The shocking data behind yesterday's market slump

After rallying somewhat over the past week or so, the markets had another rough day yesterday. So what upset investors enough to inspire the triple-digit falls in the FTSE 100 and Dow Jones? asks John Stepek.

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After rallying somewhat over the past week or so, the markets had another rough day yesterday. So what upset investors enough to inspire the triple-digit falls in the FTSE 100 and Dow Jones?

There were any number of reasons to worry. But one in particular stood out - US jobs data.

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The constant refrain of those who say that this is all a storm in a teacup, is that the problems are confined to the markets and the 'real' economy is fine. Their main piece of evidence for this is that employment growth has stayed solid on both sides of the Atlantic.

What rattled the markets yesterday was the first evidence that this is no longer the case

Planned redundancies by US companies rose by 85% in August. Around half of those were in financial services, according to employment consultants Challenger, Gray & Christmas. Meanwhile, another survey from ADP showed that the jobs growth rate is slowing sharply. There were 38,000 private sector jobs created last month, less than half the 83,000 analysts had been expecting, and the slowest growth rate for four years, notes James Quinn in The Telegraph.

Meanwhile, the number of US home sales in the pipeline plunged by 12.2% in July, according to the National Association of Realtors. That's the worst figure since the survey began in September 2001 and it suggests that activity in the housing market is unlikely to pick up any time soon, leading to more job losses.

It's no surprise that the OECD is now worried that recession is a real possibility in the US. The organisation cut its forecast for economic growth this year from 2.1% to 1.9%. "Downside risks have become more ominous. What we had not forecast was the extent of the spread of this financial risk beyond the US," warned chief economist Jean-Philippe Cotis.

Everyone in any sort of position of financial authority seems to have been caught out by that one. US subprime is contained, they said, not so long ago. And then in the same breath, they added that financial derivatives were a good thing, because they spread risk around.

That would be fine - if it was the same amount of risk being spread around. The only problem is, because everyone in the chain thought that they were passing their risk on to someone else, they took on a lot more of it.

If someone approaches you for a loan, which you have to fund from your own savings, you'll think very carefully before giving them the money. But if someone else gives you their money, and then pays you a fee for every person you lend it out to, regardless of who they are, then how much attention are you going to pay to credit quality?

Very little, I'll bet. That's pretty much what has happened with subprime mortgages, and that's why derivatives have actually amplified risk to the point where there's more than enough about to cause an awful lot of trouble, regardless of how far and wide the risk has been spread.

So that's one of the main reasons why a whole lot of people in the US are now losing jobs that only ever existed in the first place because of a property bubble built on nothing but overly cheap money.

That's the flaw in this ridiculous notion that this crash is somehow just about the financial economy' and not about the real' economy. You can't separate the two. The apparent spreading of risk encouraged lenders to seek new people who would never have been allowed to buy houses under the old system. More buyers meant higher prices. Higher prices lead to more construction, and more real estate agents. So the financial' world created the boom in the real' world.

And where have all those whopping bonuses been coming from that have been pouring into London's economy? From the financial sector. So if you're a believer in trickle down' economics, then you have to be worried about the turmoil in the markets just now.

Forget any division between the markets and the real world. Right now the markets are in trouble and that means the real economy is in trouble too.

Turning to the wider markets

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In London, banking stocks led the FTSE 100 in a triple-digit slump yesterday as a poor start on Wall Street accelerated earlier losses. The index ended the day 106 points lower, at 6,270, and the broader indices were also down. Mortgage bank Northern Rock was the day's worst perfomer, falling over 5% on a downgrade from broker Lehman Brothers. Peers Bradford & Bingley and Alliance and Leicester also notched up losses. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 was 21 points lower, at 5,672, and the Frankfurt DAX-30 was down 133 points at 7,588.

On Wall Street, stocks closed lower following the release of data showing a fall in existing home sales to their lowest level since 2001, along with weak employment data. The Dow Jones closed 143 points lower, at 13,305, with financial stocks including JP Morgan Chase and American Express leading the declines. The S&P 500 was down 17 points to 1,472. And the tech-heavy Nasdaq was off 24 points to 2,605.

In Asia, a late rally saw the Nikkei close up 98 points at 16,257, whilst the Hang Seng was down 18 points at 24,050.

Crude oil futures continued to climb this morning - last trading at $76.23 a barrel - and Brent spot was at $75.38 in London.

Spot gold rose to a fresh six-week high of $684.10 this morning, but had since slipped to $683.70. And silver had risen to $12.22.

In the forex markets, the pound had strengthened to 2.0232 against the dollar this morning, and was steady at 1.4817 against the euro. And the dollar was at 0.7322 against the euro and 115.36 against the Japanese yen.

And in London this morning, music retailer - and Waterstone's owner HMV Group - reported a 5.8% rise in same-store revenue in the first quarter, thanks to demand for the new Harry Potter and stronger-than-expected DVD sales. Chairman Carl Symon said that the company was 'in good operational shape' ahead of the key Christmas period. Like-for-like sales at HMV stores rose 9.6% and the those at Waterstone's stores rose 2.7%, although the latter would have been static had it not been for the publication of Harry Potter and the Deathly Hallows. Shares in HMV had climbed as much as 2.5% in early trading.

And our recommended articles for today...

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- There is no quick cure for the disease of excessive debt that has brought the market to its knees. The Fed may be able to prevent contagion, but it should be some time before markets return to normality. To read more on whether central bank policy can help get us out of this mess, click here: Is monetary medicine enough to heal the market?

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John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.