Some weaker economic data and statements from the Federal Reserve indicating that it has downgraded its view of the economy caused stocks to sink sharply last week, ending a multi-week run of gains. The Dow Jones Industrial Average lost 3.3% to end the week at 10,303, the S&P 500 Index declined 3.8% to 1,079 and the Nasdaq Composite fell 5.0% to 2,173. With these losses, all three indices are back into negative territory on a year-to-date basis.

The major economic story last week centered on the Fed’s policy meeting Tuesday. The central bank indicated that it expected weaker growth in the months ahead and reiterated its view that it was too soon to consider a shift in interest rate policy. The Fed also stated that it would begin to reinvest the proceeds of maturing agency and mortgage debt into long-term Treasuries. The total amount of these investments may not be overly significant, but the actions signal that the Fed is not starting to think about shrinking its balance sheet, which may have been the case before the onset of the current period of economic weakness. On balance, investors interpreted the Fed’s statement as a broadly negative one, as it indicated that economic growth had again deteriorated to the point that action was required. In response, Treasury yields fell sharply (as prices rose) and stock prices sank.

Recent economic data seemed to confirm the Fed’s view. July’s weaker-than-expected labor market report was followed last week by worse-than-expected unemployment claims. Retail sales figures also were somewhat disappointing, as consumer spending has been struggling to improve in the face of ongoing deleveraging. Additionally, last week brought news that the trade deficit had deteriorated in June, which likely knocked about 0.5% off of second-quarter gross domestic product growth.

One bright spot in the macro picture continues to be corporate earnings, as the faltering of the economic recovery has not stopped the recovery in profits. Based on the almost-complete second quarter reporting season, earnings per share were 84% higher in the second quarter than they were one year ago. Companies that have high levels of foreign exposure have produced particularly good results — corporations that have over 20% of their businesses outside of the United States saw revenues advance by 16% for the quarter.

The combination of extremely low Treasury yields (the yield on the 10-year Treasury fell to just over 2.6% by the end of last week — its lowest level since April 2009) and struggling equity markets has again caused many observers to raise the specter of deflation. Some are suggesting the United States is entering into a deflation spiral similar to that seen in Japan in the 1990s or the US version from the 1930s. While there are some similarities between those time periods and the present, one of the main differences is that today the US Federal Reserve is fully aware of the policy mistakes made in the past and is deeply committed to pushing hard in the opposite direction in order to minimize the probability of a long-term period of deflation. We place a low likelihood on the chance that the United States will endure prolonged deflation.

Bob Doll is Vice Chairman and Chief Equity Strategist for Fundamental Equities at BlackRock®, a premier provider of global investment management, risk management and advisory services. Mr. Doll also is lead portfolio manager of BlackRock’s Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer of Merrill Lynch Investment Managers.