News Article
BusinessWeek.com
May 17, 2006
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Stocks Tumble on Inflation Worries

The Dow had its biggest drop in three years, while the Nasdaq erased its 2006 gains. Says one pro: "The market is grasping for leadership"

Wednesday brought fresh misery to the stock market's not-so-merry month of May as major indexes finished broadly lower on heavy trading volume. Investors headed for the exits after a surprisingly firm inflation report which fanned fears of higher interest rates. The data overshadowed strong quarterly results from technology bellwether Hewlett-Packard (HPQ ), says Standard & Poor's Equity Research.

The Dow Jones industrial average fell 214.28 points, or 1.88%, to 11,205.61, its biggest decline since Mar. 24, 2003. Alcoa (AA ) and Boeing (BA ) were among 29 Dow components retreating on the day.

The broader Standard & Poor's 500 index dropped 21.77 points, or 1.68%, to 1,270.31. The tech-heavy Nasdaq composite declined 33.33 points, or 1.5%, to 2,195.8, extending its losing streak to seven sessions and dipping into negative territory on the year.

NYSE breadth was decidedly negative, with 28 issues declining for each 6 advancing. Nasdaq breadth was 22-8 negative.

A closely watched inflation gauge spooked investors Wednesday. The overall consumer price index rose 0.6% in April, while the core index added 0.3%, the Labor Department said. The slightly higher-than-expected core figure likely negates the market benefit of Tuesday's downside surprise in the core producer price index, says Action Economics.

The inflation data suggest the Federal Reserve will have to continue hiking interest rates when it meets in June, some analysts say. "There is little evidence that the April CPI report was driven by one-time factors and, as a result, the second month of an outsized gain in the core cannot be dismissed," says Lehman Brothers economist Drew Matus. "We believe that this will keep the pressure on the Fed to maintain their inflation-fighting credentials and increases the odds of a June rate hike."

Indeed, for the Fed to pause from its tightening cycle at this point would be a mistake, others say. "The upward pressure on inflation is coming from the services area and thus inflation reports such as the PPI become less of a guide to trends in inflation," says John Ryding, chief U.S. economist at Bear Stearns. "We have argued that as the home ownership market eases and the rental market tightens, higher rents will put upward pressure on inflation and that this dynamic, once it begins, is fairly sticky. This raises the risk, therefore, of higher inflation readings going forward."

The markets were also dealing with recent reversals in industrials, commodity prices and the energy complex. "This is what has really been the buttress of the stock market for the last six months or so, and we've lost that in the last couple of trading sessions," says Gary Wolfer, senior portfolio manager with Univest Wealth Management & Trust. "The market is grasping for some form of leadership."

Investors now await the May 25 preliminary reading of gross domestic product (GDP) for further inflation clues. First-quarter GDP growth is forecast to be revised up to 5.8%, from the 4.8% gain in the advanced report, says Action Economics.

On the economic docket Thursday, initial jobless claims are expected to drop 9,000 to 315,000 for the week ended May 13. The April leading indicators index is seen remaining unchanged.

In company news Wednesday, Hewlett-Packard was the Dow's lone bright spot, rising more than 3% after the computer maker posted a 51% increase in fiscal second-quarter earnings. The upbeat results followed a profit warning last week from rival Dell (DELL ).

On the downside, Applied Materials (AMAT ) was lower after the maker of tools used to manufacture chips said orders this quarter will rise from 5% to 10%, less than the 15% analysts expected.

French media giant Vivendi (V) was lower despite a 41% rise in first-quarter earnings. The company also said it has turned down a breakup proposal by shareholders.

Two teen clothing retailers posted double-digit profits. Abercrombie & Fitch (ANF ) reported a 39% jump in profit, while rival American Eagle Outfitters (AEOS ) enjoyed a 16% rise, both beating expectations.

Outside of earnings, Honda (HMC ) was lower after the automaker said it will open a new factory in the U.S. as part of a $1.18 billion expansion.

Elsewhere, XM Satellite Radio (XMSR) was sharply lower after the Recording Industry Associaton of America filed a lawsuit against the satellite radio operator alleging copyright infringement.

In the energy markets, June West Texas Intermediate crude oil futures closed down 84 cents to $68.69 a barrel, after a weekly inventory report showed a decline of 100,000 barrels.

European markets finished sharply lower in sync with their American counterparts. In London, the Financial Times-Stock Exchange 100 index tumbled 170.7 points, or 2.92%, to 5,675.5. Germany's DAX index slid 196.25 points, or 3.35%, to 5,655.67. In Paris, the CAC 40 index dropped 161.38 points, or 3.18%, to 4,920.31.

Asian markets finished higher. Japan's Nikkei 225 index rose 149.25 points, or 0.92%, to 16,307.67. In Hong Kong, the Hang Seng index climbed 222.44 points, or 1.36%, to 16,615.55. Korea's Kospi index rebounded 19.36 points, or 1.4%, to 1,401.47.

Treasury Market

The Treasury market also suffered in the wake of the April CPI report as yields rose on the solid inflation data. Prices for 10-year Treasury notes fell to 99-22/32 with a yield of 5.16%, while 30-year bonds dropped to 88-09/32 for a yield of 5.28%.