Investors Quick to Don Bearskin - TheStreet

What a difference a day makes. Prior to Wednesday's sharp selloff, the market was arguably doing a fine job of digesting earnings that were generally good, but not great. After the "hump-day" decline, however, many wondered if the rally has ended.

Of course, the question is really whether such concern is justified. In sum, a variety of factors and forecasters point to more short-term pain for those long, but no reason to panic.

Back on

Oct. 10, Rick Bensignor, chief technical analyst at Morgan Stanley, reiterated a forecast that the

S&P 500

was on the verge of a "volatility squeeze" that could take the index into the 1075 range. On Thursday, Bensignor issued a note warning the low 1050s might now represent the high for the index, which he said is susceptible to "a drop of more than 100 points."

In fairness to Bensignor, he was far from ebullient on Oct. 10, cautioning that the squeeze needed to arrive sooner vs. later. Shortly thereafter, he recommended traders lighten up near S&P 1052, predicting a 20- to 40-point decline from there. This week, he came to a more draconian conclusion that a 10% drop was more likely than a mere 4% correction. The technician declined to comment further ahead of a more detailed report scheduled to be published Friday morning (after my deadline).

Bensignor's rising concern is notable, and follows some cautious comments from Morgan Stanley's Chief Strategist Steve Galbraith last week.

Certainly, there are reasons for concern, most notably disappointing earnings and/or guidance from firms such as

Merck

(MRK) - Get Report

and

Amazon.com

(AMZN) - Get Report

. On Thursday,

Macromedia

(MACR)

,

KLA-Tencor

(KLAC) - Get Report

and

Computer Associates

(CA) - Get Report

suffered heavy losses after posting quarterly results, but major averages avoided serious damage. (Indeed, Thursday's middling session and a solid quarter/guidance from

Microsoft

(MSFT) - Get Report

after the close calmed some frayed nerves.)

With almost 38% of the S&P 500 having reported through Wednesday, 80% were in line or above expectations, the best results since at least the first quarter of 2001, according to Mark Fulton, deputy director of U.S. Equity Research at Citigroup's Smith Barney unit. However, "good results have been well anticipated

and the last couple of days haveseen more negative results."

In addition to earnings, concerns about the dollar and the Bush administration's policies thereabout have resurfaced, along with ongoing consternation about the situation in Iraq.

Less obviously, Oct. 31 marks the end of the fiscal year for many mutual funds, "creating a scenario where mutual fund managers may begin to sell stocks with tax losses to offset capital gains," Diane Garnick, chief strategist at Dresdner Kleinwort Wasserstein, observed in a recent report.

Garnick, who could not be reached for additional comment, noted this is the second year when mutual funds must report after-tax results to the

Securities and Exchange Commission

, but the first in which there are substantial gains on the books. Taxes are a secondary concern to fund managers but this requirement "creates an incentive for fund managers to sell their losers to reduce capital gains distributions," she noted.

Such considerations may explain the heavy selling in pharmaceutical stocks or inability of energy names to gain much traction, despite a seemingly favorable fundamental backdrop.

Selling losers, or "anything that didn't perform well during the previous rally," is also the recommendation of Paul Desmond, president of Lowry's Reports. "If stocks won't go up in an uptrend, they're bad risks in a downtrend."

Lowry offered that recommendation to his (mainly) institutional clients earlier this week, citing concern about investor complacency and a "sharp turn to the upside" of downside volume. The latter indicates waning enthusiasm among investors to hold stocks and "makes us feel as if we're headed toward a short-term correction -- more than anything since the March lows," Lowry said Thursday afternoon.

Still, there are "no classics signs of a market top," and "the long-term trend still appears quite positive," the veteran technician continued. "We still expect the market to make new highs for several more months."

Selling laggards now will improve the quality of your portfolio and provide cash to employ "when we get to a classic oversold condition," Lowry added.

Notably, we're "still a long way" from those levels, he said, suggesting the correction has only run about 50% of its course.

Chicken Soup for the Portfolio

Sentiment gauges suggest rising concern among traders but no dramatic fear.

On Wednesday, the CBOE equity-only put/call ratio rose to 0.77 vs. 0.59 Tuesday while the total put/call ratio jumped to 0.98 from 0.70. The Market Volatility Index -- based on S&P 100 options (i.e. "the old VIX") -- rose to 19.06 from 17.82 Tuesday. Meanwhile, the 1-day Arms Index rose to 1.52 Wednesday vs. 1.10 the prior day. (On Thursday, the overall put/call ratio fell to 0.84 and the Arms Index slid to 0.89, while the old VIX rose 0.4 to 19.10.)

That said, anecdotal evidence suggests rising consternation. I was out sick Wednesday and returned to an email box full of very dire forecasts in the wake of that day's decline. Following Japan's more-than-5% decline overnight Thursday, there was far more concern amongst

RealMoney.com

contributors vs. just 12 hours prior. (For those curious, the analogy between the S&P and

Nasdaq

to

Japan's postbubble Nikkei suggested a peak midweek next week for major averages; either they've either jumped the gun, will rally sharply in the coming few days or are diverging from that unpleasant path.)

Meanwhile, the readiness of some participants to come to a bearish conclusion arguably reflects ongoing disbelief in the rally. At the San Francisco Money Show last week, Kenneth Fisher, head of the $17 billion Fisher Investments in Woodside, Calif., observed the rally won't be over until notable bears such as Pimco's Bill Gross and Merrill Lynch's Richard Bernstein are subjected to the same scrutiny and ridicule as the Abby Cohens of the world were after the bubble burst.

Renewed chest thumping by the bears and the financial media's embrace of them after a few days of weakness suggest we're a long way from that juncture.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.