recent survey of investment advisers showed 49.1% were bullish, far exceeding the 29.3% that were bearish.

Another contrary indicator, recently highlighted by Michael Larson, editor of the Safe Money Report newsletter in a commentary to subscribers, took note of a release from the American Association of Individual Investors -- viewed as Wall Street's "dumb money" -- that investors are more optimistic about the stock market than at any time since October 2007, May 2008 and January of 2010.

That's an unbelievably strong contrarian signal, observes Larson, who notes that these points in history, in fact, marked major stock market tops, leading to Dow declines ranging from 900 to 6,600 points.

Tack on his expectations of a double-dip recession, a skid into the Dow 9,000s before year end and he says investors should be loaded to bear with inverse exchange-traded funds, a bet that these vehicles will go up in price as the stock market goes down.

His favorites: ProShares Short Real Estate (REK), an inverse ETF designed to rise 1% for every 1% gain in the Dow Jones U.S. Real Estate Index, ProShares Short S&P 500 (SH), also designed to rise 1% for every 1% drop in the S&P 500, and ProShares Short Financials (SEF), likewise geared to advance 1% for every 1% decline in the Dow Jones U.S. Financials Index. Needless to say, if the market goes up, these investments will spell trouble with a capital T.

Larson also favors a stake in what's now everyone's investment darling -- that precious yellow metal. Here, he favors a gold bullion ETF, SPDR Gold Trust (GLD).

Charles Biderman, the CEO of West Coast liquidity tracker TrimTabs Research, partially owned by Goldman Sachs, is another worry-wart, noting the U.S. economy is stalling, new offerings are soaring and insider buying is plunging.

Near term, say for the next few weeks, Biderman is neutral on equities. But after that, he says, watch out. Given the enormous amount of debt in the economy, final demand is unlikely to grow rapidly over the next few years, he says. Unless incomes grow faster than 2% a year and above growth in unemployment -- which is not what he expects -- less money will be coming into equities over time. And that means, he believes, price-earnings multiples (now above 15, based on trailing 12-month earnings), could drop below 10.

That's as ominous a forecast as one could make. The S&P 500 is presently trading at around 1,145. Based on inflation-adjusted earnings for the past 10 years, the S&P 500 would have to fall to 550 for its PE ratio to drop to 10. If that were to occur, stock prices would be stripped of more than half of their value from current levels.

Sounds incredulous, but no less incredulous than what actually took place between October 2007 and March 2009 -- an astounding 53% drop in the Dow from 14,100 to around 6,500.

It's worth noting that one of my favorite indicators -- call it the "Dorfman indicator" -- reflects the thinking of an investment adviser who boasts an unenviable record of never being right. In other words, whatever he thinks, just go the other way. His latest market view: "We're on the verge of a huge decline in stock prices."

It all reminds me of those colorful Autumn leaves that are already falling in many parts of the country. Relating that to the stock market, if our three bears are right, more than Autumn leaves will be falling. and that could include the economy, the number of Democratic House and Senate seats and President Obama's already sinking approval ratings.

What do you think? E-mail me at Dandordan@aol.com