Why Stocks Sold Off Tuesday: Improving Economy Equals No More Stimulus

| About: SPDR S&P (SPY)

In yet another sign of just how dependent the market has become on central bank stimuli, stocks sold off sharply after the release of the FOMC minutes Tuesday as the Fed now appears reluctant to implement further quantitative easing. To the casual observer, the sell-off would have looked rather odd considering the Fed minutes indicated that committee members are now relatively more upbeat about the state of the economy than they were in January.

The Fed acknowledged that economic prospects have brightened in the past three months and noted that global economic strains have eased since the beginning of the year. Given this, one might have expected stocks to rise, as conventional wisdom says that one of the main reasons for the run-up in the market since October is improving economic data -- Tuesday's sell-off lends the lie to this contention. The market has rallied because of central banks' injection of nearly $2 trillion into the market this year. When viewed from this perspective it is no surprise that we got a sell-off following the release of the Fed minutes, as committee members indicated they are now far less likely to implement a new round of monetary stimulus. Without the prospect of more central bank aid, market participants see no way for stocks to move higher.

This state of affairs is exacerbated by the fact that, put simply, there is no 'dumb money' in the market right now -- the only money participating in the rally is the 'smart money.' This contention is supported by the fact that, according to ZeroHedge, during the

20% ramp in the stock market, ... not only have retail investors ... pull[ed] out $66 billion in cash from domestic equity mutual funds, ... but the week of February 29 [a high point for the market this year] ... saw the biggest weekly outflow of 2012 at $3 billion."

It's no wonder, then, that we see a sell-off as soon as the Fed becomes a bit more hawkish -- the smart money knows good and well that the only thing supporting this rally is central bank stimuli, so the obvious thing to do is sell when it appears that further stimuli may be off the table for the time being.

It may well be that the only way to propel the market further in the short term is to coax retail investors off the sidelines. This may be difficult to do as the average investor still doesn't trust the market. If the media, large financial institutions, and the central banks of the world are successful in pulling average Joe into the fray, you will likely see an exodus of the smart money from the market as the dumb money drives the market up further. In the end, it would be the retail investor holding the bag (again) when things go wrong and the bottom falls out. This is already happening anyway as the number of corporate insider sells per week has recently spiked. Beware the artificially inflated market. Buy put protection in the S&P (NYSEARCA:SPY).

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours.