Dow plunges 512 points: Here's what's bothering the stock market

The Dow suffered its worst day since December 2008, when the US was sliding into recession. The flight to bonds was so extreme that stock market investors were paying the US to hold their money.

The stock market went into free fall Thursday and suffered its worst day since December 2008, a time when the economy was sliding into a recession.

Intense selling drove the widely watched Dow Jones Industrial Average down 512.76 points, off more than 4 percent for the day. Almost every market index slid, as did the prices of oil and gold, as investors moved their money into US Treasury bills, a haven in times of stress.

Investor fears were so extreme and the sums of transferred money so vast that the yields on the short-term Treasuries were negative, meaning investors were paying the US government to hold their money.

The drop in stock prices was the eighth in the last nine trading sessions. Since July 22, the Dow average has lost 1,297.32 points, or about 10 percent of its value. In addition, the bad day on Thursday meant that almost all the major averages are lower for the year.

Market analysts blamed the steep drop on a number of factors.

In the morning, there was concern about the health of parts of the European banking system. Then, investors began to worry that a recent sharp rise in the value of the yen would cause export-oriented Japan to slip into recession. And, during the day, some economists began to reassess the probabilities that the US economy might slide into recession.

Weighing on the market is also the prospect that on Friday the Department of Labor will report that the July employment numbers are disappointing. While some of the market's decline previous to Thursday was attributed to concerns over the debt-ceiling negotiations in Washington, analysts did not cite that as a factor in the one-day plunge.

The turmoil in the markets puts an onus on the Federal Reserve, which meets next week to set short-term interest-rate policy. Although the Fed was silent on Thursday, some stock market observers wondered if Fed Chairman Ben Bernanke might be forced to provide some assurance to markets. The Fed could do this by agreeing to backstop European banks or make a surprise announcement that it would resume buying long-term US securities, a stimulus program it just ended in June.

“The risk to the US economy is that corporate leaders and consumers looking at the stock market as an economic bellwether see stocks plunging and suspend small and large buying plans,” says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. “Then we would have economic fallout in the US.”

Although the stock market can be a predictor of economic slack, it is not always accurate, notes Sam Stovall, chief investment strategist at Standard & Poor’s in New York. “There have been 54 market declines of 5 percent or more since World War II but only 12 recessions,” says Mr. Stovall.

“Why is this different?” he asks. “Because the market decline has been accompanied by worse than expected numbers in GDP, ISM [Institute for Supply Management], factory orders, and jobs,” he answers.

Stovall says Standard & Poor’s, which had thought there was only a 30 percent probability of a recession, now puts the probability of a recession at between 30 and 50 percent. Often, the economic fundamentals lag the stock market by seven to eight months, he notes.

In yet another indication that the markets are expecting lower demand in the months ahead, the price of oil fell to $86.53 a barrel, the lowest level since February. Gold, which had been soaring during the past two weeks, also fell by $14.30 an ounce.

Friday morning, US investors will be watching to see what happens in Europe. On Thursday, banking regulators in Europe indicated that the European Central Bank (ECB) had hit its own internal funding limit.

After the bank indicated it might seek additional money from its member states, some, including Finland, the Netherlands, and Germany, pushed back, concerned that they might lose their AAA credit rating, says Mr. Dickson.

“The euro sold off and that spilled over to the US market,” he says. “Now all of a sudden the stock market is readjusting global valuations to a weaker economy spilling from Europe to China to the US.”

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