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Reasons for the financial ‘downalanche’

By: Marc Cuniberti
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Truth sometimes is stranger than fiction. A week back or so I penned an article called the “Melt up” which detailed the great run up in stocks and how rare it was to see such a sustained rally. Also detailed in that article was the caveat that “this is usually followed by a meltdown.” No sooner did the article hit the wires did the market start to crater and in a big way. From the high of 26,616 on the Dow Jan. 26, last week saw wild gyrations almost daily. It culminated with a handle gripping 1,175 drop on Feb. 5. It has been down 1,579 mid-day so I guess it could have been worse.

We can make an educated guess as to why the “downalanche” (a coined phrase of mine) started but the cause touted by some was that the Federal Reserve would raise interest rates after an economic positive unemployment number came out from the Bureau of Labor Statistics.

Why good economic news causes a stock market selloff seems to be the new norm in the last decade or so is the perplexing question. Not so perplexing however say many analysts.

With the Federal Reserve coming to the rescue after the ‘08/’09 crisis and repeating program after program to stave off periodic sell-offs, investors apparently learned a Pavlovian type of response, knee jerking the market up or down in response to not what the economic fundamentals are telling them but more as to what the fed will do in response to it.

It all revolves around the elixir the fed administers when it comes to monetary stimulus, which is to say how they respond to stock market falls or economic news. Historically the feds drop interest rates to goose an economy (or rescue one) and increase rates to cool off an economy that’s running too hot.

With interest rates near zero for eight years running, some believe the markets quadrupling since 2009 is solely due to these almost zero rates. That being the theory, raise rates and the logical conclusion would be the markets will fall and investors are acting preemptively to this belief.

It’s indeed counterintuitive to think good economic statistics would trigger sell offs but the proof is in the proverbial pudding. A good unemployment number hit the wires the day the selloff began and when another bit of good news hit Feb. 8 (jobless claims at a four-year low) the market started down hard again.

In my opinion, this type of “sell the good news, buy the bad” where market direction is now more influenced by fed monetary policy than economic fundamentals sets a dangerous precedent and a confusing picture to the average investor. The question now becomes: Do you buy stocks when the economy shows signs of weakness because you believe fed will rescue it or do you buy stocks when the economy shows signs of improvement which seems more logical?

According to the most recent market action, the former seems to hold true. But considering the logic of all of it and how we arrived at this point, who’s to say one day the market’s reaction to economic news will once again revert back to a saner evaluation of economic fundamentals?

Which is to say: Wouldn’t it make more sense to buy stocks when the economy is improving and remove the fed from the picture all together? That would mean the fed would have to back off trying to alter market direction and let the free market reign once again. Doesn’t that seem to make more sense?

This analyst thinks so.

This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. Cuniberti is an investment advisor representative through Cambridge Investment Research Advisors, Inc., a registered Investment advisor. He can be contacted at SMC Wealth Management, 164 Maple St. Auburn, 530-559-1214, moneymanagementradio.com. SMC Wealth Management and Cambridge are not affiliated. California insurance license # OL34249.