What Spooked The Market?

With US indexes having the worst performance in months, investors are scrambling to find a reason for the steep decline.

Mainstream Wall Street pundits attribute the decline in the S&P 500 to the contraction in the Chinese factory output released overnight while the US markets were closed. With China being the growth story over the last 15 years, a sudden contraction in its pace of growth may have worldwide implications.

What cannot be blamed is earnings season. So far, of the 101 index members that have reported, 73% have beaten estimates and 66% have exceeded sales projections. Also, per-share profit for companies is expected to climb in the fourth quarter along with sales.

So far this year, the economic data that has been released has been benign. The unemployment rate has continued to decline and the economy appears to be improving, albeit at a slow place.

Federal Reserve officials, which use the labor data to determine the rate of tapering, modestly reduced their monthly bond purchases by $10 billion to $75 billion at the December meeting. The lesser-than-expected reduction in bond purchases sparked the year-end rally to all-time highs.

Perhaps social unrest in Ukraine and Thailand that has fostered riots and anti-government protest has contributed to the market's decline and ignited a rally in the gold market.

So, if earnings have been good, economic data benign and the Fed continuing to be accommodative, what is spooking the market?

Nothing. When taking into account the huge gain for the market in 2013 and over the last four years, the expectations for this year's markets are way too high. While ending the year at an all time high, many investors expected to start 2014 the way 2013 ended.

When this scenario did not come to fruition, as evidenced by the market repeatedly failing to make new all time highs, some investors were willing to take some chips off the table. And with a slew of positive earnings reports not pushing the market to new highs, investors have taken “sell the good news” approach as opposed to waiting for bad news to exit.

Also, take into account the wicked consolidation for the index during 2014. Excluding the the two lows made on January 13 (1809.50) and January 14 (1812.75) the index has been confined to less than a thirty point trading range for the year. Very rare indeed.

Now the moment of truth has arrived for the index. Since coming within a few points of the yearly low (1809.75) in Thursday's trading, reaching 1813.75, the index is already attempting to stage a rebound, rallying back to the 1818 level.

If the market can continue the rally, the index may very well drift back to upper end of the year long trading range and make yet another attempt at making new highs.

On the other hand, if the index cannot recover from Thursday's steep decline over the next few days and breaches the yearly low, then investors may be in store for a more substantial correction in the bull market than they were accustomed to in 2013.

This story was written by Joel Elconin.