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August’s payrolls data was greeted with chants of “Goldilocks” for being not too hot and not too cold. Investors, however, forgot that “Goldilocks and the Three Bears” didn’t really have a happy ending.

It’s easy to see why markets initially celebrated the report. While the U.S. economy added 315,000 jobs in August, a touch more than the 300,000 economists had been predicting, the unemployment rate and the number of people who decided it was time to start looking for a job both increased, and wages grew at a slower-than-expected pace—maybe just enough for the Federal Reserve to slow the pace of rate hikes. That was the way the stock market initially treated it on Friday, with the

Dow Jones Industrial Average,

S&P 500,
and

Nasdaq Composite
all trading up more than 1% early in the day.

The gains turned to losses, however, as markets seemed to realize that maybe they’d gotten ahead of themselves. Job creation, while slowing, has only dropped from extremely high levels—more than 300,000 new positions would be considered strong under most circumstances—and wages continue to rise at a 5.2% clip.

“As a result, the door is still wide open for the Fed to keep moving, and we also think this keeps the potential for a 75-basis-point [0.75%] hike at the September meeting still on the table,” writes Rick Rieder, BlackRock’s chief investment officer of global fixed income.

As a result, the Dow finished the week down 964.96 points, or 3%, while the S&P 500 fell 3.3%, and the Nasdaq Composite dropped 4.2%.

It was the S&P 500’s third consecutive weekly drop since it tried and failed to retake its 200-day moving average at what proved to be the high point of the summer rally. That doesn’t bode well for the near future. The 200-day moving average, now near 4290, has been declining for 90 consecutive days, notes Dean Christians, a senior research analyst at Sundial Capital Research.

That has happened 23 other times since the beginning of 1930, and the S&P 500 has dropped an average of 5.8% over the six months following the 90-day mark, while rising just 30% of the time. “The S&P 500 remains mired in an established downtrend, which suggests a potentially unfavorable outcome,” Christians writes.

It isn’t just the Fed’s potential rate hikes that could cause a problem. The central bank is about to ramp up the shrinking of its balance sheet, a process known as quantitative tightening, as it continues to normalize U.S. monetary conditions.

The importance of that shouldn’t be understated, says Solomon Tadesse, head of quantitative equities strategies North America at Société Générale. He estimates that the balance-sheet reduction would be akin to raising rates by 4.5 percentage points—on top of a peak federal-funds rate of 4.5%, a rather massive tightening. That could shake stocks as it did in 2018, when quantitative tightening, not rate increases, caused a December selloff that forced the Federal Reserve to pivot to rate cuts in early 2019. “By the same token, it could be a ramp-up in QT, this time on a larger scale to erode a much larger balance sheet, that could surprise markets,” Tadesse writes.

That’s the problem when you’re in the home of a bear.

Write to Ben Levisohn at Ben.Levisohn@barrons.com