The Dow fell more than 300 points yesterday, adding to the misery that was January. By now, most individual investors are worried, especially since it hit all-time highs in 2013. What's going on?
First, there's an ongoing sell-off of emerging market currencies. Investors realize that the governments of Turkey, Argentina and India may not be able to raise interest rates enough to keep their currencies strong. If the rates are too high, it will slow these countries' economic growth, and increase inflation by raising import prices. This could turn into a global crisis, which always makes investors flee to safe-haven assets likes gold, the U.S. dollar, Treasuries -- and now the euro.
Second, the market is long overdue for a correction, which is when prices drop 10% or so. Investors know this, and aren't ready to put more money into stocks until after it happens. This correction won't harm the average person who's not in the market. It just means stock prices will more accurately reflect what's going on in the real economy.
Third, holiday retail sales were weak, and this trend will continue through Valentine's Day. Consumers are holding their breath, waiting for the next shoe to drop. As a result, several retailers are reporting poor earnings.
Fourth, in the back of everyone's mind is a good chance that Congress will threaten default on the nation's debt later this month. Many tea party Republicans can't seem to replace this political strategy as a way of forcing their will on the country. They are considering demands to change part of Obamacare or approve the Keystone XL Pipeline.
Fifth, the lackluster jobs report started the year off on the wrong foot. Lots of great jobs haven't been created, household incomes haven't risen as fast as they should, and so demand is just not there. If Friday's report isn't dramatically better, expect the stock market to swoon again.
Despite the sell-off, the Fed will continue tapering Quantitative Easing. It knows that the program of ultra-low interest rates is like pushing a string. Banks won't lend if there isn't demand. In addition, banks don't get a good return on loans when long-term interest rates are about equal to short-term rates. That's why a steeper yield curve might be goods news for the economy. See more about the Yield Curve.
How It Affects You
Wall Street is just catching up to what the rest of us have known all along -- the economic recovery just hasn't been that great. Companies haven't invested in business growth because they don't see the demand from consumers. They haven't bought plants, equipment and most important, haven't created jobs.
Instead, they've bought other companies, sent cash to stockholders in the form of dividends, and bought back their stocks to boost prices. This made last year's earnings reports look good, but they can't keep doing that. They need demand, and growth, to continue to have good earnings and good stock prices. That's not happening.
However, here's why the stock market will ultimately get better. Congress agreed on a FY 2014 budget. This gets rid of the spending cuts from sequestration. It also allows businesses to know what the taxes will be, so they can plan. They don't have to worry about another government shutdown. This will boost economic growth later in the year. Article updated February 4, 2014
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