Stocks Claw Their Way Back

Buyers swooped in the last hour Thursday after heavy selling pushed major indexes 10% below their recent highs

It was another wild and wacky day on Wall Street as stocks snapped back from a deep plunge thanks to some late-day short-covering and buying tied to Friday's monthly options expiration.

Thursday started as another dreary day on Wall Street as bad news from Countrywide Financial (CFC) sparked more worries about credit markets, mortgage lenders, and even the broader economy, sending the Dow Jones Industrial average and the S&P 500 index tumbling into a correction territory -- typically a drop of 10% or more from highs.

On Thursday, the Dow Jones industrial average ended down 15.69 points, or 0.12%, to 12,845.78 -- after falling as much as 344 points during trading, which amounted to a 11% drop from its closing high of 14,000.41 on July 19.

The broader S&P 500 managed to finish higher, up 4.57 points, or 0.32%, to 1,411.27. During trading, the index dropped 12% from its closing high of 1,553.08 on July 19. The index is now down 0.5% for the year.

The tech-heavy Nasdaq composite index lost 7.76 points, or 0.32%, to 2,451.07. During the session, the index fell as much as 12% from its closing high of 2,720.04 on July 19.

The CBoE's volatility, or VIX, equity index -- a measure of market fear -- hit a new high Thursday of 37.50 as stocks kept falling, and then retreated to 30.83 by the close.

This week's turmoil has prompted many bulls to offer hope that the problems in the credit and mortgage markets won't throw the economy into a tizzy. U.S. Treasury Secretary Henry Paulson told the Wall Street Journal he believes the turmoil on financial markets "will extract a penalty" on U.S. economic growth, but "the economy and the markets are strong enough to absorb the losses" without creating a recession.

Other market watchers wondered when the selling will turn to buying. "The market is obviously in a heightened state of paranoia and if we see the full fledged selling panic come in, you may have to buy simply based on the fact we are probably a bit oversold," wrote Jay Collins of DT Trading in Chicago in an early morning note.

The big debate was whether the Federal Reserve would step in and cut interest rates to ease the pain of the credit crunch. The New York Fed injected another $12 billion in reserves with overnight repurchase agreement, or "repo", on top of the $5 billion 14-day repo put in place earlier in the morning to help ease the liquidity crunch. On Wednesday, the New York Fed used a repo to add $7 billion to financial institutions.

In the last week, central banks in the U.S. and Europe have injected money into the markets to help stabilize the credit markets.

But some experts argue that a cut in rates by the Fed may not be needed now that market rates have fallen. Action Economics notes that the Fed's injections over the last several sessions have kept the effective funds rate below the 5.25% target rate, and has traded with around 4% since last Friday. "This is an effective easing from the Fed," says Action Economics.

Meanwhile, the Fed's rescue attempts are making investors nervous that more financial and lending companies are in danger. "The Fed pumping money into the system is positive, but the more money they pump in, the more the fear factor increases," explains Peter Cardillo, chief market economist at Avalon Partners in New York. "People think there are still a lot of problems out there."

And those problems could hurt the rest of the economy. In a report Thursday, U.S. housing starts dropped 6.1% to 1.38 million in July (economists were expecting 1.42 million), from a 1.47 million in June, which was revised lower. July permits fell 2.8%. Single-family starts were off 1.6% while multi-family starts fell 6.1%.

The Philly Fed index, an indicator of manufacturing activity in the Northeast, tumbled to 0.0 in August (median estimate was 8.4) from 9.2 in July. And U.S. initial jobless claims rose 6,000 to 322,000 in the week ended Aug. 11.

"Weak headline data on housing starts and the Philly Philly Fed added to fears that distress in the financial sector is spilling over to the real sector," said Action Economics.

In the currency markets, the yen carry trade was also a highlight of the day. Collins of DT Trading noted that "it looks as if the only trade left to disintegrate will be the yen carry trade and based on the dollar-yen right now, it looks as if this may be beginning." Action Economics says the wholesale unwinding of yen funded carry trades led the Japanese currency sharply higher against the U.S. dollar, which dove over 550 points from highs to around 112.00 in New York trading.

Among stocks in the news Thursday, Countrywide Financial (CFC) says it need to rely on a $11.5 billion credit facility to fund its operations. Moody's and Fitch Ratings cut their credit ratings for Countrywide. The stock fell another 13% and hit a new 52-week low.

J.C. Penney (JCP) reported earnings of 78 cents in the second quarter, up from 75 cents a year ago. Same-store sales rose 1.9% and total sales rose 3.6% for the retail chain. It raised its 2008 earnings guidance by 1 cent. (CRM) reported earnings of 3 cents per share in its second quarter on a 49% rise in revenue. The firm broke even a year ago.

Petsmart Inc. (PETM) reported earnings of 36 centts, vs. 27 cents a year ago on 4% higher comparable-store sales. The retailer also announced a $300 million stock buyback program.

Oil prices fell Thursday. September West Texas Intermediate crude oil futures dropped $2.36 to $70.97 a barrel. Selling was dominated by fund selling, which was largely linked to deleveraging and carry trade unwinding activity, says Action Economics. Traders were also watching the tropical storm activity.

In Europe, stock indexes finished with sharp losses on Thursday as credit woes spread. In London, the FTSE 100 index plunged 4.10% to 5,858.9. Germany's DAX index dropped 2.36% to 7,270.07. In Paris, the CAC 40 index lost 3.26% to 5,265.47.

Asian markets also moved sharply lower. In Japan, the Nikkei index dropped 1.99% to 16,148.49. In Hong Kong, the Hang Seng index fell 3.29% to 20,672.39. The Shanghai composite index slid 2.14% to 4,765.45.

Treasury Markets

Treasuries jumped sharply on back of a broad asset allocation shift out of anything risky into the safety of U.S. government debt, says S&P. The shift represents fears that the fallout in securities realted to subprime mortgages will impact liquidity, broadly speaking, that would hurt financial markets across the board and around the globe, S&P says.

This sent the 10-year note up 29/32 to 101-04/32 for a yield of 4.60%, and the 30-year bond also to 101-04/32, up 49.32, for a yield of 4.92%. Perhaps a better barometer of the sense of panic in financial markets, the two-year bill skyrocketed 122/32 to 100-00/32 for a yield of 4.08%, notes S&P.

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