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Stocks: Another Subprime Stumble

S&P's warning on mortgage-backed debt, along with gloomy earnings news from Home Depot and Sears, sent investors to the exits Tuesday

Equity investors, faced with a batch of negative headlines on corporate profits, subprime loans, and oil prices, beat a retreat on Tuesday, with major U.S. indexes each losing over 1%.

On Tuesday, the Dow Jones industrial average fell 148.27 points, or 1.09%, to 13,501.70. The broader S&P 500 index declined 21.73 points, or 1.42%, to 1,510.12.

The tech-heavy Nasdaq composite index shed 30.86 points, or 1.16%, at 2,639.16.

Two major retailers painted a less-than-appealing picture of consumer spending. Sears and Home Depot warned investors about lower-than-expected sales numbers.

Profit taking may have also been spurred by renewed concerns about subprime debt. Standard & Poor's Ratings Services put $12 billion of subprime-backed mortgage-backed securities on CreditWatch negative for potential ratings downgrades, and said many collateralized debt obligations (CDOs) are exposed to subprime loan deterioration as well. The move instilled fear that these widespread credit derivatives could come back to haunt the financial sector, says Action Economics.

John Thornton, portfolio manager at Stephens Investment Management Group, says he will be closely watching earnings numbers to see how consumer spending is holding up. Tuesday's news from Sears and Home Depot was a sign consumers may be feeling pressure. Thornton will look at profit reports to gage the impact on consumers of the poor housing market, including mortgage woes, and high energy prices.

Also, Thornton says, he'll be watching the earnings of industrial concerns closely, to see if they're bouncing back from the slow economic growth in the first quarter.

Alcoa kicked off the summer earnings season Monday evening with disappointing profits.

Yum! Brands (YUM; -2.46%) issues its report on Wednesday, Marriott International (MAR; -2.66%) on Thursday and General Electric (GE; -1.85%) on Friday. The earnings season really heats up next week, when many more companies report.

Trading activity was moderate, with 26 issues declining in price for each 8 posting price gains on the NYSE. Nasdaq trading breadth was 22-8 negative.

Crude oil futures were higher Tuesday, at one point hitting a 10-month high. August WTI crude futures were up 62 cents to $72.81. News from Iran and the Persian Gulf raised the worries of traders, Action Economics says.

Oil prices are "at a relatively tricky point," Thornton says. High oil prices usually help energy firms, but Thornton worries prices at this level could actually hurt the energy sector by cutting into demand. He notes that while oil prices have remained high, natural gas prices have eased over the last couple weeks.

In economic news Tuesday, U.S. wholesale inventories were up 0.5%, stronger than the expected 0.3% reading and the unrevised 0.3% reading seen in April. U.S. wholesale sales jumped 1.3% in May, below the upwardly revised 1.5% reading in April (1.3% before). The inventory-sales ratio fell to 1.11 from 1.12 in April, and bodes well for manufacturing later on, notes S&P MarketScope.

A speech by Fed Chairman Ben Bernanke, while widely watched for clues on future interest rate policy, had little impact on the market. Bernanke did not discuss the economy or the policy outlook, reports Action Economics, but kept his speech more academically oriented, covering the conceptual frameworks of inflation expectations, the implications of anchoring inflation expectations, and how the Fed forecasts inflation.

Investors will also be eying initial jobless claims figures on Thursday. Retail sales, Michigan consumer sentiment and business inventories are on the economic calendar for this Friday.

Among stocks in the news on Tuesday, Alcoa (AA; -1.65%) kicked off second-quarter earnings season with a bit of a disappointment. After the close of trading Monday, the aluminum giant reported second quarter income from continuing operations of 81 cents per share on revenue of $8.1 billion, shy of the analyst consensus estimates of 82 cents and $8.4 billion compiled by Reuters.

Home Depot (HD; +0.12%) expects 2008 profits to be 15 to 18% lower because of weaker conditions in the housing market and the announced sale of HD Supply. Same-store sale growth will be in the mid-single digits, the company says. Home Depot also announced a 250-million share buyback program, helping shares hold steady.

Sears Holdings (SHLD; -0.14%) fell after saying Kmart same-store sales fell 3.9% and Sears domestic same-store sales fell 4%. If current sales trends continue, the company expects earnings of $1.06 to $1.32 in the second quarter. The company also announced a $1 billion stock buyback program.

Pepsi Bottling (PBG; +0.36%) reported earnings of 70 cents per share, vs. 61 cents a year ago on a 7.1% rise in revenue. The firm raised its earnings guidance for 2007 from a range of $1.90-$1.98 to $2.02-$2.07.

Noven Pharmaceuticals (NOVN +0.97%) will buy JDS Pharmaceuticals for $125 million in cash, plus assumption of about $10 million in net liabilities.

European indexes fell on Tuesday. In London, the FTSE 100 index was off 1.22% to 6,630.90. In Paris, the CAC 40 index moved down 1.4% to 6,019.22. Germany's DAX index fell 1.39% to 7,964.76.

Asian markets were mixed. Japan's Nikkei 225 index edged down 0.05% to 18,252.67. In Hong Kong, the Hang Seng index climbed 0.3% to 22,885.84. In mainland China, Shanghai's benchmark index fell 0.78% to 3,853.02.

Treasury Market

Treasuries rallied sharply Tuesday , boosted by an asset allocation shift out of equities, which suffered steep losses. The shift reflected a flight to safety after S&P Ratings placed

$12 billion in subprime mortgage-backed securities on CreditWatch with negative implications. The 10-year note jumped 24/32 to 95-30/32 for a yield of 5.03%, and 30-year bonds were up 46/32 to 94-10/32 for a yield of 5.12%.

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