Stampede to the Exits

A huge U.S. selloff follows a big decline in China, which could reverberate around the world.
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It's somehow poetic that a plunge of almost 9% in China's stock market sparked the most panic-stricken day in the U.S. stock market since the Sept. 11, 2001, terrorist attacks. China is our silent partner in sustaining economic growth via the symbiotic relationship of its excess savings and cheap labor fueling our excess spending and debt.

So when already jittery traders saw China's stock market and other world markets plunge overnight and U.S. durable goods orders come in much weaker than expected, investors decided it was finally time to redefine risk and take money off the table.

On the heels of

Monday's record-setting M&A transaction and former

Fed

Chairman Alan Greenspan's talk of recession, the market that was "due for a correction" finally hit its payday.

"This could be an inflection point here," says Randy Diamond, trader at Miller Tabak. "We're finally getting one of those days ... the kind of day we haven't had in a long time."

The action was panicky and dramatic, and the carnage may get only worse. Not only are there several key data points this week that could provide more grist for the bears, including a revision to fourth-quarter GDP growth Wednesday, but the emerging-market corrections could be amplified by the wildness of the U.S. session.

After a day of pure red, the last hour of trading ratcheted the damage and the fear to bloodbath status.

"The breadth and intensity of the selling was at levels last seen during the crash of 1987," wrote

RealMoney.com

contributor James "Rev Shark" DePorre.

The

Dow Jones Industrial Average

was already down nearly 300 points heading into the final hour of trading, then gapped down to register a massive 546-point decline shortly after 3 p.m. EST. The Dow rebounded more than 100 points within a few minutes, closing down 416 points, or 3.3% to 12,216.24. The

S&P 500

slid 3.5%, or 50.3 points, to close at 1399.04. The

Nasdaq Composite

fell 3.9%, or 96.7 points, to close at 2407.87.

A computer glitch reportedly caused the giant 3 p.m. drop in the Dow, but the selling pressure was massive across all sectors of the market regardless. All 30 Dow stocks were in the red, as were a whopping 497 of the S&P 500. The

NYSE

saw 98% of stocks in retreat, as more than 4 billion shares changed hands. Declining stocks outpaced advancing ones by 7 to 1 on the NYSE, and 14 to 1 on the Nasdaq, where 3.1 billion shares changed hands. The so-called fear index, or CBOE Volatility Index, jumped 64%.

In exchange-traded funds, the selling and the shorting was fast and furious. The S&P 500 ETF, the

SPDR Trust

(SPY) - Get Report

, declined 3.9% on four times its average volume. The volume on the

Nasdaq 100 Unit Trust

(QQQQ)

was nearly three times average amid a 4.1% decline.

The worst performers on the Dow included drops of 5% or more in

General Motors

(GM) - Get Report

and

Disney

(DIS) - Get Report

, and more than 4% drops in

Exxon Mobil

(XOM) - Get Report

,

Microsoft

(MSFT) - Get Report

,

Procter & Gamble

(PG) - Get Report

and

Verizon

(VZ) - Get Report

.

Other notable losers included stocks with exposure to China (perceived or actual), such as

Goldman Sachs

(GS) - Get Report

,

Qualcomm

(QCOM) - Get Report

and

CDC

(CDC) - Get Report

, as well as high-end retailer

Nordstrom's

(JWN) - Get Report

, which issued disappointing results and guidance.

The Treasury bond market rallied Tuesday in part on a flight-to-quality trade. Traders also are embracing weak economic data, like Tuesday's durable goods orders, to price in more rate cuts and a weak economy. The yield on the 10-year Treasury bond fell to 4.51% from 4.63% Monday.

Likewise, the fed funds futures market increased odds of a fed funds-rate cut to 24% at the May 9 Federal Open Market Committee Meeting, up from 4% Monday, according to Miller Tabak. The market puts odds of a cut in June at 56%, up from 20% Monday and 2% two weeks ago.

Tail Wags the Dog

Overseas market selloffs generate fear and selling in U.S. markets, so Tuesday could be just the harbinger of more bad days to come. Many of the Shanghai Composite's stocks hit 10% decline-limits in last night's session, so those stocks could well "gap down" at the open in China, which occurs at 8 p.m. EST. New Zealand's stock market is already open and recently down 2.8%. Damage in global markets wasn't limited to the Pacific Rim, either. Brazil's Bovespa slid 6.6%, while London's FTSE 100 fell 2.3%.

A Chinese government mandate that banks' increase their reserves, combined with fears of further speculation-squashing, sparked China's correction. The reserve requirement removes liquidity from the system, similar to the impact of a rate hike or a rise in the value of its currency. Such moves may be just beginning.

The government has been on a campaign lately to discourage rabid speculation. Chinese officials warned in early February that "speculation will only cause bubbles, which will burst," adding that "the most important move to protect investor interests is to ensure the healthy development of the capital market."

China has already cooled down real estate investment with tax policies and many expect it will implement similar policies to quell stock market speculation, says Winston Ma, author of "Investing in China: New Opportunities in a Transforming Stock Market." China wants to preserve its aim of constructing a "harmonious society," says Ma, meaning reducing the gap between rich and poor as much as possible.

Whether China backs off from imposing more liquidity-reducing controls or not, the chain of events Tuesday spotlights the thin ice our markets skate on. The U.S. economy, at slightly below-trend growth and above-trend inflation levels, is ultrasensitive. China's aim, as outlined in its 11th Five-Year Plan for National Economy and Social Development last October, is to move from prioritizing "getting rich first" to "common prosperity."

That mission might not fit so well with global stock market rallies.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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