Fears drive Dow’s dive

Fear is back in the market.

Investors are worried about slower economic growth in China, a gloomier outlook for U.S. corporate profits and an end to easy-money policies in the United States and Europe. They’re also fretting over country-specific troubles around the world – from economic mismanagement in Argentina to political instability in Turkey.

Those fears converged this week to start a two-day rout in global markets that was capped by a 318-point drop in the Dow Jones industrial average Friday. It was the blue-chip index’s worst day since last June. The Dow plunged almost 500 points over the two days.

The Dow finished down 2 percent at 15,879 Friday. The Standard & Poor’s 500 index fell 38 points, or 2.1 percent, to 1,790. The Nasdaq composite fell 90 points, or 2.2 percent, to 4,128.

As investors shunned risk, small-company stocks fell even more than the rest of the market, and bond prices rose.

Despite the sell-off, U.S. stocks remain near all-time highs after surging 30 percent last year. The S&P 500 is 3 percent below its record high of 1,848 on Jan. 15.

U.S. stocks have not endured a correction – a drop of 10 percent or more over time – since October 2011.

The turbulence coincides with a global economic shift: China and other emerging-market economies appear to be running into trouble just as the developed economies of the United States and Europe finally show signs of renewed strength nearly five years after the end of the Great Recession.

The trouble began Thursday after a January survey showed a drop in Chinese manufacturing activity. Days earlier, China reported that its economic growth last year matched 2012 for the slowest pace since 1999.

“It is interesting how even a mild tremor in China’s growth causes such anxiety around the world,” said Eswar Prasad, professor of trade policy at Cornell University.

Slower growth in China is bad news for countries that supply oil, iron ore and other raw materials to the world’s second-biggest economy. Some of those countries, such as Indonesia and South Africa, were already struggling with an outflow of capital as rising U.S. interest rates drew investors to the United States.

Here’s a look at the forces buffeting global financial markets:

End of easy money

Since the global financial crisis hit in 2008, the Federal Reserve has flooded markets with cash to push interest rates lower and encourage U.S. businesses and consumers to borrow and spend. But last month, as signs of growing economic strength emerged in the U.S., the Fed cut back – reducing its monthly bond purchases to $75 billion from $85 billion. It also said it expected to reduce the bond-buying further “in measured steps” at upcoming meetings.

The Fed meets again Tuesday and Wednesday. Many economists expect the central bank to cut the purchases again – perhaps to $65 billion a month.

Political turmoil

In some countries, concerns over the local political or financial situation have worsened the market volatility dramatically. That was most obvious in Argentina, where the peso this week suffered its sharpest fall since the country’s 2002 economic collapse. The government, running short of reserves it could use to buy the currency and keep it from falling, has let the peso drop instead. The country’s economic fundamentals are grim: Inflation is believed to be running at about 25 percent to 30 percent.

The peso fell 16 percent in two days, easily the worst performer among emerging markets.

China, global growth

Since the recession, the global economy has relied heavily on China and other emerging markets as the developed economies of the United States, Europe and Japan struggled.

But China’s economy is decelerating. It grew 7.7 percent in October-December 2013 from a year earlier, down from the previous quarter’s 7.8 percent growth. Factory output, exports and investment all weakened. On Thursday, the preliminary version of HSBC’s purchasing managers’ index of Chinese manufacturing fell to 49.6, the lowest reading since July’s 47.7. Anything below 50 signals a contraction.

China’s growth is still far stronger than the United States, Japan or Europe, but is down from the double-digit rates of the previous decade.

Corporate profits

In the U.S., the outlook for corporate profits has already been weakening, and the turmoil in emerging-market currencies could make matters worse.

About two-thirds of the 123 S&P 500 companies that have reported fourth-quarter earnings so far have beaten analysts’ estimates, according to S&P Capital IQ, in line with the historical average. But the forecasts for income growth have been falling and could decline further.

As recently as this summer, analysts predicted earnings growth of more than 11 percent for the fourth quarter, but now they expect just half that – 5.9 percent.

Some companies are becoming more pessimistic, too. For the January-March quarter, seven out of every 10 that have talked about their prospects have cut projections, more than average, according to FactSet.