Stocks Drop as Economic Fears Worsen

The biggest drop in nonfarm payrolls in five years fanned recession fears and raised expectations of a large Fed rate cut

A brutal week for the battered U.S. stock markets ended grimly, as investors began to come to grips with the growing likelihood of an economic recession. As of Friday's close, major U.S. equity indexes have lost more than 16% of their value since their peaks in mid-October.

Selling in the equities market intensified Friday afternoon, before a modest recovery into the market close as investors digested weaker than expected employment figures for February that compounded worries about the state of the credit markets and confirmed investors’ worst fears about the U.S. economy. New record high oil prices suggest growing inflation risks, but Fed fund futures are projecting a 75-basis-point rate cut by the Federal Reserve in March to try to contain the economic downturn.

On Friday, the Dow Jones industrial average closed 146.70 points, or 1.22%, lower at 11,893.69. The broader S&P 500 index fell 10.97 points, or 0.84%, to 1,293.37. The tech-heavy Nasdaq composite index shed 8.01 points, or 0.36%, to finish at 2,212.49.

The financial stocks gave back early gains as members of Congress grilled top executives such as Countrywide's Angelo Mozilo on executive compensation, S&P MarketScope said. On the New York Stock Exchange, 21 stocks were down for every 9 that traded higher, while the ratio on the Nasdaq was 18 to 9 negative amid moderate trading volume.

Capping a week of discouraging economic reports, February nonfarm payrolls dropped 63,000, more than double the 30,000 decline that economists had expected on average and the largest decline in five years. January's drop was revised lower to 22,000 from 17,000, while December's growth in payrolls was halved to 41,000 from 82,000.

"One of the big surprises in the report was the unemployment rate moderating to 4.8% (median 5.0%) from 4.9%," said Action Economics. "The moderation, however, masked underlying weakness in the household survey, as this survey's employment measure fell 255,000, but was overwhelmed by a hefty 450,000 drop in the workforce."

The numbers put new pressure on the Federal Reserve to cut rates by 50 to 75 basis points at the March 18 policy meeting even though the Fed expanded its Term Auction Facility to ease the liquidity crisis in the credit markets, S&P MarketScope said.

"The jobs picture dimming could potentially force homeowners to sell their homes," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "This is a liquidity situation. There’s no bid for anything. Anything that forces people to sell is just making things worse, whether for a bank or for an individual."

Even as the market eagerly awaits another hefty rate cut, conflicting signals from various Federal Reserve officials was causing more uncertainty. Fed vice-chairman Donald L. Kohn continues to favor rate cuts but suggested that a bigger-than-expected inflation risk from oil and other commodity price spikes could curb the Fed's wilingness to ease monetary policy.

San Francisco Fed president Janet Yellen indicated she was worried more about inflation in the near-term than over the longer term. But Dallas Fed president Richard Fisher told the market not to continue to expect rate cuts, saying the Fed needs to be careful to take a steady, measured approach to new economic events.

The Fed's announced that it was increasing the Term Auction Facility to $100 billion from $60 billion in March, with the first auction being a $50 billion auction on March 10, followed by a second $50 billion auction on March 24. That extra capital is intended to give the banks more confidence to continue making loans without fear that their funding lines will dry up.

Despite Fed Chairman Ben Bernanke's claim to the contrary, it wasn't a coincidence that the TAF injection was announced around the same time as the grim February payroll report came out, says Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, N.J.

"Their vehicles of choice is the term auction facility to try to prevent an intermeeting rate cut," he said. "

If the [liquidity] problem gets out of hand, [the Fed] would have to do an intermeeting cut but then they''d have nothing left two weeks from now."

One key reason for the liquidity crisis has been the muddled communication coming out the central bank, which has made the banks question whether their source of funding will continue to be available, Roberts said. "This problem is not going to go away [quickly]. This is more like stanching the bleeding," he said.

He said interest rates are certain to be reduced to 2.0% and may have to be cut back to 1.0% again in order to allow the credit markets to repair themselves.

Echoing the plunge in the Conference Board's index of consumer confidence for February released last week, the RBC Consumer Attitudes and Spending by Household, or CASH, Index fell to 33.1 in March from 48.5 in February, led by a sharp drop in consumers' optimism for the future. The numbers showed consumer confidence is down to the lowest levels since 2002, when the index started.

"The U.S. consumer, who has carried the economy for the past half-dozen years, is in full defensive mode, battered by falling housing values, spiking food and energy prices, tightening lending standards, the teetering stock market and hints of weakening in the labor market," T.J. Marta, economic and fixed income strategist for RBC Capital Markets, said in a statement.

Shares of Ambac Financial Group (ABK) came under new pressure Friday after the bond insurer issued $1.25 billion in equity at a price of $6.75 per share but rebounded to close 28% higher.

Oil prices hit a new high of $106.54 on Friday on expectations of another rate cut, which would further weaken the U.S. dollar, before sliding back slightly. Crude oil for April delivery on NYMEX settled 32 cents lower at $105.09 per barrel.

The dollar's decline to record lows on Thursday had been sparked by the European Central Bank's decision not to lower interest rates, putting a priority on vigilance against higher inflation. While short covering fueled a rebound ahead of the weekend, the fundamental backdrop hasn't changed for the greenback given the ongoing credit problems in the U.S., and renewed concerns over recession, Action Economics said. With Friday's gains nothing more than position squaring from an over-extended foreign exchange market, more downside pressure is expected to emerge after a day or two of consolidation next week.

Among the stocks in the news on Friday, AngioDynamics Inc. (ANGO) shares plummeted 37.5% after the company said it expects its third-quarter sales to grow 14% to $40.7 million but that earnings will still likely miss Wall Street estimates. While its oncology product line has done well, the medical devices manufacturer said the 10% sales growth of its interventional product lines was less than expected. It said its dialysis product sales continued to be hurt by considerable price competition. The company cut its fiscal 2008 sales forecast to $165 million to $167 million from a prior estimate of $170 million to $175 million.

National Semiconductor (NSM) shares rose 11.7% after the company posted earnings of 28 cents per share for the third quarter, vs. 22 cents a year ago on a 5.2% sales increase. The company expects sales to be $440 million to $460 million in the fourth quarter. Standard & Poor's upheld its hold rating.

Citigroup (C) said it plans to reduce residential mortgage assets in its U.S. mortgage business by about $45 billion over the next year, a 20% decrease from December 2007. The bank will also cut the amount of new loans to be held in its portfolio by more than 50% in the next year. Separately, CEO Vikram Pandit reportedly denied rumors that the company may put its South Korean unit up for sale. Shares ended 1.2% lower.

Dynamic Materials Corp. (BOOM) shares fell 19.1% after the company reported lower-than-expected fourth-quarter earnings of 56 cents per share, vs. 54 cents a year ago on a 55% rise in sales. Narrowed gross margins damped the results. The company sees 2008 revenue growth of up to 60%, with gross margins comparable to the 32% achieved in 2007. It also expects first-quarter operating income to be hurt by lower gross margins than in the fourth quarter and about $3 million of acquisition-related amortization expense. The impact of higher interest costs is expected to result in first-quarter earnings comparable to a year ago.

European indexes were trading lower again on Friday. In London, the FTSE 100 index slid 1.15% to 5,699.90. In Paris, the CAC 40 index dropped 1.26% to 4,618.96. Germany’s DAX index was off 1.17% at 6,513.99.

Asian indexes ended lower on Friday. Japan’s Nikkei 225 index dropped 3.27% to 12,782.80. In Hong Kong, the Hang Seng index fell 3.60% to 22,501.33.

Treasury market

Treasury prices climbed in response to growth in the payrolls shortfall in February from revised lower January levels, ignoring a surprising decline in the unemployment rate. The 10-year note rose 14/32 to 99-23/32 for a yield of 3.53% and the 30-year gained 8/32 to trade at 97-08/32 for a yield of 4.54%.

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