Talk Is Cheap and Has a Price

All the chatter about the 'need' for a market correction suggests a troubling level of complacency.
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Maybe it's self-serving for a writer to say, but words sometimes speak louder than actions. Words, rather than actions, are certainly at the crux of this week's stock market volatility. And words could well be at the crux of why there may be more drama to come.

To recap, China's stock market crashed overnight Monday because officials had uttered some words about squashing speculation. Back on this side of the planet, strategists and analysts say that until Tuesday, they couldn't attend a client meeting without hearing the constant head-shaking mantra of "we really need a correction," or "this market is just unbreakable."

So the China stock market selloff quickly turned into the U.S. economy story, where fears of a recession became the hook for a correction many traders had virtually willed into existence. On the heels of a weak durable goods report Tuesday, the reminder from ex-

Federal Reserve

Chairman Alan Greenspan that recessions are possible (not "probable" mind you) was particularly resonant. The subsequent outrage over whether Greenspan should or shouldn't have said so just proves how much the market probably needed to hear it.

Traders on Wednesday were just as easily sedated by the soothing words about future economic stability from current Fed Chairman Ben Bernanke. He said the markets acted "normally," that there was not a single trigger for the selloff, and that the economy later this year is likely to be stronger than the fourth quarter of 2006. The Commerce Department that morning downwardly revised fourth-quarter GDP growth to 2.2% from 3.5% previously. The markets bounced, albeit somewhat anemically.

Thursday's market, which at the outset looked ready to repeat Tuesday's whitewash, was absent official words. A dramatic 206-point drop on the

Dow Jones Industrial Average

was swiftly rescued by the stronger-than-expected ISM report. But there certainly were lots of words bandied about, and the complacency that brought the market to such low levels of fear and volatility heading into this week is clearly not washed out.

After flip-flopping up and down all day, the Dow slipped 0.3% on the day to close at 12,234.34. At the first initial drop, the index slid as low as 12,059, about 20 points past Tuesday's low. The

S&P 500

closed down 0.3% at 1403.17 on the day and the

Nasdaq Composite

fell 0.5% to close at 2404.21.

The market was moving largely in unison, but sectors that seemed stronger included the homebuilders, where some bottom-feeding may have resumed.




D.R. Horton

(DHI) - Get Report



(HOV) - Get Report


KB Homes

(KBH) - Get Report

marked gains ranging from 1.2% to 2%.

The technology space showed some signs of life as well Thursday.


(AAPL) - Get Report

gained 2.9% on an analyst upgrade, while


(ORCL) - Get Report

rose 2.1% on its announcement it plans to buy software company



, which soared 20%. Also,


(SAP) - Get Report

rose 3.3% on speculation of a private-equity buyout.

The 10-year Treasury note ended up a fraction, but unchanged in yield at 4.5%.

Speak No Evil

Back to the words. Regarding Tuesday's selloff and Thursday's early swoon, many traders and commentators said some version of: "There is nothing fundamentally wrong."

They may be right.

The foundations of the liquidity boom that fueled this bulled-up market are still in place, says Ethan Harris, chief economist at Lehman Brothers. The world isn't embarking on a synchronized tightening of monetary policy. Japan doubled its interest rate two weeks ago but to a still minuscule 0.5% and no financial institution blew up as a result. Plus, $60 per barrel crude oil still has the petroleum-producing nations awash in so-called petrodollars they will put to work.

Harris believes the market and the U.S. economy are more likely to come out of the other side of this correction with bullish sentiment back on track. But he does acknowledge the risk that excess caution, or a move to cash, could cause liquidity to quickly vanish from the system.

"When people call for a correction, they're just waiting to get back in," says Art Hogan, chief market analyst at Jefferies & Co. "There is still pent-up demand for equities at a better price. As opposed to looking at this as, 'How long does this last?' the question is more, 'Maybe now we have that better entry level, where we can get cash on the sidelines back in the game?' "

Maybe that's true about both the fundamentals and the dip-buyers. But if this market correction was about flushing out complacency, such stubborn defense of the bullish case after just

one very bad day feels like reason enough to stay worried.

"If there was a more fundamental force in its

the market decline's cause, we might be inclined to make changes," says James Paulsen, chief investment strategist at Wells Capital Management, who has decided to stand pat with his portfolio recommendations and weather this storm. "I think when it calms down we're left with a cheaper market, and we can make some plays there," he says, adding that there may be a few more days of volatility before things calm down.

But Paulsen caught himself: "What makes me wonder is that too many people seem to be saying that same thing."

Margie Patel, portfolio manager at Pioneer Investments, had a similar thought amid Tuesday's selling. "Absent fundamental bad news, I don't see how this correction could be that big of a correction," she says. "Admittedly, that is how the Thai baht looked too," before its seemingly innocuous 1997 devaluation led to the so-called Asian contagion that roiled global financial markets for a year.

Liz Ann Sonders, chief investment strategist at Charles Schwab, agrees that "there is still a lot of complacency," and worries that the "financially engineered" liquidity created from the trillions of dollars of derivative products sold to thousands of hedge funds could be the cause of something more dangerous than a 3%-4% drop in the stock market.

For example, "the size of the subprime mortgage market doesn't accurately portray the size of the risk there," she notes.

So whether the damage from this newfound volatility is done or not seems too early to say ... or write.

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


to send her an email.