Stocks dove on Friday as the renewed market volatility is beginning to remind investors of the bad old days from a year ago. After gaining nearly 200 Dow points on Thursday in response to a GDP report that came in above expectations, traders apparently had a change of heart as the market gave back all of the prior day’s gains and then some.

The big question on the mind of the average investor (and most of the folks on TV as well) was: “What gives?” In short, there is usually a reason for a swoon of 250 points – especially when the dive occurs the day after one of the best days in months. But on Friday, there was little to complain about as the opening bell rang, other than what appeared to be a little profit taking, that is.

But from there, things got ugly – in a hurry. By the time traders came back from lunch, the DJIA found itself down -275 points. And with no real news to speak of, we’re guessing we weren’t the only ones looking for a reason for the market’s tank-job.

Thus, we went looking for something that would explain the sudden loss of confidence. But instead of one single news story, we found seven different things for traders to find fault with. So without further ado, here’s the not-so lucky seven:

The Not-So Lucky Seven

Reality Check for Economy. Thursday’s GDP report, which initially prompted a chorus of “Happy Days are Here Again” from word that the economy grew at an annual rate of 3.5% in the third quarter, served as a wake-up call of sorts on Friday. Although, it was nice to see the number come in better than expected, when you dug into the report, one of the big questions became: Is this going to be sustainable going forward?

This, of course, brought about cries of “too far, too fast” and “the market is ahead of the fundamentals” from the bear camp. But in reality, they may have a point as few rallies in history have traveled as far or as fast as the March 10 – October 19th run for the roses. And since everybody in the business knows that we are overdue for a meaningful correction, it is little wonder that the buyers simply stood aside on Friday.

The Passing of the Buck: Perhaps a better heading for this section would be “Dollar Carry Trade Starts to Unwind.” But in reality, that sounded awfully technical (and more than a little dull). However, it is the idea that big-time traders around the world have either borrowed dollars at our bargain basement rates to buy other assets, or are flat-out short the greenback that is a part of the problem. As we’ve seen over the past several months, the advent of the “dollar carry trade” has meant that when the dollar is falling and stocks are rising, everything is hunky dory.

But, a rising dollar and/or rising interest rates puts a crimp in the profitability of the carry trade. And with traders around the globe beginning to worry about the economic recovery theme, they naturally gravitate to the world’s safe haven currency – the U.S. Dollar. So, with the dollar actually getting a bit stronger and the economy not looking so solid, the programs kick in and stocks get sold.

Wake-up Call For Banks: Calyon’s Mike Mayo came out with a report on Friday suggesting that Citigroup (C) might need to write down as much as $10 billion in something called deferred assets in the fourth quarter. And while analysts quickly came to Citi’s defense and the bank itself called the idea preposterous, the report reminded investors of the fact that the balance sheets of America’s banks are still a mess (and maybe a little of the stonewalling from Lehman and Bear).

Then There is Commercial Real Estate: Speaking of problems with the banks, renowned investor Wilbur Ross said Friday that commercial real estate is a ticking time bomb for the banks. While this is hardly a new idea, it is indeed something to worry about. And since the market is suddenly in worry mode again…

Speaking of Worrying: One of the bear camps’ favorite themes is the idea that the consumer is not showing signs of life. Since households, unlike corporations, can’t go out and issue stock to pay down their debts, they have to tighten their belts. And with just about everyone expecting the next cycle to be a “jobless recovery” it is hard to see what it going to put the consumer back in their happy place – aka the shopping mall. So, with the October Jobs report on tap next week, investors may be worried about what might be in the Big Kahuna of economic releases next Friday.

Looking For the Exits? Another issue cited for the current corrective action in the stock market is the concern that the Fed may soon start looking for an exit strategy for its ultra accommodative monetary policy. Late last week, the Financial Times ran an article suggesting that Bernanke & Co. may change the language in their statement accompanying next week’s rate decision. Although the move is inevitable, traders worry about the concept of taking away the punchbowl too soon.

The Tape Tells All: Market technicians argue that there is no need to worry about any of the above. No, the chart watching crowd prefers to watch the wiggles and giggles found on their screens instead of worrying about such trivial things as fundamentals. While you may find this amusing, we’ll bet you can’t name three investors that don’t at least look at a chart before making an investment decision. The point being that chart watching has become prevalent in today’s investment world.

Why should you care? In short, important happenings on the charts sometimes (but definitely not always!) become self-fulfilling prophecies. Thus, Friday’s breach of the 50-day moving average was seen by the chartist community as a negative sign – and a precursor of more bad things to come.

And while we’re talking tape action, we would be remiss if we didn’t mention that the market’s momentum and internal action weakened considerably this past week. Although like a nagging cough, this condition can persist for some time without being life threatening, it is disconcerting all the same.

So there you have it; seven reasons for the red ink. Of course, the question now becomes: Will it continue? Most everyone in the media says yes at the moment (but then again, weren’t these the same folks singing the economy’s praises on Thursday?). However, we’ll bet that this winds up being a correction instead of a new bear market. And as such, it is important to remember the correction battle cry: Panic early or not at all.

Enjoy your weekend,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

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