A Rolling Capitulation

Despite the rally on the upcoming appointment of Timothy Geithner to Treasury, last week was still a dismal week in the markets.  However, we are starting to get some anecdotal evidence, at long last, of capitulation.  Thursday’s downturn was particularly interesting.  Ostensibly triggered by concerns over Citigroup, critical intermarket spreads didn’t bear this out.  The TED Spread, that reliable indicator of systemic meltdown risk, barely budged.  So, if the selloff wasn’t about increasing systemic risk, what was going on? 

Our sources in the mutual fund world noted a tremendous amount of liquidation by individual (“retail”) investors last week.  This anecdotal evidence is supported by the high volume on Thursday.  Such behavior is a commonly associated with the final leg of bear markets, as retail has historically been considered a “weak hand” and skittish, typically selling at bottoms.  This cycle has been somewhat different in that mom & pop-type investors have shown great fortitude and courage.  My sense is that institutions and other so-called sophisticated investors have played a larger role in liquidations this year.  The widespread presence of leverage in the system been the driving force in this phenomenon, forcing selling by investors who traditionally held through declines.  This leverage was found in borrowings against concentrated stock held by executives, in hedge funds, and in structured products.  So instead of one retail-driven capitulation event, we have had a rolling series of entities throwing in the towel.  If retail is indeed capitulating, this is perversely good news — bear markets end when there’s no one left to sell.

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