Stocks Smacked by Rising Rates

Bond yields surged Tuesday amid heightened inflation fears

Bond yields surged late on Tuesday, reflecting inflation fears and sending U.S. stocks lower. Market sentiment was also hurt by some disappointing earnings guidance.

Yields on 10-year Treasury notes surpassed 5.25% for the first time in a year. If yields stay this high, perhaps supported by inflation data expected on Thursday and Friday, then it's "a different game," said Bill Larkin, fixed income portfolio manager at Cabot Money Management. The high yields could cause money managers to rebalance their portfolios all at once, he says.

Bonds skidded on inflation worries as China said inflation accelerated at the fastest pace in more than two years and Bank of England Governor King signaled U.K. borrowing costs may need to rise. Larkin says many traders were sitting on their hands during the spike in yields late in Tuesday's session. "People want to see if there's some support [for yields] at this level," he says.

That support could come from economic data later this week that should give insight into how much inflation there is in the U.S. economy. May Retail Sales and the Fed's Beige Book arrive on Wednesday; the May producer price index, or PPI, on Thursday; and May consumer price index, or CPI, along with industrial production and capacity utilization, on Friday.

The CPI and PPI will be "huge" for bond markets, says Larkin, who doesn't believe inflation is a big problem and thinks bond markets may be "over-shooting." He notes 10-year bond yields hit a peak of 5.29% a year ago before backing off.

On Tuesday, the Dow Jones industrial average fell 129.95 points, or 0.97%, to 13,295.01. The broader S&P 500 index, was down 16.12 points, or 1.07%, at 1,493.

The tech-heavy Nasdaq Composite index lost 22.38 points, or 0.87%, to 2,549.77.

Shares of homebuilders were particularly hard hit Tuesday, with industry leaders such as Toll Bros. (TOL) and Lennar (LEN) posting losses. The S&P Homebuilding index was down more than 1% amid the fresh uptick in bond yields.

There was little economic news on Tuesday. The ICSC-UBS index of chain store sales showed a 1% rebound in the week ending June 9, reversing a 0.5% decline for the prior week. Lower gas prices contributed to the best week-to-week performance since February, Action Economics says.

In the energy markets Monday, July WTI crude was down 62 cents to $65.35 per barrel. Prices fell despite news that the International Energy Agency boosted its forecast for oil demand in 2007. Concerns about higher interest rates and slowing economic growth apparently pushed down prices, Action Economics says.

Among stocks in the news on Monday, Lehman Brothers (LEH) reported earnings per share of $2.21 for the second quarter, beating analysts' estimates of $1.88 and above earnings of $1.68 per share a year ago. The firm says revenue from overseas helped drive profits. Net revenue was 9.2% higher.

Texas Instruments (TXN) was trading lower after saying it expects earnings per share of 40 to 44 cents this quarter, vs. previous guidance of 39 to 45 cents.

Horizon Offshore (HOFF) received an offer from Cal Dive International (DVR) to buy the company for about $650 million, including about $22 million in debt, in a cash and stock deal.

American Commercial Lines (ACLI) was down almost 10% after it lowered its 2007 earnings guidance to a range of $1.45 to $1.65 per share, vs. analysts' previous expectation of $1.84 per share.

The firm cited weakness in spot grain markets and lower productivity in it manufacturing segment.

Coley Pharmaceutical Group (COLY) agreed to buy a majority stake in 3M Co.'s (MMM) therapeutic Toll-like receptor cancer programs. 3M will receive $20 million in cash payments over a three-year period, along with royalties and milestone payments.

The Chicago Board of Trade (BOT) moved higher after the U.S. Justice Department said it had no objection to its acquisition by its crosstown rival, the Chicago Mercantile Exchange (CME). The government had been investigating concerns the deal raised anti-trust issues by stifling competition in the futures markets. The CME is now in a bidding war with the InterContinental Exchange (ICE) over the CBOT. The CME was traded lower on Tuesday, while the ICE was up.

European stock markets finished solidly lower Tuesday. In London, the FTSE 100 index was down 0.72% to 6,520. Germany's DAX index was off 0.36% to 7,678.26. In Paris, the CAC 40 index was lower by 0.71% at 5,898.

Asian markets finished mixed Tuesday. In Japan, the Nikkei index was off 0.41% to 17,760.91. In Hong Kong, the Hang Seng index edged up 0.1% to 20,636.39. In China, the Shanghai Composite index was up 1.91% to 4,072.14.

Treasury Market

Treasury bonds were down all day but fell further toward close of Tuesday's session. The 10-year Treasury note ended down 22/32 to 94-07/32 for a yield of 5.265%, the highest since May, 2002. The 30-year bond was off 1-15/32 to 90-31/32 for a yield of 5.36%. The two-year note fell 4/32 to 99-21/32 for a yield of 5.07%.

Before it's here, it's on the Bloomberg Terminal.