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This Market Selloff May Be Different

Stock markets were beset by interest-rate jitters on Friday, making it the worst day for the major U.S. averages since late June.

Every one of the 10 Standard & Poor’s sectors ended in the red, and bonds and commodities also had a bad day. The backdrop to the selloff was recent developments indicating that consensus market expectations have attached too low a probability to a Federal Reserve interest-rate hike this year, as I have argued.

The generalized move down in stocks is sparking an interesting discussion about how investors should respond. After all, we have experienced such sudden air pockets in the last year. These events have been rather infrequent given the context of unusually low market volatility, and all have proved both temporary and quickly reversible.

Whether this equity market selloff will follow the same course is, of course, open to debate. Already, some are urging investors to “buy the dip,” hoping to repeat a strategy that has proved profitable in the past. Other commentators are more cautious, and some have suggested that investors should sell before prices fall even further.

Where you end up on this issue has less to do with your assessment of corporate and economic fundamentals than with how you see the prospects for a continuation of the recent exceptional period of both public and private liquidity support for financial markets. Specifically:

  1. It is unlikely that fundamentals will improve significantly any time soon.

    International Monetary Fund Managing Director Christine Lagarde signaled last week that the IMF is again likely to revise downward its forecasts for global growth, a confirmation that the world economy remains fragile and uneven. The sputtering of structural and cyclical expansion engines is being accompanied by highly unbalanced macroeconomic policy responses, including the prolonged excessive reliance on central banks, weak global policy coordination and an inability to translate good policy intentions into effective improvements.

  2. Politics and geopolitics aren’t helping.

    The political context in many Western countries is far from conducive to good and calm economic policy: The U.S. is in the final stretch of a contentious presidential election; in the...