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Market Insider: Scaredy Cat Market

The screeching volatility that took stocks to the worst decline since October, 1987 wiped out much of Monday's gains and leaves traders afraid that investors will shy away from stocks for a very long time.

Thursday offers investors another helping of economic news and earnings ahead of the opening bell. But investors go into the session with a heightened sense of fear after a nasty sell off accelerated Wednesday afternoon, taking the Dow down 733, or 7.87 percent to 8577. Both the Dow and the S&P 500, off 90 points or 9 percent, saw their biggest percent declines since October, 1987.

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As investors watched for signs the government's plans to jump start credit markets by guaranteeing lending and recapitalizing banks would lift confidence, the credit markets still flashed signs of concern. While the drop in Libor was a good sign, strong buying in short-term T-bills pushed those yields to micro levels and signaled a flight to quality. Treasury prices rose on increasing worry about the economy, as the latest data confirmed fears the economy is heading for a more severe recession.

Traders talked about margin calls, hedge fund redemptions and a number of other factors behind the selling, but they all mentioned the lack of buyers. "The sellers are just relentless. The last few days we had some good swings. We had buyers and sellers. I was just hoping we'd see a mix of buying and selling but it seems like they're just sitting out today," said Todd Leone of Cowen Wednesday afternoon.

Leone said after Monday's record 11 percent gain, traders have been hoping to see the week finish with stocks higher. "This week it's important that we don't give up that whole gain," he said. Stocks finished last week with a record 18 percent decline.

Pat Kernan, who trades S&P 500 options at the CBOE, said he believes the stock market's moves have been exaggerated because of S&P options expirations this coming Friday. He said the trading activity around options expirations could easily turn a three percent market move into a five percent move.

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"I'm looking at stocks and the only thing I see in the green are the VIX and Coke," said Kernan, managing partner at Cardinal Capital. "The rest of this week is going to be highly volatile ... I will say I think some of the volatility will be out next week. I think it will still be extremely volatile but I don't think if we'll see the same 7, 8 percent moves."

"With the continued down moves, we are definitely seeing a serious lack of liquidity in the market because the normal players have kind of exited the building," Kernan said. He said the November S&P options show that investors expect big swings in the market to continue. He said they are implying daily moves of 37 points in the S&P 500.

Econo-phobia

Markets reacted badly out of the gate Wednesday to the disappointing 1.2 percent drop in September retail sales. Fed Chairman Ben Bernanke also spoke Wednesday about the significant risks to the economy from the credit crises, and the Fed's Beige Book, released in the afternoon, was a gloomy look at the economy's slowdown in September. Economic activity in all 12 Federal Reserve districts weakened, and credit availability declined in several.

On Thursday, weekly jobless claims and the Consumer Price Index are reported at 8:30 a.m. TIC data on capital flows is reported at 9 a.m. Industrial production is reported at 9:15 a.m., and the Philadelphia Fed survey is due at 10 a.m. The National Association of Home Builders report their survey for October at 1 p.m.

Deutsche Bank chief U.S. economist Joseph LaVorgna said things may start to snap back once the Fed gets involved in the commercial paper market and the government buys more bank's assets. "Generally speaking, I think we're in for much rougher sledding than we imagined a couple weeks ago," said LaVorgna.

"I think we're still dealing with the ramification of the Lehman liquidation, which I think is impacting all sorts of investors, especially hedge funds, so we're still dealing with a fear driven market," he said. "I think the problem is we're in a holding pattern right now, and the market is trying to find out what economic damage has been done."

Getting Technical

Technical traders have been watching to see if Monday's big move up would be confirmed, but Wednesday's action was disappointing.

"Today traders were looking to see if the market would hold 8600 to 8800 (on the Dow) which would have been a 50 percent retracement of the move from Friday's lows to Monday's open," said Scott Redler, chief strategic officer of T3Live.com. "By breaking that level, the market has tipped its hand that a retest of those lows is in the cards, and basically how the market handles itself around that area will be how traders handle their strategy going forward."

Redler said the type of moves the market has made in just days would have taken several weeks in past markets. "The violence is back. The next two days are going to be crucial," he said.

"If stocks hold Friday's lower range and rally from there, it would be a successful retest. If it doesn't hold, we'll be looking at new lower levels," said Redler. "Investors should hope for a gap and go tomorrow. That that would trap shorts and give us some fuel for a potential move higher."

Oil Slick

Oil finished at $74.55, off $4.09 per barrel, or more than 5 percent. Futures are trading at the $73 a barrel level in the Asian session Thursday. Oil is now 50 percent off its high, and analysts predict it could fall even further. "If there's a silver lining, this is it," LaVorgna said of the decline in energy. He said falling prices could ultimately spur some spending activity. Oil and natural gas weekly inventory data is released Thursday at 11 a.m.

Earnings Central

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Some important earnings reports are expected Thursday, including Citigroup, Nokia, United Technologies and Merrill Lynch before the bell, and Google, IBM and AMD after the bell.

Mad Scientists

That's what Carl Icahn called the Wall Street chieftains whose banks are getting money from the government. In an interview on "Fast Money," he said those same managers were like "mad scientists" who ran a chemical company, then blew up the factory releasing a cloud of toxic fumes. The factory then gets rebuilt by the town, and there they are - the same mad scientists back in charge.

Questions? Comments? marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.