Market madness started with end of Fed's QE

For nearly six years running, the U.S. stock market has withstood a myriad of body blows, from a stuttering economic recovery to a debt crisis in Europe to massive political instability in Washington.

Underpinning each move higher was the knowledge that the Federal Reserve would keep the printing presses running, with aggressive quantitative easing programs that sent market confidence high and asset prices soaring.

Now, though, comes a shock that has Wall Street reeling: The Black Swan-like collapse in oil prices that has provided a stern test of whether equity markets can survive nearly free of Fed hand-holding.

So far, with volatility spiking, traditional correlations breaking down and the bad-news-is-good-news theme no longer in play, the early results are not particularly reassuring.

"Stuff happens when QE ends," said Peter Boockvar, chief market analyst at The Lindsey Group. "It's no coincidence that the market started going into a higher volatility mode, it's no coincidence that the decline in commodity prices accelerated, it's no coincidence that the yield curve started flattening when QE ended."

Indeed, the increase in volatility and its effect on prices across the capital market spectrum was closely tied to the Fed ending the third round of QE in October.

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That month marked a momentary collapse in bond yields on Oct. 15, a day that also saw the Dow Jones industrial average plunge some 460 points at one juncture before slicing its losses. The day, and the general tenor of markets as the Fed ended QE amid a global Ebola and economic growth scare, helped make October the most volatile month of 2014. In second place for monthly volatility was December, according to a Tabb Group analysis, as investors pondered the meaning of "patient" in a Fed statement on when it planned to raise rates and waited for a Santa Claus rally that failed to materialize.

January has proven to be an even bumpier month as investors evaluate an oil plunge that sent a gallon of gasoline below $2 in some locations but has raised question about longer-term effects on corporate bottom lines and business investment.

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Then came Wednesday's disappointing retail sales numbers, all of which raised concerns about whether Wall Street is capable of negotiating its way through rough times with only zero-bound short-term interest rates as a backstop.

"The assumption that low energy prices were unambiguously good was called into question with December retail sales," said Art Hogan, chief market strategist at Wunderlich Securities. "I think it's all connected, but I'd be hard-pressed to tie it just to monetary policy."

To be sure, the Fed may have ended QE3, but it has hardly exited the easing picture.

Besides keeping its policy rate near zero—with expectations for at least a modest hike later in the year—the Fed is not rolling off the more than $4.5 trillion in debt securities it holds, but rather reinvesting the proceeds. The result, in fact, has been a modest expansion of its balance sheet even since QE's end.

Moreover, the European Central Bank likely will step into the accommodation void next week when it follows through on President Mario Draghi's "whatever it takes" pledge to keep the floundering economy afloat.

Read MoreECB QE needs to buy shares and bonds: Generali

But while it would be reasonable to expect a bounce off the ECB's easing announcement, the future from there seems far less certain.

"Whatever the ECB announces next Thursday, this is the final act of dramatic central bank easing. After that, there's not much left," Boockvar said. Should the Fed try to reinstitute QE in the face of more volatility, "their credibility would be shot."

That leaves investors in quite a quandary should oil prices continue to streak downward, accompanied by a general collapse in commodities including copper, which is supposed to be an economic bellwether but instead has been sinking even amid mostly bullish global growth forecasts for 2015. Of course, not a lot in the market has been making sense these days. Gold, for instance, is up 4.5 percent year to date even as the U.S. dollar has gained 2 percent against a basket of its global competitors, a positively correlated relationship that is not supposed to happen under normal circumstances.

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Economist Michael Pento predicted in an October analysis that the end of the Fed's QE would see "inflated asset prices deflate back to normalized levels," and believes now that the process is well under way and is likely to continue.

QE works "much better for equity prices than it does for economic growth," Pento said. "You had a huge separation where markets went based on the Fed's $1.7 trillion QE(3) program and where GDP growth was on a global basis. Now you're seeing those two reconcile."

"Copper's down over 20 percent. You're looking at global yields in the toilet and oil prices down over 50 percent," he added. "If you add all those things together, it adds up to global slow growth and the bursting of the commodity bubble that we saw courtesy of central banks."

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With stock prices seemingly joined at the hip to oil, there appears little near-term hope for an end to the volatility. The S&P 500 is off 2.2 percent this week, bringing the 2015 decline to 2.9 percent.

One ray of hope is that some technical strategists believe the market losses have been tied more to violating support levels on charts than the fundamental landscape. Art Cashin, Wall Street's dean of trading and head of floor operations for UBS, discussed it in his morning note to clients, and others, even with a bearish bias, have been inclined to agree.

"The fuel for the fire over the last several years has been stock repurchases, and that has been fueled for the most part by the zero interest rate environment. As long as that continues, there's still some room for the stock market to continue higher," said Brian LaRose, a strategist at United-ICAP. "The path of least resistance is still to the upside."