Thursday, August 4, 2011 4:47 PM – Selloff Steepens into Close

What a nasty day in the stock market! After bouncing off support the selling resumed and got much worse in the last hour. The S&P 500 index was -4.8% for the day. All indexes are now in negative territory for 2011. Even gold and silver were down today as were oil and other commodities.

Treasury bonds, the safe haven for big institutions were bid up to a new record high price. The yield on the 2-year US Treasury is now roughly 0.25%. That rate is even lower than during the panic of 2008-09.

Europeans are driving the selling in stocks as they raise cash. For much of this downward fall the last 10 days US markets didn’t really join the selling until today. Lows for the day were usually set in the morning while European traders were still working.

The fact that gold is down tells me that margin calls are prompting further selling so that institutions are even willing to sell their winners to raise cash.

I don’t see the market as measured by the S&P 500 index dropping below 1100. For the Dow Jones Industrial Average that would be 10,500. That would be a further drop of 8% and would take us back to levels we last saw in Summer 2010, before Chairman Bernanke announced his quantitative easing program.

I say that because panic selling, the last stage of a market decline has started today. Also, the market is down 10% from the high in July and 10%-15% is a normal correction in a bull market. The correction in Spring 2010 was 16%. I expect this one to be about the same.

This is not like 2008 in that big financial institutions are not going bankrupt and banks are not refusing to lend to each other, seizing up the credit markets so that the economy stops. Yes, whole countries are now having liquidity problems and maybe that seems worse to some people but there are solutions to that problem, such as extending bond maturities or pulling out of the European Union and revaluing the country’s currency.

Strange as it may sound, large banks not being able to raise the cash they need to stay afloat is worse than countries struggling to raise cash. A bank can die; a country lives on unless it is conquered in war. Even that is sometimes temporary, as in WWII. That’s why allowing the big banks to take on so much risk prior to 2008 was as stupid and dangerous a behavior as a group of financiers and regulators can possibly engage in.

Generally, I have only sold those stock funds that are down 15% and that is a small portion of our portfolios. Our bond funds are generally up. If tomorrow is like today, more sells of stock funds would likely be triggered. However, I think the bottom is very close in terms of time. Risk on the market indexes is down to a total of 15% loss from the high in 2011, about 8% lower than here.

Tomorrow at 8:30 we get the unemployment figures. Most people focus on the unemployment rate. Professionals are more concerned with the shorter-term net change in the numbers of people working. Unless the report is dramatic, unemployment numbers will not be the main attraction. That is likely to be renewed European selling. We’ll see.