On Monday, severe selling pushing the S&P 500 to a 12-month low, drove the Russell 2000 ETF (IWM) into bear market territory and crushed many individual stocks. The selling accelerated throughout the day and, even though oversold technical conditions were obvious, market players had no interest in trying to catch a market turn.
The fact that the market is undergoing some severe corrective action after years of an uptrend isn't surprising. It is the nature of the market to go through cycles of ups and downs and by almost any measure, the recent bull market has been longer than most.
What is making the current correction more difficult is that there isn't any simple explanation for it. If there was a simple news event, like impeachment of the President or higher interest rates, the market could discount the event and move on. Bad news can be priced in and the market can then move on.
When the market corrected in 2000 and then in 2007-8, there wasn't any big mystery about the cause. In 2000, many stocks had become outrageously valued, as metrics like 'clicks' and 'page views' were used to drive stocks to crazy levels. The fallout took years to play out, but there was no mystery about the driving force.
In 2007-8 the catalyst, it was the unwinding of subprime debt and the highly leverage balance sheets of banks and brokers. The market was supported by trillions of dollars of bad debt, and as it unwound, the foundation of the financial sector was shaken.
The current correction lacks a similar dramatic catalyst. There is no crazy valuation bubble and financial institutions are not overly leveraged. What the market is struggling with is a variety of vague problems that are creating uncertainty.
The biggest positive is that the economy is healthy. Growth is slower, but still strong at around 3%, unemployment remains historically low, stocks are not overvalued, corporate profits are strong and there are few signs of inflation. There is nothing similar to what drove the last two bear markets.
There are concerns that central bankers are removing accommodation as the economy slows, but the Fed has backed off recently from a hawkish posture and is likely to confirm a "wait-and-see" approach tomorrow.
The market does not want a hike tomorrow, but currently the odds are around 68% for a quarter-point hike. That is down from nearly 80% recently, but the action of the stock market has put more pressure on the Fed to forego this next hike as they take a more dovish stance.
The trade war issue and the political drama of President Trump have contributed to the pressure on the market, but both these things are driven by media drama to a great extent. The market can discount the issues, but it is unable to fully discount these issues that are emotionally driven, vague and uncertain.
However, just because the catalyst for the worst corrective action in many years is not very clear doesn't mean that it can't continue. In fact, selling of this sort tends to feed on itself, because there isn't any one issue that can be discounted and then ignored.
Rather than try to argue that the price action is unjustified, we have no choice but to respect it and wait for it to shift. Eventually the issues that are driving the action will be fully discounted and stocks will improve, but currently we have no choice but to stay defensive and protect capital.