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Why Wall Street’s Selloffs Have Been, and Will Continue to Be, Brutal: News Analysis

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The stock market is like a theater where traders, portfolio managers and individual investors act out the sentiments felt in the broader economy. In more placid times the show can be rather ho-hum, but this past week’s brutal selling on Wall Street, despite its precipitating causes, is a reflection of ongoing pain on Main Street.

Economists believe the stock market is a leading indicator of investor expectations. While the headlines have focused on the Fed’s Operation Twist and Europe’s sovereign debt and banking crisis, the negativity fully matches sentiment on Main Street.

A Gallup poll this week, one of a series surveying the U.S. economy, shows that a large majority of Americans, 61%, expect the economy to be no better one year from now than it is today. This is a complete reversal from a similar poll taken in 2009 at the end of the recession, when 65% of Americans expected the economy to be better or fully recovered by 2010.

While the National Bureau of Economic Research has not officially weighed in on the question, 80% of Americans surveyed by Gallup have already declared we’re in a recession. (The Economic Cycle Research Institute, an allied but independent forecasting group, reported slippage in its weekly leading index Friday.) The negativity has not moderated much from the peak 84% who told Gallup we were in a recession in 2009–when, indeed, we were.

The glumness amid nonrecession (unless of course we actually are in a recession) is likely the result of dashed expectations. Historically deep recessions are followed by robust recoveries. Despite all the stimulus (and some would say because of it), the recovery has been anemic. A Gallup survey released last week shows that economic confidence and consumer spending never really picked up from the time the last recession ended.  Indeed, in Gallup’s survey economic confidence has fallen to a level last seen in February 2009, when Congress passed a $787 billion stimulus bill. Between now and then confidence essentially flatlined for three years.

On the jobs front, Gallup found some improvement from 2009-2010 lows, but there is still a yawning gap with pre-crisis employment levels. Its survey shows an 18.5% underemployment rate and a 9.1% unemployment rate. Gallup concludes “recovery is far from reality in terms of economic confidence, job creation, employment, and consumer spending.”

Which brings us back to this week’s stock market drama.

All that fitful selling–that 391-point drop in the Dow on Thursday–is fueled by our era’s negative sentiment. There are up days and there are down days, to be sure, but in today’s environment there is a powerful readiness to believe bad news, to act on it and to realize it as self-fulfilling prophecy. That is no different than the positive sentiment of the late ’90s, when there was a willingness to grant credence to virtually every story about some new dot-com stock whose future profits were thought to be as far as the eyes could see.

Until some meta-catalyst comes that can fundamentally change today’s negative dynamic–massive new hiring, new confidence-inspiring leadership, the outbreak of world peace, whatever–dark drama will continue to be showing at stock market near you.