Economic Collapse: US Stocks, Bonds Plunging Sharply

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The Dow Jones Industrial Average on Thursday suffered its worst decline since June, as fears intensified that the Federal Reserve will reduce its stimulus in the fall, potentially eroding a key element in this year's stock-market advance.

The Dow tumbled 225.47 points, or 1.5%, to 15112.19. It was the second consecutive triple-digit decline, following a 113-point pullback Wednesday. After being up as much as 19.5% for 2013 on Aug. 2, the Dow now is up 15.3% this year.

The big news hurting stocks was a seemingly positive report: New weekly unemployment claims were the lowest since 2007, the latest in a series of indications the job market is improving.

But that reinforced fears that the Fed will decide as soon as September that the economy is strong enough for it to begin reducing its $85 billion in monthly bond purchases designed to stimulate the economy.

"People are saying that is the consensus expectation" at major Wall Street firms, said Henry Herrmann, chief executive of asset-management company Waddell & Reed Financial Inc., which oversees more than $90 billion in Overland Park, Kan.

The problem, Mr. Herrmann said, is that other recent economic data and corporate reports have suggested the economic recovery remains fragile. Some investors fear a cutback in stimulus might be coming too soon, and that corporations could have trouble continuing to turn in record profits.

Bonds took the news badly. Their prices fell, pushing the yield of the benchmark 10-year Treasury note up to 2.755%, its highest level since July 29, 2011.

Investors fear a cutback in Fed stimulus for two reasons. First, the monthly purchases keep bond prices high and bond yields low. That stimulates the economy by holding down mortgage rates and other borrowing costs, which in turn helps boost corporate profits.

Now, bond yields, mortgage rates and other market interest rates already are moving higher on expectations the Fed will reduce its stimulus, which makes economic growth harder.

Second, a share of the Fed's money eventually makes its way into the stock market, boosting demand for shares and pushing their prices higher. With stocks up so much already this year, and with many worried about what the Fed will decide to do next month, some short-term investors have chosen to cash in some of this year's profits.

"Right now, investors are used to having the Fed support bond prices, so, in the short term, investors are focused on the negative if that stops," said Peter Jankovskis, co-chief investment officer at OakBrook Investments in Lisle, Ill., which oversees about $3.5 billion.

The other news adding to the market anxiety included a July decline in manufacturing output and disappointing news from two companies that are among the Dow, Wal-Mart Stores WMT -2.60% and Cisco Systems CSCO -7.17% . Wal-Mart announced that same-store sales fell in the most-recent quarter, while Cisco said it would cut 4,000 jobs.

Stocks also declined in major markets outside the U.S., including Japan, China, Australia, Britain, Germany and France. Asian markets fell further in early trading Friday.

The dollar dropped against the euro and the yen. Futures in gold, silver and oil all rose, but copper futures declined.

On top of the bad corporate news, James Bullard, president of the Federal Reserve Bank of St. Louis, said that, although the economy has improved, it might not be strong enough for the Fed to decide to shrink stimulus as soon as its September meeting.

Some investors took those comments, together with the manufacturing news and the corporate reports, as signs the Fed might choose to delay any stimulus cuts. But others were concerned the Fed might act anyhow, running the risk that the economy could suffer a setback from its move.

Overall, Thursday's economic reports suggested that U.S. growth is continuing its gradual bounce-back. The number of Americans filing new claims for unemployment benefits last week fell to the lowest level since October 2007, two months before the recession began. The drop, signaling growing confidence about the economic outlook among businesses, could translate into stronger hiring in coming months.

A separate Labor Department report showed consumer prices rising across a broad range of goods and services in July, a move that could ease fears within the Federal Reserve about inflation falling from already low levels. The Labor Department's consumer price index rose 0.2% from a month earlier and was up 2% from a year ago.

Some figures earlier this year showed annual inflation closer to 1%, raising concerns among some Fed officials who think a robust economy should generate 2% inflation. A stabilizing inflation picture could give central-bank officials comfort in dialing back their $85 billion-a-month bond-buying program. Many economists expect decision about a first reduction to come at the central bank's meeting next month.

Despite a brightening outlook, the economy continues to grow at a modest pace. Employers have added to payrolls slowly, and a number of other measures suggest the expansion will remain relatively week. Indeed, a Fed gauge of the factory sector released Thursday showed that U.S. manufacturing activity fell in July—a sign of the sector's struggles amid slow growth in the global economy.

 (WSJ)

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