Dow drop: Good news at home could be to blame

Believers in Goldilocks took a bite full of economic and stock market news Thursday that was too hot to swallow.

Lately, investors have been lulled by the Goldilocks principle — nothing too hot or too cold. The stock market has continued rising while investors assumed the riskiest of bonds couldn't go wrong so long as the Federal Reserve and the world's central banks poured trillions of cheap money into markets.

But then came Thursday.

The Dow Jones industrial average plunged 317 points and gave up its gains for the year as disconcerting news came from throughout the world.

Russia, hit by sanctions, may be able to buy less from the rest of the world and may even punish Europe with high energy prices.

The Middle East remained a potential threat to oil prices.

Germany's economy has been slipping anyway. Sportswear brand Adidas and Lufthansa airlines acknowledged as much this week when they disappointed investors with second-quarter earnings.

Analysts are expecting European companies to report a 1.9 percent decline in sales for the second quarter. And a weak Europe weighs on the U.S. since about 20 percent of large U.S. company sales are made there.

Outside of Europe, Argentina unsettled the world by missing a debt payment on its bonds, effectively going into default.

Investors began to wonder, as they did in the financial crisis in the U.S. in 2008, just what that failure to pay would mean for other financial institutions and investors that will be exposed in a tightly interrelated global financial system.

There are billions of credit default swaps involved, perhaps held far beyond Argentine borders. The swaps are supposed to be insurance policies to protect investors if bonds default, but now the question is who has them and whether trouble with the swaps and the bonds could infect financial institutions long distances from Argentina.

Likewise, the long calm about Europe's debt crisis has been displaced by harsh realities.

While it might have seemed like Europe's banking issues were a bad memory, bank struggles were merely masked by high hopes that came months ago when European Central Bank president Maurio Draghi said he would do whatever it takes to save the Eurozone.

This week it became apparent that at least one major bank could not keep it's troubles buried. Portuguese lender Banco Espirito Santo's finances are in such disarray that some analysts have expressed a fear of collapse. Regulators have ordered the bank to raise capital.

It's a reminder that while other European banks remain troubled, the EU does not have a system like the Federal Deposit Insurance Corp. to step in to secure troubled banks.

As troubled banks languish in Europe, lending has suffered. With loans not readily available, businesses and consumers have not been able to borrow as needed. The economy has been unable to gain traction. It is now teetering on the edge of recession again.

While Banco Espirito Santo stock fell 42 percent this week, Portugal's stock market lost 3 percent. The Stoxx Europe 600 index fell 1.7 percent in July and the German DAX by 4.3 percent.

Amid the global tumult, it might seem ironic that the twinges of fear in the U.S. market came primarily from signs of strength in the U.S. economy.

Second-quarter GDP grew at a strong 4 percent on an annual basis. So few people lost jobs that unemployment claims for the month dropped to the lowest level since 2006.

That upbeat data, which will get tested when the nation's unemployment rate is released Friday, gave investors pause. They know the Federal Reserve has had a sharp eye focused on labor markets.

If the Fed decides jobs and pay are picking up, it might be inclined to raise interest rates sooner than the late 2016 period many economists were expecting. Now, many economists have moved their expectations for the first rate increase up to next summer.

Meanwhile, against this backdrop of worry about better times and potentially higher rates, investors see havoc around the world. And even with low interest rates the U.S., the housing market sputters.

Potentially too cold overseas, potentially too hot at home. Sounds about right, Goldilocks.

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis

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