The equity market on Monday suffered its worst session since the financial crisis of 2008 on the back of what some observers will say was panic selling.  From our vantage point, it wasn't a panic trade.  It was worse.  What we witnessed on Monday was a trade of despair.

Gold prices surged; Treasury prices surged (after the S&P downgrade); volatility surged; and just about everything else got clobbered with the financial sector (-10.0%) and Bank of America (BAC, -20%) in particular leading the retreat.

The market's behavior reflected a lack of hope in the economic outlook that was predicated on a lack of faith in the political leadership both here and in Europe.

The telling distinction about that lack of faith in leadership was borne out in two instances. 

The first was that the market sold off in spite of the ECB saying it will buy Italian and Spanish bonds.  The second was that the market slid to what were then intraday lows as President Obama talked of the need to extend the payroll tax cut and unemployment benefits, and how we can create jobs by investing in our country's infrastructure.

We are not attacking the messenger in the latter instance.  Rather, we are highlighting the point that the message he was delivering -- one that was billed as backing worthwhile growth initiatives -- was scoffed at by market participants.

In effect, there was a forlorn sense that stopgap solutions in the EU and the U.S. are living up to their definition of simply being temporary expedients.

And so the market turns its attention to the FOMC meeting today to see if the Fed can restore confidence in the equity market.  It faces a high bar in that respect considering the market was non-responsive yesterday to headlines that might have sparked a rally in prior months (i.e., ECB bond purchases and talk of extending payroll tax cut).

There is a burgeoning belief that the recent selloff will push the Fed to enact QE3 or at least to quantify in no uncertain terms what it means to say policy rates will be exceptionally low for an extended period of time.

There is an added presumption, too, that the Fed will cite increased downside risks to the outlook and that it may have to amend its growth projections given the recent GDP revisions.

At this juncture, we do not think a statement that acknowledges the risks but simply circles back to indicate the Fed is waiting and watching the data will appease the market.  Admittedly, though, we are uncertain as to how the market will react to anything the Fed says today.  To that point, the more telling response by the market to a "new" declaration might not be the response we see today, but the one we see tomorrow.

The equity market is oversold on a short-term basis and seems anxious to bounce from the oversold condition, so anything from the Fed that sounds remotely supportive could help turn the selling tide today. 

The biggest risk we see as it relates to the Fed decision is if the market rolls over (today or even in the next few days) after a "new" support initiative is announced, because that will create a feeling of desperation that the market doesn't even think the Fed can help things at this point.

For the time being, the equity market is poised to bounce at the open.  It has been a volatile trade for the S&P futures, but they are currently trading 0.7% above fair value after looking past a report that showed productivity declined at a 0.3% annual rate during the second quarter. 

That decline followed on the heels of a 0.6% decline in the first quarter, which was revised down from an originally reported 1.8% increase.   Additionally, unit labor costs were revised sharply higher for Q1 (to 4.8% from 0.7%) and were reported to be up 2.2% in Q2, as hourly compensation increased by 1.9% while productivity decreased 0.3%.

As an aside, with yesterday's selloff, the earning yield for the S&P 500 on a forward four quarter basis is now 9.6% or 720 basis points higher than the current yield on the 10-year Treasury note.

--Patrick J. O'Hare, Briefing.com

Patrick J. O'Hare is the Chief Market Analyst for Briefing Research, Briefing.com's institutional research service. To request a free trial please email researchsales@briefing.com.