Stock Selloff A Long Time Coming

It’s a sea of red out there across U.S. stock markets and Wall Street is careening toward its worst January since the darkest days of the financial crisis.

Relax. Take it easy. Don’t panic. Analysts say if it wasn’t the ongoing tumult in emerging markets it would have been something else to trip the selloff.

Stocks had been on a tear for over four years. Both the S&P 500 and the Dow Jones Industrial Average closed out 2013 at record highs and it’s no secret why: Federal Reserve stimulus in the form of historically low interest rates and three rounds of massive bond purchases, or quantitative easing.

But the Fed announced in December the beginning-of-the-end to all that easy money and the response was swift:

• The S&P 500 is down 4.1% this month, its worst month since May 2012 (down 6.3%) and its worst January performance since 2008 when the S&P 500 fell 6.12%.
• The DJIA is down around 5.7% this month, the worst month since May 2012 (down 6.21%) and the worst January since 2009 when the blue chip average fell 8.84%.
• The NASDAQ is falling 2.3% this month, the worst performance since October 2012 (down 4.46%) and the worst January since 2010 when it fell 5.37%.

This hasn’t exactly come as a surprise.

“Stock markets have been up sharply the last year and we need to clear the air so that stocks don’t get overly expensive,” Peter Cardillo, chief market economist at Rockwell Global Capital, said Friday morning.

Asked if a correction would be such a bad thing right now, Cardillo responded without hesitation, “No. This market was headed for a correction. It’s been a long time coming.”

Cardillo is hardly a lone-wolf contrarian on the subject and the idea that stocks may have been approaching bubble territory has been a nagging concern for months.

“Fear Factor” Gripping Markets

During Janet Yellen’s confirmation hearing in December to replace Ben Bernanke at the helm of the Fed, she was asked directly if the Fed’s stimulus policies had contributed to stock market froth and whether she was concerned about potential asset bubbles.

Yes to the former: Fed policies have had an impact on asset prices, she said. But no to the latter: stocks “aren’t in territory that suggests bubble-like conditions,” Yellen testified.

Cardillo agrees, saying stock prices aren’t overvalued. Nevertheless, even ahead of the current emerging markets crisis he had predicted a correction of 8%.

The selloff in EM currencies, triggered in part by the Fed’s decision last month to start rolling back its easy-money policies, has contributed to a “fear factor that’s gripping the markets,” Cardillo said.

Friday, the last day of January, could be a turning point. If the selloff sharpened dramatically and the S&P 500 slipped below a support level of 1770, that would be cause for concern, according to Cardillo. The broad S&P index was down 10 points at 1784 at 11:30 a.m. EST.

The Dow, after falling more than 180 earlier in the session, has recovered but was still down around 100 points in midday trading.

Meanwhile, more mixed economic data released Friday raised hopes for growth in some sectors but disappointed elsewhere. (That’s essentially been the story of this long, slow recovery.)

Fed Isn’t Worried

To wit, U.S. consumer spending rose more than expected in December, but weak income growth offset the good news. The Commerce Department reported Friday that consumer spending increased 0.4%, better than the 0.2% predicted by economist and the strongest growth in three years. That’s important because consumer spending accounts for nearly 70% of the U.S. economy.

Analysts see the trend continuing upward for consumer spending growth.

“We expect real consumer spending to grow at a faster pace in 2014 than in 2013, since the housing market, job prospects, and consumer confidence are expected to make further gains in the New Year,” said Chris Christopher Jr., director of consumer economics at IHS Global Insight.

Significantly, the Fed passed on an opportunity this week to raise additional concerns about the strength of the recovery, completely ignoring the emerging markets mess and essentially dismissing December’s lousy jobs report.

Instead, the Fed gave the U.S. economy a tacit vote of confidence, voting to continue its tapering plan with a long-term eye toward returning monetary policy to something resembling normal.

So if Janet Yellen, who takes over as Fed chair on Monday, wasn’t concerned about stock valuations in December, she should be even less concerned when this likely-temporary correction plays itself out in the coming weeks.