The Dow-Jones had its worst one-day drop on Thursday, July 31 since last February, tumbling almost 320 points (1.9%), and erasing all of its gains for the year. As I write this update, the Dow-Jones has fallen another hundred (+/-) points this morning and is currently hovering just below 16,500. Although it is still well above its early February 2014 lows, I guess we have to say good-bye to Dow-17,000, at least for now.

 

So why the sudden reversal, especially in light of this morning’s (Friday, Aug.1) encouraging job and unemployment reports?

The Bureau of Labor Statistics reported that 209,000 new jobs were created in July, the 6th straight month of 200,000-plus job gains. In addition, the BLS reported that job gains in both May and June were revised upward, adding an additional 15,000 jobs in those two months (5K in May and 10K in June).

 

While the unemployment rate went up again, it was only a small increase, from 6.1% to 6.2%. This could be interpreted as a positive indicator for the economy since it may be a reflection of the fact that recent strong employment gains are drawing more discouraged workers back into the labor market.

 

So, what else is going on?  Why would the Dow drop again today, following large drops earlier in the week, when such relatively good economic news kicked off the day?

 

Ironically, it may be the very fact that the news is good that is driving the Dow and other Equities Markets downward. For some time, Wall Street has been living in fear of the day when the economy finally improves enough to force a change in policy at the Federal Reserve.  For many months now, even years, the Fed has been pumping cheap money into the system to compensate for all of the economic damage created by the last recession. During this time, Wall Street has become very accustom to this “new normal” and has profited greatly from the attractive margins on investments that can be earned when money can be borrower for next to nothing.

 

But everyone knew that this “easy-money” would not last forever. At some point, a rising economy would force the Fed to tighten the supply of money by increasing its cost in order to keep inflation at bay. Of course, increasing the cost of anything reduces demand and leads to slower overall growth. Business costs rise and the economy cools, a trade-off that everyone agrees is necessary, but that nobody likes.

 

So, we accept the need for a tighter monetary policy – but at the same time, the markets always seem to throw a collective temper-tantrum when the tightening first begins. I guess you could look at the sell-off this week as the collective temper tantrum in action.

 

We’ll find out over the next few weeks if the market correction was a simple reaction to impending changes in Fed policy – in which case the markets will probably go back up again – or if there are more fundamental problems to contend with – in which case the markets could continue to fall. In the meantime, we can take some comfort in knowing that the economy continues to expand, even if the markets can’t always keep pace.