Traders work on the floor of the New York Stock Exchange.
Photo by Spencer Platt — Getty Images
By Shawn Tully
October 15, 2014

Why is the stock market sliding so fast? Why do the Wall Street mavens who were predicting big gains for 2014 suddenly look so wrong?

In a day of elastic swings, though always in negative territory, the S&P shed 15 points on Wednesday. It’s the most recent leg in a series of sharp daily declines that have erased virtually all of the once-sumptuous market advance for 2014.

On September 2, the S&P stood at an all-time high of 2017, handing investors near double-digit gains in just eight months. In a flash, the S&P has retraced a parabola that puts it back nearly to where it started. The Dow is faring even worse. Following its 173-point decline on Wednesday, the index has now dropped 2.6% from the start of 2014.

It’s easy to find logical-sounding reasons for the sudden reversal. The fall in oil prices is frequently cited as a major catalyst. The collapse of Europe’s over-advertised recovery also appears to be spooking investors. The military conflicts flaring across the globe are a credible culprit as well.

All of these factors may be hastening the downturn. Or they may not. In each case, the argument that they have little or no effect is just as convincing as the case that they’re decisive. For example, the drop in the price of crude will boost profits for airlines and truckers, and pad folks’ wallets for spending at restaurants and auto showrooms. That will largely offset the drag in growth and profits from oil production. The bad news in Europe has been mounting for months—just as the S&P hit its historic peak. The story of escalating world conflict is similar.

And much of the recent news appears reasonably favorable to markets. The dovish Fed minutes released on October 8 sparked a big market rally and nourished hopes that interest rates will remain extremely low for many months to come. Earnings have been mixed, but hardly disastrous, with marquee names such as J&J (JNJ), Alcoa (AA), and Costco (COST) beating estimates, offsetting disappointing results at Monsanto (MON) and Yum Brands (YUM).

So the question is, why now?

The correct answer is that whenever stocks drop, the “experts” summon all kinds of after-the-fact reasons. Meanwhile, similar things happened during many other periods when stocks fared just fine. Why didn’t the market go through a major correction when Ukraine erupted earlier this year? The market trend over a month or even much longer tells us nothing about where prices will be in a year.

All we know is what already happened. And what has happened tells us that investors, right now, want to be paid in the future for taking the risk of owning stocks.

Put simply, the market is vulnerable to a big drop now because prices are so high. That makes stocks more vulnerable to a correction. The fall in the S&P from 2017 to 1865 has pushed the price-to-earnings multiple, based on one year of trailing earnings, from 20.2 to 18.6. A reasonable measure of future returns is the reverse of the PE, or the earnings yield. By that yardstick, investors can now expect 5.4% annual returns before inflation, versus 4.9% at the market’s peak. So our best conclusion is that investors suddenly decided they weren’t getting paid enough for the volatility and churning anxiety of holding stocks, and they wanted a bigger cushion for living with that uncertainty.

We don’t know if that trend will continue. Still, it’s clear that the drop so far has been relatively small, and that the extra comfort level built into stocks has been slender. The danger is that investors will want a lot more cushion. If they do, share prices will need to drop far, far more.

In fact, the events of recent weeks simply underscore how risky stocks really are. The best argument for today’s high PEs is that equities are now a placid, reliable place that resemble bonds more and more. Just look at how smoothly they’ve risen since the depths of 2009. So if stocks lack the menace of yore, you should be happy to own them even if their returns won’t match the glories of the past.

But churning of the markets over the last few weeks undermines that argument. Who wants to put their nest eggs and emotions through this kind of turbulence without getting paid handsomely? It’s possible that the current selloff marks the start of a giant reset caused by investors’ suddenly deciding equities are a rough ride after all. Or maybe not.

The stock market’s fate is reminiscent of the famous tale from ancient Babylonia—and title of a great John O’Hara novel, known as Appointment in Samara. The fable tells of a servant who saw Death in a marketplace, and in a panic, borrowed a horse from a merchant and galloped off to Samarra, and what he thought was safety. Death approached the merchant, and the merchant told him why the terrified servant had fled. “I wasn’t looking for him here,” Death explained. “I was just surprised to see him in this marketplace, since I have an appointment with him tonight in Samarra.”

Maybe the market will prosper in a Samarra of low expectations. Or maybe it will succumb to the menace that always comes, and few anticipate, when investors want to get paid more, a lot more, for gains that dissolve like a mirage in the desert.

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