Stocks in Big Selloff As Investor Worries Mount

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As you give a prayer of thanks on this forthcoming American holiday, you ought not forget that nice stock market rally that has taken place this autumn.  Only problem is, the gains might be gone before your turkey leftovers run out.

Tuesday’s big selloff, or course, is in reaction to North Korea’s unprovoked attack on a South Korean island and heightened concern that Spain could be the next financial domino. But stocks have been falling for the past week, so there’s more at play here and the issues aren’t going away. One factor weighing on stocks is the simple fact that good news these days is not really good news at all. That is, it’s typically about new government measures to address the world’s ongoing debt crisis (think aid to Ireland, QE2 for the U.S., etc) or a slight improvement in otherwise nasty statistics, such as home foreclosures or widespread unemployment. That’s not good news so much as it is a lesser degree of bad news, as in the student who improves from an F to a D.

Here are a few other  factors weighing on the market?

Stocks are not cheap. After the market’s big rally of recent months the bargains are mostly gone. Goldman Sachs strategist David Kostin estimates that fair value for the S&P 500 is about 1200, and that’s just about where the market is.  Thus,  there’s no compelling undervaluation to prompt investors to summon courage and buy stocks. At times like this, Kostin notes, stocks tend to be moved by “information surprises,” typically relating to the economy and corporate earnings but also open to such negative shots as an unprovoked North Korean military assault on its neighbor to the south. Beyond that concern there is the ever-present issue of the economy, and with the  pace of growth slowing after a decent third quarter, the information surprises will not likely be positive ones.

Professional investors are bullish. Why is that negative? Because the market climbs a wall of worry since worriers are open to pleasant surprises. But investors who are already upbeat are vulnerable to  negative news because they are not expecting it.

What has made investors so bullish is the impressive stock market rise that has taken place since mid summer–from July 1st to November 5th the market rose more than 20%. The recent losses undo less than a quarter of the gain that occurred in the past four months, so there’s a lot of bullishness still in the air. Economist and strategist David Rosenberg of Gluskin Scheff  notes that we are seeing “widespread complacency” and the professional investors are close to fully invested in stocks, spurred on by the November election results and the buildup to the Fed’s QE2 decision. “It became clear in the days following the midterm elections and the Fed meeting in early November that we had a good dose of performance chasers piling into equities in particular and risk assets in general with a consensus view that the post Jackson Hole gravy train was going to remain on the tracks through the year end.”

The most troublesome part of the stock market’s recent weakness is that high-end consumers may tighten their purse strings as they watch their portfolios shrink–and a weak holiday selling season would quickly translate into more weakness for stocks.