A Sharp Reversal for Stocks

Nervous times continue on Wall Street, with indexes plunging over 2% only one day after Tuesday's Fed-inspired rally

Easy come, easy go. One day after the Dow industrials soared 420 points on a jumbo interest-rate cut by the Federal Reserve, investors had some second thoughts about the rally. Major U.S. equity indexes, pummeled by a late-session wave of selling, each sank over 2% on Wednesday.

On Wednesday, the Dow Jones industrial average tumbled 293 points, or 2.36%, to finish at 12,099.66. The S&P 500 index dropped 32.32 points, or 2.43%, to end the session at 1,298.42. The Nasdaq composite index finished lower by 58.30 points, or 2.57%, at 2,209.96.

Trading measures in the broader market were negative. On the New York Stock Exchange, 22 issues declined in price for every 9 that rose. The ratio of decliners to advancers on the Nasdaq was 20-8. Volatility in the S.&P. 500 reached a 70-year high, according to Howard Silverblatt, an analyst at Standard & Poor’s.

What happened? Ahead of Thursday’s Quadruple Witching – Wall Street-speak for the quarterly expiration of option contracts and futures contracts, and single-stock futures, frequently characterized by heavy market volatility – investors decided to take some profits off the table on Wednesday, according to S&P MarketScope.

Investors, still unnerved by the credit crisis, found fresh reason to worry after news hit that a unit of Merrill Lynch (MER) was suing XL Capital, a unit of bond insurer Security Capital Assurance, alleging the company is attempting to avoid its financial obligations of up to $3.1 billion under seven credit default swaps. Merrill shares sank 11% Wednesday, helping drag the S&P Investment Banking & Brokerage index down 4.68%.

Positive profit reports and news that there's more relief coming to government-sponsored U.S. mortgage companies, which could provide the liquidity needed to start thawing the credit markets, were trumped by the market’s continued jitters about the effects of the credit crunch. A successful IPO from credit-card titan Visa also failed to inspire the broader market.

Bonds prices rose as the Fed left the door open for an April rate cut. The dollar index gained. Oil and mining stocks skidded as energy and precious metals futures plunged following Tuesday's FOMC rate cuts and policymakers’ comments on inflation risks.

Thursday's reports on initial jobless claims, the Philadelphia Fed index, and leading indicators could add fuel to the debate over whether the economy has bottomed or the downturn is worsening, says S&P MarketScope..

“The lack of follow-through buying [on Wednesday] is disappointing for near-term bulls,” says S&P technical analyst Chris Burba.

Richard Sparks of Schaeffer’s Investment Research said there were rumors that Merrill might be preparing to take more subprime-related writedowns. But there might be a simpler reason for the stock market’s late-day sell-off on Wednesday: After Tuesday’s big rally, investors got nervous stocks were getting ahead of themselves.

“One of the things we’ve seen in the market over the last few weeks has been a propensity to sell off any rally,” Sparks says. With so many worries about the economy and credit and housing markets, he said, “The path of least resistance has been down.”

Georges Yared, of Yared Investment Research agreed, saying the murky environment might have encouraged investors to take profits from Tuesday’s rally. “It might be as simple as that,” he says. Investors realize they still must wait for more clues on the direction of the economy, and first quarter earnings reports don’t arrive until mid-April, Yared says.

Although the Fed shorted Wall Street by a quarter-point on Tuesday by cutting the benchmark Federal funds target rate only 75 basis points to 2.25% instead of the full percentage point that was expected, some say the Fed's action the was best outcome for the economy and financial markets in the immediate period ahead, according to S&P MarketScope. Not only did the central bank leave the door open for further monetary easing in April, but by showing some concern about the inflation risk, the Fed also provided a boost to the U.S. dollar index.

On Wednesday, Morgan Stanley (MS) relieved some concerns about the investment-banking group by reporting better-than-expected earnings from continuing operations of $1.45 per share vs. $2.17 in the first quarter of 2007 on a 17% drop in consolidated revenue.

The market was also encouraged by Adobe Systems (ADBE), which posted non-GAAP earnings of 48 cents per share in the first quarter vs. 30 cents a year ago on a 37% jump in revenue. That was above the software maker's non-GAAP earnings target range of 44 to 46 cents. The company sees second-quarter revenue of $855 million to $885 million, a non-GAAP operating margin of about 39%, and earnings between 45 and 47 cents per share. It reaffirmed its fiscal 2008 revenue growth target of about 13%, and non-GAAP EPS target of $1.86 to $1.92.

And the promise of relief in the mortgage markets also sparked investor enthusiasm. The Office of Federal Housing Enterprise Oversight, the regulator for Fannie Mae (FNM) and Freddie Mac (FRE), is scheduled to announce Wednesday a partial lifting of the capital surplus requirements on the U.S. mortgage finance companies, which will allow them to pump about $200 billion into the shaky mortgage market, sources familiar with the plan told Reuters on Tuesday.

In a throwback to the glory days in equity markets before the credit crisis, Visa (V) became the biggest initial public offering in U.S. history on Wednesday, selling 406 million shares at $44 apiece to raise $17.9 billion. The deal tops the previous top U.S. IPO, AT&T Wireless's $10.6 billion offering in 2000. Because Visa generates revenue from credit and debit card transaction fees and doesn't carry consumer debt on its books, it should be able to do well in an economic downturn, especially if people depend more heavily on credit cards to get by, analysts say.

The sole piece of new economic data on Wednesday came from the Mortgage Bankers Association, which released its Weekly Mortgage Applications Survey for the week ending March 14. The Market Composite Index, a measure of mortgage loan application volume, showed a 2.9% decline to 652.0 on a seasonally adjusted basis from 671.7 one week earlier. On an unadjusted basis, the Index was down 2.8% from the prior week and down 3.7% lower from the same week one year earlier. The Refinance Index fell 4.6% to 2335.0 from the previous week.

April NYMEX crude last traded down $6.18 per barrel on Wednesday at $103.25, after ranging between $102.95 and $107.53. “Wholesale bailing out of long positions was the theme of the day,” asays Action Economics, which also cites a firmer dollar and a general commodity market sell-off as factors.

Indeed, the dollar index was up 0.57 to 72.44 in late trading. Reuters reports

that European Central Bank policymakers said financial market turmoil is worse than earlier thought and the euro zone is unlikely to escape unscathed. But many central are bankers also worried inflation would rise due to high commodity prices even as economic growth slows.

Gold, silver, platinum and palladium prices plunged Wednesday as speculators cashed in on huge profits made the past year.

Among the other stocks in the news on Wednesday, SI International (SINT) cut its first-quarter earnings guidance to 24 to 27 cents per share on revenue of $128 million to $130 million from previous guidance of 31 to 35 cents on revenue of $133 million to $141 million. The company notes program delays in the funding and start of several new key programs and now sees 2008 earnings at $1.40 on revenue of $560 million to $580 million.

Capital Corp. of the West (CCOW) delayed filing its 2007 annual report after determining that certain of its loans required an adverse classification and substantially greater provision for possible loan losses, primarily due to a rapid decline in real estate values in California's Central Valley in the fourth quarter. The company says it had material weaknesses in its credit/lending and accounting functions.

European stock markets were unable to build on Tuesday's gains as indexes slipped in late trading Wednesday. In London, the FTSE 100 index was lower by 0.59% at 5,572.90. In Paris, the CAC 40 index declined 0.67% to 4,551.85. Germany’s DAX index lost 0.06% to 6,389.87.

Asian markets rose overnight. Japan’s Nikkei 225 index climbed 2.48% to 12,260.44. The Hang Seng index in Hong Kong advanced 2.26% to 21,866.94.

Treasury market

Treasuries rallied sharply due to a shift in investment capital to areas of relative safety, as the stock market failed to maintain the big gains achieved yesterday. The 10-year note climbed 41/32 to 101-10/32 for a yield of 3.34%, while the 30-year bond soared 77/32 to 102-26/32 for a yield of 4.21%.

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