Dose of reality from Fed jolts markets after long upward run

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Wall Street suffered through its worst day of the year Thursday, bringing investors down from the “sugar high” they have enjoyed this year as the markets topped milestone after milestone.

The Dow Jones industrial average plummeted for the second consecutive day Thursday, at one point tumbling by more than 360 points, or nearly 2.4 percent, to close at 14,758.32, one day after the Federal Reserve hinted that it may soon tighten the monetary spigot. Disappointing news on China’s latest manufacturing statistics contributed to trader pessimism, as well.

A day earlier, the Dow dropped more than 200 points, or 1.3 percent — making the total from Wednesday and Thursday about 560 points, or just shy of 4 percent.

The broader S&P 500 index, meanwhile, tumbled below the 1,600 mark, closing at 1,588.19, down more than 40 points, or 2.5 percent on the day, while the tech-heavy Nasdaq fell more than 78 points, or 2 percent, to 3,364.64.

Federal Reserve Chairman Ben S. Bernanke on Wednesday suggested that the Fed may start winding down its stimulus program because the markets are strong enough that they no longer need the government’s help.

The Fed has been spending $85 billion each month, investing in Treasurys and U.S. equities to keep the economy afloat. And it has worked. The unemployment rate has shrunk to 7.6 percent from 8.1 percent when the buying program started in September.

Greg McBride, senior financial analyst at Bankrate.com, said this has fueled the record run on Wall Street.

“It just goes to show that the market has been on a sugar high from Fed stimulus and reality is beginning to set in,” said Greg McBride, senior financial analyst at Bankrate.com.

Paul Edelstein, U.S. economist at IHS, agreed that the Fed is responsible for Wall Street’s success this year. “But it’s predicated on the Fed staying the course until things get better on their own,” he said.

The Fed expects the unemployment rate to continue to decline to about 7.2 percent by the end of the year, which would justify pulling back — but neither Mr. Edelstein nor Mr. McBride thinks this will happen.

Unemployment is still high at 7.6 percent, household income is stagnant, and revenue growth is hard to come by for companies, Mr. McBride said.

“This is not an economy that’s hitting the cover off the baseball by any means,” he said. “Those are not the type of market fundamentals that would justify a market that’s up double digits year to date.”

So without the Fed’s backing, the markets are bound to take a tumble, analysts say.

“I think the Fed has been very supportive of the economy,” Mr. Edelstein said. “One of the reasons that the economy has done so well this year is because of the Fed’s support. So if the Fed withdraws that support, I become much less optimistic.”

Investors received further bad news from China, the world’s second-largest economy, where the manufacturing sector may have contracted in June, according to a report.

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