Stock Selloff: This the One Everyone Was Expecting?

Stocks may finally be getting set to give back a chunk of their 30 percent plus gains of the past six months, but analysts expect a relatively shallow pullback unless the U.S. economy starts to deteriorate.

NYSE Trader
NYSE Trader

Bonds rose and stocks fell, after signals that the Fed may soon end, and for now, not resume the extraordinary easing programsthat have helped keep rates low and made stocks an attractive investment alternative.Worries about Spainbecoming the latest victim of Europe’s sovereign crisis also worried investors Wednesday.

The S&P 500, as of midday, has lost 2.3 percent since Monday. The Fed released the minutes of its last meeting Tuesday, showing no promise of a new quantitative easing round or extension of its current asset purchase program. Meanwhile, strategists have been calling for a stock market pull back, or correction, since February, when key stock indices first surpassed last year’s highs.

“This is to some degree a bad day, so I don’t know if this is finally it,” said Daniel Greenhaus, chief global strategist at BTIG. “Certainly you have to start somewhere and this very well might be it, but I would add that the market has been acting poorly for some time now.”

But Greenhaus, and others say the selloff could be relatively shallow. “The mentality among investors is still to buy every dip,” he said. The S&P is now up 30 percent since its Oct. 4 low.

Analysts also say the timing is right for a sell off as May approaches. The “sell in May” factor could play a role this year, as it has in the past two years. Stocks in the past two years reached their highs of the year in April.

“What would be interesting is if we started moving back to the 1,350 level. If so, you could make that ‘sell in May’ argument,” said Greenhaus. The S&P 500 was down 22 percent from last May through early October, but analysts expect any sell off this year to be less severe.

“Whatever happens will be pretty shallow,” said Thomas Lee, chief U.S. equities strategist at J.P. Morgan.

Lee said it makes sense for a pullback now, but he adds he’s been expecting one for weeks.

“It’s logical. The risk reward is different now. On December 31, people were bearish. Risk premium was really high. Ownership of stocks was low. Funds were defensive,” he said. “In Q1, we had risk fading, and now we have risk flaring. For instance, there’s a lot more talk about a hard landing in China. We’re talking Spanish debt problems right now, and in the U.S., it’s gasoline. I think in a way it’s a very different set up. I don’ think it means this market is down 10 percent this quarter, but I do think it means there’s headwinds.”

Friday’s monthly jobs reportcould be pivotal for stocks. If it surprises in either direction, it could have significant impact on market psyche, since investors now view it as the next piece of data the Fed will consider before discussing easing at its April 24/25 meeting. While the Fed is not expected to act at that meeting, traders say speculation will immediately return that it could, should the jobs number disappoint.

Wedbush Securities managing director Steve Massocca said the duration of the selloff will be more clear Monday morning, after the jobs report is release Friday. The first time U.S. stocks trade after the 8:30 a.m. ET report Friday is Monday morning. Bonds and some futures markets are opened for shortened sessions Friday.

“A bad number would be new news. A good number, or an okay number, is not going to be that meaningful,” he said. Economists expect to see about 205,000 new jobs were created in March.

Massocca said the Fed is not the only thing worrying the market, and there are other reasons for its decline. “I think Europe doesn’t look too good. It’s starting to affect our market. There’s rumors Greece is looking to get out of the euro. The Spanish auction (Wednesday) didn’t go too well,” he said.

Yet, he notes stocks are higher than they were a few days ago.

“It’s not that the charts have broken down or anything. We’ll have to wait and see if it continues. Right now you’d have to say the rally is intact. It’s rolled over about 15 times on the way up,” he said. “If it takes out 1390 (on the S&P 500) but importantly if it takes out 1386, then you’re looking at 1340, which was March 6, but right now it’s not really breaking down. It feels like it is to me, but I’m not convinced. The Nasdaq is the one to really watch because it’s the one that’s been up the most.” Nasdaq is up about 33 percent since October and was down 1.8 percent in afternoon trading Wednesday.

PNC Wealth Management chief investment strategist Bill Stone said he’s been waiting for a 5 percent pullback and this could be it. But he says it’s a positive the Fed doesn’t look like it will act now, and the market is really reacting to worries about Europe.

“You hope it’s the pause that refreshes. In some respect, I'm heartened when I see some move up in rates. It’s kind of like blood pressure—too low and you’re dead,” said Stone.

Analysts say the current bull run was launched in part as steps to stop the spread of the European sovereign debt crisis appeared to work, particularly the European Central Banks’s LTRO liquidity facility implemented late last year. Fed easing has also been another additive to the mix, and stocks have been heading higher since shortly after the Fed announced its latest “operation twist” Treasury program in the fall.

“We don’t believe that the economy is going to cave in without QE3, and we’d even be more concerned that a QE3 might do more harm than good,” Stone said, adding that a negative of past QE programs was the run up in commodities prices.

Stone said it is important that the employment numbers continue to hold up, since without the improved jobs outlook, the economy could spin into a double dip scenario again.

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