Stocks: The Liquidity Rally Just Died

If anyone had any doubt that this year's rally was partially (or, perhaps, even heavily) fueled by the market's happy hope of eternal Fed liquidity, the market's reaction to Ben Bernanke's announcement on Wednesday afternoon that the central bank expects to slow its bond buying this year should erase any and all of them. Today was a big day for the markets - all of them:

  • The S&P 500 and the narrower, price-weighted Dow Jones Industrial Average finished the day down 2.5% and 2.3%, respectively. The S&P 500 is now off its May 21 high by roughly 5%. It's worth noting that the market achieved that high one day prior to the notion of a 2013 tapering in QE3 first surfacing from the Fed.

  • Government bond prices also fell. According to Tradeweb, the yield on the 10-year Treasury note hit 2.425% this afternoon - its highest level in nearly two years. On May 1, the same yield was 1.63%.

  • Let's be clear: Yesterday, the Fed rang the death knell for the long gold trade. As investors come to terms with the fact that the economy and financial markets are normalizing, gold's appeal as a safe haven diminishes. Furthermore, as interest rates rise (see above), so, too, does the opportunity cost of owning gold, which offers no yield. The price of gold fell today, but it's the magnitude of the decline - 5.8% -- which is really worth noting, as the yellow metal closed below $1,300 for the first time since Sep. 2010. Shareholders in the SPDR Gold Shares ETF have suffered a 24% loss year to date, which is pretty impressive for a "store of value."

  • Finally, underscoring investors' nervousness, the CBOE Volatility Index (VIX) shot up 23%, to close above 20 for the first time this year. The last time it closed higher was last Dec. 28, when the market was wrestling with fear of the the "fiscal cliff." (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

Faced with volatility, jitters are normal, but there is no cause for panic -- this process looks very healthy to me. The stock market is down just 5% from its all-time (nominal) high, and that mark always looked a bit frothy, anyway. There was no reason to believe that the Fed's monetary largesse would last forever, even if the market wanted to behave on that basis. We're on the path to normalization, and fundamentals are reasserting themselves; surely, no genuine investor could have cause for complaint there.

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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