03/18/2010 05:12 am ET Updated May 25, 2011

Selling Panic Could Rock Stocks

Go figure this crazy market following another bout of schizophrenia. Take last week, a week that may have flashed bum tidings ahead for investors, even the possibility of a selling panic. First came terrific Thursday, then wicked Friday, as big money was made and even bigger money was lost.

Most noteworthy in last week's final two trading sessions were the huge roller-coaster moves in the stock market that really necessitate ulcer-proof stomachs to cope with the tremendous volatility, sharply conflicting good and bad tidings on the economic front and a scary signal that the equities market could be rocked by a selling panic at any time.

One money manager, Arnold Silver of Los Angeles-based A. Silver Associates, figures Friday's dismal market performance might well have been an early sign that the market -- despite its recent strength -- could be slammed by a wave of panic selling the next time it's struck by unexpectedly bad news, maybe kicked off by a lightening quick 200-300 drop in the Dow Jones Industrials.

"Thank heaven for the saps," quips Silver, a reference to what he describes as "those dummies who pushed stock prices appreciably higher on Thursday."

That was the day -- following three recent losing market sessions in which knocked the Dow plunged nearly 325 points on economic fears -- when gloom suddenly turned into euphoria as impressionable investors went ga-ga, driving up the Dow a hair under 200 points.

That buying binge followed the revelation that day that the country's ailing economic health had taken a decided turn for the better, as demonstrated by the news of spirited third-quarter GDP growth of 3.5%, the strongest growth rate in two years.

The economic bulls viewed that showing as fresh, unmistakable evidence that the recession now rests in the graveyard, despite what some market professionals view as alarming facts to the contrary.

A skeptical Silver, the skipper of A. Silver Associates, used the runup in stocks to short them (a bet they would fall in price), particularly banking and retailing shares. "Anyone who thinks we're finally out of the economic woods has got to be living on Mars," he says. You've got to create jobs to get this economy rolling again and we're just not doing it." In addition, based on what he says he hears from the banks, "commercial real estate failures and the ensuing bank write-downs will be a killer."

Friday, though, produced an expected about face in response to unfavorable economic news, namely that consumer spending -- which represents about 70% of the economic activity -- fell in September, the first such decline in five months. In turn, the previous day's buying spree turned into a selling spree as the Dow got smashed for a loss of just under 250 points, giving up all of its Thursday gain and then some.

To the economic bears, it meant an economic awakening, a recognition that the reports of the death of the recession had been greatly exaggerated.

So what's next? The words vary, but the message is clear. It depends on whom you believe. The recession is dead, long live the recovery. That was essentially the cry throughout Wall Street Thursday, following the positive third-quarter GDP news Even the Wall Street Journal-turned economic soothsayer got caught up in the buoyancy, declaring on Friday that the economy had snapped its long slump. In other words, goodbye recession.

I don't know about you, but the market's euphoric outburst Thursday based on a renewed percolating economy just doesn't smell right to me. Nor does it to some market pros. The reason: such exuberance is suspect, given a number of troublesome figures out there that are wreaking economic havoc. Among them:

  • The woes in housing, though showing some signs of improvement, are far from over. Some examples: There's an excess inventory of one million housing units looking for buyers and about 5.2 million homeowners (nearly 11% of them) are no longer paying their mortgages.
  • The jobs picture continues to look grim. Of the roughly 15.1 million unemployed Americans, nearly 36% of them have been

  • out of work six months or more. At the same time, growing numbers of people are disappearing from the work force, about 500,000 in September alone.
  • Incomes are steadily shrinking, with wages and salaries slumping 4% to 5% from year-earlier levels.
Madeline Schnapp, director of economics at West Coast liquidity tracker TrimTabs Research, which is partially owned by Goldman Sachs, thinks the economic bulls are wearing blinders. Schnapp, who insists the recession is fae from over, takes the view that the 3.5% growth in third-quarter GDP was one of those now you see it, now you don't, events.

Why so? Because, she explains, that growth rate largely reflected government stimulus program, such as a cash for clunkers auto promotion and an $8,000 tax credit for first time home-buyers. Schnapp, in fact, figures the two contributed as much 1.5% to 2% of that 3.5% third-quarter growth. But she expects economic reality to be painfully obvious in the current quarter's results. Her outlook: plummeting GDP growth to between 0.5% and 1%.

The auto promotion is now kaput, and the $8,000 tax credit is set to expire at the end of November, although there's speculation it may be extended. Housing also has another catalyst going for it. The government is purchasing about 80% of all mortgage-backed securities, which is helping to keep interest rates low, but this kind of buying will expire in March. In addition, home sales in October are showing signs of slowing from September's pace, notably in California, and Schnapp calculates that they'll drop about 10% month over month.

The economic key, as Schnapp sees it, is that private market consumption will not kick in without job creation, and "we don't see that happening anytime soon." Making matters worse, she says, we have an economy that's losing around a million jobs every three or four months, an economic deterrent which she doesn't see easing until the summer of 2010 at the earliest. "And even then is a big if," she observes.

Meanwhile, Schnapp notes investment money is swimming like a shark looking for yield (which is puny in most money-market instruments) and finding it stocks and bonds. But she feels the stock market is chasing a pipe dream because the market lacks positive fundamentals. "We're looking at another bubble and all bubbles end badly," she says. "Eventually, at some point, without a solid foundation, people sell when there's nothing there, and then you have panic selling."

Write to Dan Dorfman at