The major indices suffered through another day of intense selling on Thursday. The drop was enough to crack some key support areas and pushed the overall market into a technical correction as defined by Investor's Business Daily.
The selling has become increasingly correlated as it has continued and left few stocks untouched. Initially, the corrective action was triggered by a rotation out of technology stocks that had benefited from the work-at-home movement and into the "reopen the economy" stocks such as hospitality and airlines.
This rotation action was driven by optimism about the reopening of the economy, but one of the primary consequences of a stronger economy is higher interest rates and inflationary pressures. This is what has been driving the recent corrective action.
On Thursday Federal Reserve Chairman Jerome Powell addressed the growing concerns about inflation and helped to make the situation worse. The bond market took no comfort from his comments and remained under pressure. This spilled over into an equities market that was already struggling and accelerated the selling momentum.
Momentum cuts both ways. We have enjoyed it to the upside since the bottom last March, but now the bears have the edge and have the market under extreme pressure.
The key thing to keep in mind right now is that corrective action of this type is primarily index-driven. Stock picking won't help you avoid the selling. All stocks, good and bad, are at risk in this market right now. Market players simply want to protect capital and will dump stocks without regard to their individual merits.
What makes this corrective action so difficult for many market participants is that they do not want to let go of their good stocks because they are convinced they will come back strongly when market conditions improve; however, there is just no way to know how far they might sink during this correction. In good markets it is very easy to misjudge how high stocks may run, and in bad markets it is very easy to underestimate how low they may drop.
When dealing with a market correction such as this one there is little choice at times but to cut some of your favored stocks and then plan to buy them back when conditions improve. Sometimes you will be able to rebuy them better, and sometimes you will have to pay up in order to re-establish a position. The important thing is to protect capital and maintain a high level of flexibility so that you can move aggressively when conditions improve.
Early market indications are flat, but this is a nervous environment right now. Sell stops will quickly be triggered if Thursday's lows are tested.
The good news is that correlated, index-driven corrections always eventually lead to some excellent stock picking. We simply have to protect capital and wait until conditions shift.