Trader Talk

A perfect storm of events, but traders look for oversold bounce

Even best stocks hit hard: Pisani

What caused the sudden drop? BMO's Brian Belski now famous answer on our air: "It's August, dude!" certainly has some truth in it, one reason investors should not over-react.

And it's also true there is not one single event that caused the decline. We have known about China's slowdown since at least June, along with the effect on commodities.

However, two events have occurred in the last two weeks that have added to the anxiety of traders:

1) China's August 11 currency devaluation has thrown a monkey wrench into the two assumptions on which China investors had hung their hats: a) that China could maintain a 7 percent GDP growth, or somewhere very close, and b) that it could engineer a soft landing to its economic slowdown.

Whether fair or not, the markets have interpreted this devaluation as a sign that it no longer was sure it could do either. This has eroded confidence.

2) But the most important story in the market's decline last week was likely the mid-week release of the Federal Reserve minutes, which revealed a Fed deeply divided on whether it should raise rates.

The week could be divided into two parts: Pre-Fed minutes and post-Fed minutes. Markets were relatively calm in the first half of the week, but every metric of stock market activity picked up in the second half of the week: Volume, volatility, and sentiment indicators, culminating in a mild panic on Friday that caused investors to sell even the best performing stocks on the year, winners like Amazon, Facebook, Google, and Neflix, but even less talked-about winners like Mastercard, Nike, Home Depot, and Pfizer.

Volume was heavy in all sectors, indicating traders were lightening up on positions across the board.

For whatever reason, the Fed's indecision seemed to deeply rattle investors. Some explained it by noting the Fed is in a "damned if you do, damned if you don't" situation. If they raise rates, the market is afraid there will be a disproportionate negative reaction. If they don't, it will be an acknowledgement that after eight years of gargantuan efforts on behalf of the Fed the economy cannot even handle a modest 25-basis point hike.

There were several other, smaller events that rattled investors:

1) Brazil's market decline accelerated, hitting a 10-year low as demonstrations against corruption and President Dilma Roussef continued; fear that high-level business executives may get swept up in the investigations has created uncertainty throughout Latin America, as Brazilian investment companies are engaged in much of the infrastructure development on the continent.

2) Tensions between North and South Korea caused large outflows from South Korea, particularly in the main Korea ETF (EWY), which hit a 5-year low Friday, a further blow to confidence in a key investment country.

3) Walt Disney , a dismal performer since it's August 4th earnings release, dropped another 7% for the week after Bernstein downgraded the stock, reciting similar concerns about declining subscriber growth.

Bottom line: A "perfect storm" of negative news descended on the markets. The issue now is whether the Chinese markets can stabilize. Traders are widely anticipating that the People's Bank of China will cut the Reserve Requirements, allowing banks to lend more.

If they can, it is very likely we will see some kind of oversold bounce. I heard of many traders looking to buy into the close on Friday, particularly small cap stocks, where there was aggressive buying of the Russell 2000 ETF, which ended the day down only 1.2 percent, far outperforming the S&P 500's decline of 3.1 percent.