"Recently, there have been a number of divergences that have developed, where large caps continued to hold in and small caps did poorly. This is closing some of those divergences. It's clear some of this is related to the dollar and commodity prices and investors' fears about Europe and deflation there," said Gina Martin Adams, institutional portfolio strategist at Wells Fargo Securities.
The dollar index, meanwhile, rose to a four-year high as the euro slid to a near two-year low on expectations the European Central Bank will go further into easing mode as the Fed pulls back.
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Adams said the pending end of the Fed's bond buying program this fall leaves the market faced with uncertainty it hasn't seen during the period the Fed has conducted quantitative easing, while promising rate hikes far into the future. The time is getting closer for Fed rate hikes, and hawkish Dallas Fed President Richard Fisher reminded markets of that Thursday when he said the hikes could start in the spring, sooner than the consensus of June 2015.
The dollar has moved higher in recent weeks as traders look forward to higher interest rates. Commodities, like oil and gold, have fallen sharply as a result.
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"I think the Fed has created for themselves a situation that the market is generally very sensitive to every communication that comes out from the Fed. I wouldn't dismiss anything a Fed president says or a Fed speaker as potentially market moving. We are going to be in that environment until we have a much greater sense of what the end of QE means," Adams said. "When QE goes to zero, we can ultimately shed that and see how the market reacts."
Peter Boockvar, chief market analyst at Lindsey Group, said the Fed bond buying program may have been the catalyst. "At the end of QE, stuff happens. At the end of QE, the beer goggles come off. We've been leading up to this," he said. "We had the least amount of bears since 1987. This was an extraordinarily loved rally to the point where there weren't any bears."
Boocvkar said the rally Wednesday was a head fake, after two big down days earlier in the week. He said the Russell 2000 has been sending a warning.
"Damage is being done here. This is not your run of the mill little pull back because of the breadth of selling. This is more than a short-term thing," he said.