Market tumult enters new, scary phase

The persistent pounding global stock markets are taking seems to be taking on a more sinister tone and more dangerous phase, with emotions and fear taking on a bigger role in the rout, investors questioning the ability of the world’s central bankers to calm the market’s frayed nerves and a volatile environment in which selling begets more selling.

At the moment, the world’s stock markets are stuck in a negative feedback loop where a selloff in one part of the world sparks a stock plunge in another corner of the globe, which then spreads to yet another market. In short, fear in one part of the globe sparked by growth fears, sinking oil prices, interest rate confusion and – yes, falling stock prices -- is spreading to other places, causing a market-specific type of contagion that causes a self-fulfilling prophecy of ever-lower stock prices.

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Indeed, what started out as a selloff in the energy patch has spread to the key financial sector and once-high-flying tech sector.

“We’re at the stage when fear begets more fear,” says Nick Sargen, senior investment advisor at Fort Washington Investment Advisors.

Adds Brad McMillan, chief investment officer for Commonwealth Financial Network: "We are moving from a selloff based on broad general fears, such as a Chinese slowdown, to one based on some specific and credible fears around the European banking system."

The financial pain is adding up. The Dow Jones industrial average cratered another 255 points Thursday and is now down 10.1% for the year and 14.5% from its record high back in May. In another sign of pain, the Nasdaq composite after Thursday's 0.4% drop is now down 18.2% from its July 2015 peak and is flirting with a bear market, or drop of 20% or more.

Investors are running to havens such as U.S. government bonds and gold after hitting the sell button on stocks based on bad things they think may happen.

European banks, for example, have gotten pounded this week on worries that bad loans, low profits, stresses in credit markets and slow growth around the globe have put them in a vulnerable position. The selloff in U.S. shares is based on the fear that a recession is coming, even though job growth is robust, housing is solid and consumers continue to spend and remain in good shape. Wall Street is basically pricing in a recession that may not even happen.

There’s also growing fear that a big backstop for markets since the last financial crisis back in 2008 – the world’s central banks – have little fresh ammunition to fight the latest firestorm in financial markets.

“The main fear today is that we’re in unchartered waters, with the U.S. and global economy slowing while the major central banks have interest rates at or near zero,” explains Sargen. “Normally, investors turn to policy makers to act when there is a loss of confidence, but they may be out of bullets.”

Two days of testimony before lawmakers by Federal Reserve Chair Janet Yellen has done little to soothe the frayed nerves of investors around the world. Yellen, while noting the potential risks to the U.S. economy from the recent market turbulence and lower growth trajectory of the global economy, says it is too early to say these headwinds will have a major adverse impact on the U.S. economy. That message has created confusion as to whether the Fed will continue with the interest rate hike cycle it started in mid-December with a quarter-point hike that took rates off zero.

Wall Street is starting to price assets – many with inflated prices due to the Fed’s easy-money policies in recent years -- based on the underlying strength of the business or economy, as opposed to simply hoping the Fed or other central banks will ride to the rescue. In short, the market is in the process of re-rating the market’s price-to-earnings multiple downward.

“The market is still expensive as we migrate away from central banks and move toward fundamentals,” says Jack Ablin, chief investment officer at BMO Private Bank.

When investor decisions are dominated by emotions, even stocks not massively affected by the negative trends of the day get crushed, too.

“When emotions overtake reason, behavior becomes bizarre,” says David Kotok, chief investment officer at Cumberland Advisors. “Fear is rampant.  So fundamentals (or things like sales, earnings and market position) mean nothing.”

If there’s a silver lining it is that the fear-based selling and jump in irrational pessimism could be signaling that this wretched period for markets could be transitory, adds Kotok.

Says Kotok: “This is temporary and marks the capitulation stage. Panic intensifies. When sellers are exhausted, the situation reverses. We are close,”  adding that he’s been buying “selected exchange traded funds which are getting cheaper every day.”

There is also a sense that investors no longer view big market price dips as a good entry point, as they see few catalysts at the moment to drive stock prices higher, market experts say.

“I think some people that were ‘forced’ into stocks due to low interest rates are throwing in the towel, (which is resulting in) a general reset on the market after a nearly seven year run,” says Bill Hornbarger, chief investment strategist at Moneta Group. “Some of the high flyers in the Nasdaq are finally rolling over and they typically have the higher P-Es (or higher valuations).”

Still, despite the flight from risk in financial markets, Hornbarger says it “feels much more orderly than (market meltdowns in) 2008 and 2000 and there isn't the panic and other disruptions we saw then as of yet.”