NEW YORK (CNNMoney.com) -- Stocks took a nasty tumble Tuesday after the People's Bank of China surprised investors with its first interest rate hike in nearly three years.
But even with this drop, the market may still be vulnerable to even bigger sell-offs in the coming weeks because stocks have surged so dramatically in the past three months. The S&P 500 is still up nearly 15% since hitting its low point for the year on July 1. And it's been a streak with few significant down days.
So the fact that China was able to spook the markets shows that investors are still nervous. Add in the disappointing reaction to strong earnings from tech giants Apple (AAPL, Fortune 500) and IBM (IBM, Fortune 500) -- whose stocks are both near all-time highs -- and it's clear that momentum investors may be looking for excuses to sell.
What's even more worrisome though is that some experts think stocks could be due for an even bigger drop in early November.
That's because investors may be overwhelmingly banking on the likelihood that Republicans will win control of the House in the midterm elections on November 2 and that the Federal Reserve will launch a new round of so-called quantitative easing, a program of asset purchases, at the conclusion of its meeting on November 3.
"The election and the Fed are priced in to the market. The million dollar question is how much?" said Bill Stone, chief investment strategist with PNC Wealth Management in Philadelphia. "The bigger driver of the recovery has been that the soft patch in the economy has not turned into another recession. But the Fed's announcement in November will be the least biggest surprise ever."
Investors appear to be betting that a Republican victory of at least one chamber in Congress could be a boon for businesses since it may lead to less regulation, lower amounts of federal spending and more corporate-friendly tax policies.
The Fed's quantitative easing also could be a plus for stocks since it will represent a further sign that the central bank is doing all it can to rejuvenate the stalling economy.
But what happens at 2:16 on November 3 once the Fed's quantitative easing is official and investors also can put the midterm results in the rear-view mirror?
"When there is so high of an expectation of something happening and then it happens, you could have a case of buying the rumor and selling the news," said Bob Gelfond, CEO of MQS Asset Management, a global macro hedge fund based in New York.
Gelfond said he wasn't necessarily predicting a big sell-off per se. But he said that whenever the market thinks something is a given, investors have to be cautious.
In this case, there is a greater chance for investors to be potentially disappointed since there are two separate events the market assumes are a slam dunk.
"Whether Tuesday's sell-off is a one-day reversal from a strong upward move or the start of a new trend, I don't know. But you need to be cognizant that there are a lot of risks out there," Gelfond said.
The simple fact remains that no matter what the American people decide about the future of Congress and what the Fed does with its next series of bond buys, the economy is still likely to remain sluggish for some time. And that could keep a lid on stocks.
"This is a moderate recovery and it will probably continue to be that way for some time," said Bob Baur, chief global economist at Principal Global Investors in Des Moines, Iowa.
"Go back and look at how we got into this. Some people thought the economy and market should snap back because it was a deep recession. But this is so much different from the other bad recessions in the 70s and 80s," Baur added.
Hank Smith, chief investment officer with Haverford Investments in Radnor, Pa., also said the market's recent move is a cause for concern. He pointed out that individual investors are still taking money out of equity mutual funds and plowing them into bond funds.
He added though that the economy and corporate earnings are improving -- albeit modestly. So a major sell-off at the end of the year seems unlikely.
But Smith said it's fair to wonder if investors are getting all their buying out of the way now and will sit on the sidelines during two months where stocks usually perform well.
"November and December historically are good months for the market. Are we stealing from that right now? That's a legitimate question," he said.
- The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney.com, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
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