Daily Ticker

Why Today’s Market Selloff Could Be A Good Thing

Daily Ticker

Investors are learning - the hard way - that when something seems too easy, it almost certainly is.

For most of this year, the idea of riding stocks higher - even buying successive new highs in the U.S. indexes – has been viewed as a path to effortless gains, supported by central banks’ easy-money resolve and a resilient (if moderate) economic expansion.

Now, suddenly, a cocktail of worry is served - its ingredients global-growth fears, unclear central-bank intentions and a market tape that had been stretched far to the upside. The mixture is a bitter one, most dramatically spurring a 7.3% buckling of Japan’s overheated Nikkei stock index as well as a shudder of downside volatility in U.S. stocks.

Related: Bernanke Speaks: Can Anything Slow Down This Market?

The Standard & Poor’s 500 Index (GSPC) had been “melting up,” in the common description, climbing a gentle slope to a new record at 1669 Monday, up 17% on the year and 23% since mid-November, without so much as a 4% pullback. Japanese stocks, meantime, had about doubled in value in a spree of enthusiasm and fast-money speculation, a reaction to the hyper-aggressive monetary stimulus endorsed by Prime Minister Abe and the Bank of Japan to radically weaken the yen, escape deflation and stoke economic growth.

Then beginning Tuesday morning, from Washington, Beijing and Tokyo, perfectly good excuses to sell stocks emerged – and for once this year, investors accepted them.

Related: Jim Rogers: The Commodities Bull Market Is Still On

Federal Reserve Chairman Ben Bernanke sent ambiguous signals in Congress, hinting at a potential lessening of Fed asset purchases “at the next few meetings” if the economy strengthens enough. The S&P 500 sank nearly 2% from a morning high as investors used the mixed message as an excuse for some long-overdue selling, and Treasury yields lifted above 2%, a sign that the all-seeing bond market was bracing for the Fed to “taper” its monthly asset purchases.

China’s closely tracked purchasing managers’ index showed an unexpected decline, the first in seven months, reviving once-pervasive but recently calmed fears of a “hard landing” in the Chinese economy. The jarring selloff in Japanese stocks – a sudden scattering of the sparrows coming even after the market had been up early in Tokyo trading - also came as yields on Japanese government bonds – whose recent volatility has concerned some policy makers – kept surging from ultra-low levels, topping a 1% for the first time in more than a year.

So, how to characterize this global reaction to what appear to be somewhat opposing concerns, over both weaker growth and Fed scaling-back of its stimulus help in reaction to a firmer economy?

The outright fear of Fed “tapering” as a threat is probably overstated. But with the China disappointment raising the prospect of another summer slowdown scare, investors might have less confidence in the cake-and-eat-it-too belief that the Fed is shoveling cash at an economy that decreasingly needs it. In other words, the easy money medicine before was perhaps seen as going toward recreational uses, while now appears it might truly be a needed treatment.

Related: “Give the Market the Benefit of the Doubt” and Invest in Stocks: Barry Ritholtz

As discussed in the attached video, this all could very well be a tidy, plausible excuse for an overextended market to undergo the kind of helpful 5% to 10% correction that many have invited, which would reset investor expectations, banish excess complacency and refresh buying power.

It’s never possible to know whether such a downward wiggle as we’ve gotten so far will even go that deep, or if ultimately it stops at the correction level rather than ushering in a deeper downturn. Investors always say they want to buy pullbacks, but when they come it’s often on scary news that sows fear that the decline will be nastier than a nice buying opportunity.

Given the wild action in Japanese stock, bond and currency markets – and the breakneck speculative capital flows that preceded it – one potential, hard-to-gauge risk is that some group of leveraged traders ends up “trapped,” resulting in some sort of financial mishap.

Barring this, though, investors’ default assumption should probably be that markets are undergoing some needed retrenchment that could cool off giddy sentiment and settle down speculation. Of course, in February the Cyprus scare was a fleeting downside head fake. This could be another, but today stocks are much higher than in February, and more investors had crawled out on a limb when a worrisome breeze started blowing.

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