Is It Time to Panic?

End of Day Update:

It was another brutal day for the market. The S&P500 extended Wednesday’s selloff, erasing well over 50-points across these two sessions. Volume was the highest we’ve seen since we were stuck in the throws of November’s pullback.

Yesterday Janet Yellen rained on the bull’s parade. Today it was Mario Draghi’s turn. While the European Central Bank expanded its easy money policy, it didn’t go as far as many traders were hoping. That sent European markets plunging over 3%. The sour mood quickly spread to US markets where we embarked on a relentless sympathy selloff that eroded prices throughout the day. Given the dreadful headlines and all-consuming uncertainty, we found ourselves with an oversupply of nervous owners desperate to get out, but few buyers willing to step in front of this mess. The nearly nonexistent demand meant sellers had to continue offering lower and lower prices to attract buyers. But in a vicious cycle, those discounts convinced even more owners that they needed to get out. This downward spiral didn’t stop until the closing bell saved us.

Today most sellers embraced a “sell first, ask questions later” risk management strategy. The reason I know this is because nothing changed economically between today and last week. We find ourselves inside a frustratingly slow economic recovery with repressed energy prices, a strong dollar, and a looming Fed rate hikes. Just like last week, and last month.

If the fundamentals didn’t change traders’ outlook, then it had to be something else. Few things are more contagious than fear. When confident owners watched the value of their account drain as everyone else hit the sell button, they lost their nerve and joined the herd. The unfortunate thing is the market has a nasty habit of humiliating reactive traders. It almost has a sixth-sense for knowing exactly where our pressure points are and pushes us one inch beyond them. Rather than reward a reactive seller by allowing him to escape a far larger selloff, most often the market adds insult to injury by rebounding as soon as the emotional seller finishes giving away his stock at steep discount.

The looming fear is what if Friday’s Jobs Report adds more fuel to the selloff. While that is a real possibility, successfully trading is a game of playing odds. We know the vast majority of stock owners are indifferent to these minor gyrations. They are the blissfully ignorant 401k investor or the large institution that is so ginormous they cannot dance around these daily price swings. That means most of this daily volatility is driven by the small segment of active traders. The thing about active traders is while they throw their weight around with great effect, they don’t have a lot of ammunition. Once they jump from one side of the market to the other, they used up the only vote they get and it takes a new trader to keep a move going. As awful as today feels, lets not forget we are only 4% from all-time highs. This is still a long way from waking up the oblivious masses who rarely look at their brokerage statements. If today’s selloff is just another hysterical move driven by overly active traders, it will stall and reverse as quickly as every other “fearful” selloff we’ve endured this year. The scarier it feels, the closer we are to the bottom.

Jani

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