Nasdaq Selloff: Rattled by Rates, Traders May Not Chase This Dip

Today's selloff set records, but is it just a chance to buy? Wall Street's pros are taking a defensive stance for now.
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Sooner or later, the stock market will care about interest rates.

That's the best correlation between valuations and interest rates that most market watchers have been able to draw since the

Fed

met in mid-November of last year. Stocks have rallied right through 50 new basis points in yield on the long bond. They rallied right past a

Fed

statement that as much as telegraphed a Feb. 2 hike. And they've rallied strongest in those sectors that are supposed to be the most sensitive to rates: technology and the Internet.

The stock market cares now.

The long bond's move through the 6.5% yield level

yesterday put the kibosh on a massive opening tech rally. After opening up 117 points, the

Nasdaq Composite Index

swung 200 points to the downside within two hours. Sure, tech ultimately managed one of its characteristically dip-buying

rallies. But the huge damage on the European bourses today -- selling spurred, not coincidentally, by fears over U.K. and eurozone interest rates -- waylaid the Nasdaq to its largest point drop ever.

"Stocks have been ignoring rates for two months, especially the tech stocks," says Peter Boockvar, equity strategist at

Miller Tabak

. "But it can't be ignored forever. 6.5% was the 'magic level,' I guess."

The hard lesson learned by market timers who've been betting that rising yields will bring a correction is that "magic levels" are only as potent as the reactions they produce. In the stock market's special and sometimes circular reasoning, things don't matter until investors decide they matter. And investors have been quite adept at deferring that decision as long as the narrow momentum trend has remained intact.

And now it might not be. The magnitude of today's selloff prompts the question of whether the market's 10-week-long momentum train may have just derailed.

"The dynamics of momentum are to stay with the trend as long as it's going in one direction," says Richard Cripps, chief market strategist at

Legg Mason

. "When the trend stops, you've got to be quick to get out. And in the very short term, it looks like it's stopped."

One day doesn't make a trend, but a day like this changes the way traders look at the market. The smart ones aren't going to reflexively buy this dip -- they need to see something more.

"There's no panic on the trading desks," Cripps said. "You've simply got guys selling half positions, quarter positions. They have no inclination to be the buyer here -- they'll want to see some technical reversals." Traders won't want to chase an immediate bounce at tomorrow's open, if it should come. They'll wait for stronger signs of a true bottom.

Of course, Wall Streeters will remind you that we're just seeing some profit-taking, that things can't move in a straight line higher forever. Remember, the Nasdaq was up 85.6% in 1999.

True enough. Just a few months ago,

Nasdaq 3000 was a wonderful prospect beyond the most optimistic projections of most prognosticators. Today, that level would represent a 27% decline from the all-time high the index set yesterday, a correction of disastrous proportions for many investors.