US stocks plummet on fears of Fed tapering

Updated: 2013-06-21 16:29


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NEW YORK - US stocks plummeted more than 2 percent Thursday following a sell-off on Wednesday that was triggered by fears that the Federal Reserve would reduce its aggressive economic stimulus program later this year.

Experts and traders, however, believe the sell-off was temporary and will not reverse the bullish US market in the long run.

"My thinking is that this immediate short-run market reaction on the day of the announcement was a bit of an overreaction because this was all predictable," Paul Wachtel, a New York University economics professor, told Xinhua in an interview.

Taper fears sent stocks into tailspin

Both the Dow Jones Industrial Average and the S&P 500 on Thursday recorded the biggest one-day loss since November 2011 to close below their important psychological levels. Major stock indices are now roughly 4 to 5 percent off their all-time closing highs reached May 21.

Global markets also experienced across-the-board sell-offs on Thursday, with Asian stocks down around 2 percent and European shares down some 3 percent.

The drops came on the heels of the Fed's June policy meeting that ended Wednesday and was followed by Chairman Ben Bernanke's statement that the Fed expects to scale back its massive bond-buying program later this year and end it entirely by mid-2014 if the economy continues to improve.

The market right now is "very overdone" for what we have seen, said Keith Bliss, a senior vice-president at Cuttone & Company, a New York-based brokerage firm.

The Fed announced after its meeting on Wednesday that it would keep its federal funds rate and pace of asset purchases unchanged.

The announcement was within market expectations but for the first time, the Fed said the downside risks to the outlook for the US economy and the labor market have diminished since last fall.

That was "the most significant change" of the Fed's comment, JP Morgan economist Michael Feroli said in a note on Thursday.

Additionally, Bernanke gave a more explicit timeline for a tapering, saying that if incoming data was broadly consistent with forecasts, the Fed could moderate the pace of bond purchases later this year and continue to reduce its pace of purchases in measured steps through the first half of next year, ending purchases around mid-2014.

The timeline "involves no change in policy," Feroli cited Bernanke as saying, because tapering is highly dependent on incoming data and would not represent a tightening.

However, investors do not interpret the news as optimistically as many experts do.

Besides equities, bonds and commodities were also sold off on Thursday, with benchmark 10-year Treasury yields climbing to their highest level since August 2011.

Crude-oil futures posted their biggest one-day drop in seven months, while gold futures fell to their lowest closing level since September 2010.

"With the global sell-off in assets, my opinion is that many investors will seek out the sidelines and wait for more clarity on the Fed's action," Gregory J. Keating, managing director of New York-based James E. Coffey Securities Inc., told Xinhua.

Volatility in the near term

Regarding the two-day selloff, experts and traders contend that the stock market remains volatile in the near term.

"The summer trading session has not been favorable to the markets within last 3 years in particular, so I expect continued weakness in the coming week unless we can get positive economic data to kick start sentiment that the economy is on the right track and showing signs of significant growth," Keating said.

The market has been very volatile since Bernanke first hinted at a possible tapering during testimony before Congress on May 22.

"People forget how volatile the markets were when we went into these programs. They are just as volatile, if not more, when we come out of these programs," Bliss said.

The Fed and Bernanke both were supposed to use the June meeting to explain what tapering means and calm anxieties concerning the market, but the CBOE Volatility Index, widely considered as a fear gauge of the market, still hit 20 for the first time this year Thursday after surging 23.14 percent.

"I think the market going into July and August could be very volatile," said Alan Valdes, director of floor trading at DME Securities. "The days of just buying anything and watching it go up like what we did in the first six months are probably over for the summer. And we'll see what happens when the tapering comes."

Bull market not to be reversed

Despite the two-day sell-off, experts and traders don't think it will reverse the bull market and is in fact an "opportunity" for long-term buyers.

"A short-term opportunity has been created right now," Bliss said. "This is a time to buy."

Many traders think that the pullback is good for the market because it has taken some fluff off equity prices. Year to date, the Dow is still up more than 12 percent, and the S&P 500 and Nasdaq have risen more than 11 percent

"The market is now repricing, because it has got a little more ahead of itself versus the economy," said Kenneth Polcari, director of NYSE Floor Operations at O'Neil Securities. "The market has to reprice the risk (of tapering)."

The US economy is recovering in fits and starts. US unemployment benefit claims jumped more than expected to 354,000 in the week ending June 15, the US Labor Department reported Thursday.

The US Purchasing Managers' Index meanwhile slipped to 52.2 in June, according to a survey by financial information firm Markit.

In Bliss' view, Bernanke had his own "irrational exuberance" moment after the S&P hit an all-time high in late May.

"I think they (the Fed) want to take some air out of the balloon and let people valuate it," Bliss said. "Hopefully their gamble doesn't start an avalanche. I don't think it will. I think people will come in and start buying shortly."

More importantly, the US market is more resilient than it was before the financial crisis.

Most experts believe that the two-day sell-off is only a temporary phenomenon. The future policy adjustment by the Fed was predictable and wasn't expected to reverse the bullish stock market that has recently emerged.

"The economy is getting better... so by the time we taper, the market may be strong enough to withstand it," Valdes said.

The S&P 500's target for year-end 2013 will be at 1,600, according to Savita Subramanian, head of US equity and quantitative strategy at Bank of America Merrill Lynch Global Research.

Subramanian said last week that the bull market is not over, but the upside is limited after major stocks quickly rallied at the beginning of the year.