The Selloff in Stocks is Just Getting Started

The Selloff in Stocks is Just Getting Started

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Stocks suffered a resounding selloff Thursday, with major indexes falling almost 2 percent.  The selling was blamed on any number of factors, including Moody’s downgrade of Spain’s credit rating, initial jobless claims rising unexpectedly, a much bigger-than-expected increase in the trade deficit in January, and hints of political unrest in Saudi Arabia.  The bottom line, however, is that stocks have risen too high and nervous investors are prepared to sell on any hint of bad news.

The stock market is a daily game of tug-of-war between bulls and bears. Since last September, the bulls have been winning most of the contests.  Now it seems they are running out of steam.  The S&P 500 is already down 3.6 percent from its February 18 high.  Given all the serious problems threatening the economy, the index could go considerably lower. 

Rising energy prices are the most immediate concern because they sap discretionary funds from consumers, leaving them less able to afford other goods and services.  Crude oil prices have been extremely volatile ever since unrest became a daily occurrence in many previously tranquil Middle East nations.  On Thursday, it looked as if we might get some relief.  At one point, market prices for light sweet crude oil were actually down $3.65 per barrel, but they quickly regained much of that loss immediately after news broke that Saudi forces had fired upon protestors and ended the day above $102. Yet oil prices had been climbing long before the recent turmoil began in Arab countries.  The spot price for West Texas Intermediate crude oil, the market benchmark in the U.S., rallied 22 percent in the last three months of 2010.  At the time, most oil traders had no inkling of what was going on in Tunisia, the nation whose citizens inspired Arabs everywhere to revolt against their governments. 

Employment (or more correctly, the lack thereof) is another serious drag on the economy.  While it is true that private sector jobs are finally rising, growth is much too weak at this point in a supposed economic recovery.  Furthermore, many of those who are finding jobs are settling for less pay than they received just a couple of years ago.  In addition, the public sector continues to shed jobs.  It really is quite amazing that consumer spending has held up as well as it has.  However, this combination of rising energy prices and lackluster job growth could be the one-two punch that drives the economy into a double-dip recession. 

It is often said that the stock market is a leading economic indicator.  Many analysts have been arguing that the strong rally in stocks over the past six months portends strong economic growth in the months ahead.  Don’t bet on it. To a large extent, the rally was artificially induced by the Federal Reserve’s $600 billion program of quantitative easing, purchases of Treasury securities dubbed QE2, to keep interest rates low.  Given all the money the Fed showered on the economy, it is no surprise that investors bid up asset prices.  However, investors know the Fed is preparing to shut off the spigot.  Unless the Fed surprises us with QE3, it should be no surprise that investors will continue selling.