The selloff in the equity market should be expected. None of us should be surprised…and why you ask? Here are several reasons why:

1. Interest rates (and the fed funds rate in particular) were so low, for so long that it made money “cheap” and induced a borrowing frenzy of epic proportions. The effective fed funds rate dipped below 2% for the first time in almost 40 years. (For those unfamiliar with the fed funds rate, it is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions, usually overnight.)

From a “macro” standpoint, promoting low interest rates will give corporations the incentive to borrow which in turn creates an expansionary environment thus higher economic growth. And, as you will see later, higher cash flows and earnings growth will lead to higher asset prices.

2. Inflation rates never forced …

T.S. Eliot might have been out by a few months – it looks as though June might turn out to be the cruelest month of the year rather than April.

Renewed fears of inflation and slower growth caused by record energy costs played havoc with global stock markets last week, resulting in the Dow Jones Industrial Average being on track to record its worst June since the Great Depression. As stocks suffered, gold bullion surged and government bond yields dropped due to safe-haven buying.

Sentiment soured as investors became more concerned that the credit crisis still had a long way to run and that the fallout was increasingly contaminating the real economy.

Credit

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Global stock markets topped out on the back of the sub-prime/credit debacle in October 2007. Prices subsequently moved lower until reaching climatic bottoms in January/March this year, triggering rallies throughout the world until a few days ago. The big question investors are grappling with at this stage is whether the rise in prices has simply been a bear market rally, or whether we are back in a primary bull market.

I have previously said: “Whereas I am doubtful about the longevity of the rally, I am also not in the Armageddon school. Is the answer perhaps a ‘muddle-through’ market, characterized by below-average returns? That is my hunch, for what it’s worth.” (See post entitled “Poll of the Week: Stock Markets – Which Way

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