Dow Industrials Shed 240 Points: Blame the Fed?

Down goes the market.

ZUMAPRESS.com

The S&P 500 fell 1.3% to 1,946.16, while the Dow Jones Industrial Average dropped 238.19 points, or 1.4%, to 16,804.71. The Nasdaq Composite declined 1.6% to 4,422.09 and the small-company Russell 2000 finished off 1.5% to 1,085.61.

The selling today appeared to be driven by weaker construction and manufacturing data. I say appeared because this same kind of data once would have thrilled investors who would have looked at it as a sign that the Fed would maintain its easy-money policy for longer. These days, with QE set to end and investors betting on a 2015 rate hike, the weaker data is a sign that the Fed is not behind the curve but ahead of it, especially as inflation remains below its target. MKM Partners’ Michael Darda explains:

…despite the bevy of hawks who continue to urge the Fed to hike rates sooner and more forcefully than what is currently priced in, the current path of expected Fed tightening is likely to be met with persistent below target inflation, according to the forward looking inflation breakeven markets. And that is no way to exit the zero lower bound (ZLB) on short rates unless you want to return to it sooner rather than later (or ever). If the Fed really does want to exit the ZLB on short rates, getting back to if not somewhat above its inflation target should be the first order of business. And that means being patient with the onset of tightening and allowing the business cycle to run a bit hotter (in NGDP growth rate terms) than what the consensus view would suggest. Opportunistic disinflation (inertia in easing when business cycles are peaking and anticipatory tightening as growth rates revive) simply is not appropriate when 1) rates are pinned at the ZLB and 2) inflation has been persistently below target and is expected to remain below target.

The folks at Bespoke Investment Group offer a word of hope–at least for tomorrow:

Markets are sharply lower on this first trading day of October, continuing a run of weakness that we saw to end the month of September. So how has the market historically performed in the near term following prior weak starts to October? Pretty darn good actually.

…the S&P has fallen 1%+ on the first trading day of October [12 times] since the index began in 1928… [and] we have seen a snap back rally nearly every time on the second day of the month. In fact, the index has averaged a gain of 0.92% on the day after a 1%+ down move on the first trading day of October, with positive returns 10 of 12 times. The S&P 500 has done very well in the week following these big down starts to October as well. As shown, the index has averaged a gain of 3.06% over the next week when we have fallen 1%+ to start October. During the current bull market, in which the index has rallied nearly 200%, there have actually been two Octobers that started with 2%+ down moves. As shown in grey below, the market surged over the next week by 3.46% in 2009 and 8.7% in 2011.

Of course, 2009 was just the beginning of that 200% rally, while the eurozone crisis and the S&P downgrade of US debt over the fiscal cliff had pounded stocks earlier in 2011.

Let’s hope those differences don’t matter.