I think the combination of jonW and Dick Greanhaus' answers give a pretty good guess.

Namely the fact that they used to get dressed up for funerals, and given that "red" rhymes with "dead".

The answer, although probably correct, disappoints me. I was hoping to find out if the people were happy or sad at Louis's death from the fact that they got dressed in red.

I hope that some of the people who answered this question will read a new thread I am about to create about some elusive Billie Holiday songs.

Murray