As bad as September was for stocks, October was worse. US investors sold a record $56.0 billion in stock mutual funds in September and set a new record for sales of $70.7 billion in October.  Liquidations among hedge funds across all asset classes totaled $600 billion by one estimate for the last two months.  Facing that kind of selling pressure, buyers disappeared.  Through October 24th, virtually every asset class including US stocks, international stocks, preferred stocks, corporate bonds, muni bonds, asset backed securities of any kind experienced panic liquidation. 

Had the month closed October 24th, US stocks would have delivered the worst monthly return ever - worse than during October 1929 stock market crash, the outbreak of World War II, Pearl Harbor attack, Cuban Missile Crisis, assassination of Kennedy, 1987 Stock Market Crash, 9/11 attacks or any other historic event in the last 100 years.  Even with the rally of the last week, which lifted the S&P 500 11% on the week, US stocks are down 37% from last October's high, international markets down 43%.  The decline represents a loss of trillions of dollars in investor wealth and will deliver the US and most of the world's economies into recession for the next 2-3 quarters.  Of the 13 bear markets in US stocks over the last 100 years, the 46% decline through October 27th represents the 5 largest.  Stocks declined 49% from March 2000 through October 2002.

The role of hedge funds in the melt down

In principle, hedge funds are supposed to deliver positive returns in all market conditions.  In practice, many of the funds should be labeled "aggressively leveraged one-way bet funds."  Supposedly sophisticated investors allocate their capital to hedge funds in hopes of receiving outsized returns net of the funds' high fees and expenses.  In return, investors are limited in withdrawing their funds to a few times, or perhaps even once per year.  We've mentioned in previous market letters how hedge funds meeting margin calls have been dumping securities at fire-sale prices all year long.  This selling reached a crescendo when hedge fund investors delivered record notices of redemption on September 30th, forcing massive fund liquidations over the next several weeks.  Even now, every afternoon when the market looks set to close up a couple of hundred Dow points, we see a massive wave of S&P 500 futures selling in the last 15 minutes of trading as the hedge funds try to raise additional cash.

About a quarter to a third of all hedge funds will be out of business by year's end.  Those that remain will be sharply constrained by their investors and prime brokers on how much leverage they can exercise.  We hope, also, that the next administration will prepare legislation to require government regulation of hedge funds to standards at the very minimum required of investment advisors such as our firm.