Stocks Fall on Economic Worries

Tech and energy shares led the way down as an early rally faded and oil prices slumped

U.S. equities finished lower on Tuesday, giving back earlier gains with energy and technology stocks leading the way lower. Oil prices fell but recovered from a brief drop to five-month lows. Reports of minimal damage to Gulf Coast oil platforms from Hurricane Gustav had sent oil prices reeling, but some energy experts say it will take a few days for companies to inspect their facilities and return to normal production levels.

On Tuesday, the Dow Jones industrial average gave up a nearly 250-point rally to end 26.63 points, or 0.23%, lower at 11,516.92. The broader S&P 500 index closed down 5.26 points, or 0.41%, at 1,277.57. And the tech-heavy Nasdaq composite index lost 18.28 points, or 0.77%, to finish at 2,349.24.

On the New York Stock Exchange, 17 stocks lost ground for every 14 that traded higher, and the ratio was even at 17-17 on the Nasdaq, amid slow trading, S&P MarketScope said. Concerns about weaker commodity prices pushed stocks lower, with technology names also heading lower, offsetting gains in airlines, which benefitted from the drop in oil prices, and financials, which were led by increases in Fannie Mae (FNM) and Freddie Mac (FRE).

Among stocks moving Tuesday, state-owned Korea Development Bank reportedly confirms it is in talks with Lehman Brothers (LEH) over a possible joint investment in the firm with other Korean banks.

UAL Corp. (UAUA) is among airliners whose shares jumped as oil prices dropped sharply on signs that the weakened Hurricane Gustav didn't do as much damage in the Gulf as originally feared. Delta Air Lines (DAL) shares were also up dramatically.

"I was shocked to see [stocks] go up and I'm not shocked to see them come down," says Bob Andres, chief investment strategist at Investnet in Philadelphia. The impact of energy prices and inflation risks on equities are substantially less important than they would be in normal times due to the overhang of the intertwined credit and housing crises, he says.

He suspects the hands of day traders or hedge funds in the bounce of financial stocks, given that "there's no relationship between energy prices and financials." In fact, if energy prices are falling not just because the Gulf Coast avoided significant disruptions to output, but on the slowing of the global economy, it should be worse for banks and other financial institution, he adds.

It's virtually impossible for stocks to do well with volatility at annualized levels of 150% to 200% and corporate bond spreads touching all–time highs, Andres says. He believes that the stock markets won't improve until housing prices fall to where they are as affordable as they were in the late 1990s.

Oil prices traded sharply lower on Tuesday -- though off five-month lows below $106 a barrel -- as companies prepared to restart production from rigs closed by Hurricane Gustav, which spared the Gulf Coast the devastation caused three years aho by Hurricanes Katrina and Rita. The markets are watching the progress of Hurricane Hanna, followed by Tropical Storms Ike and Josephine cited in the Caribbean.

Crude oil for October delivery settled $5.75 lower to $109.71 a barrel. Oil prices are likely to be between $95 and $105 a barrel by the end of this year, Christopher Edwards, managing principal at FIG Partners Energy Research & Capital Group said in an interview on Bloomberg Television on Tuesday.

The dollar index rose as the euro and sterling plunged on the theory that the U.S. economy might be near bottom, while European growth is slowing, according to S&P MarketScope. Gold futures also plummeted as the greenback surged.

Rebutting talk that stocks are near a bottom, equity strategist Tobias Levkovich at Citi Investment Research in an email research note cited "likely performance pressures in areas that investors still seem eager to buy," and said it was too early to step up to the Capital Goods, Industrial Conglomerates, Energy and Materials sectors, barring unpredictable external factors such as a hurricane. Levkovich said his research team has found a six-month lag in stock price direction following the trend detected by the Economic Cycle Research Institute, whose weekly index continues to confirm stock price weakness.

Levkovich said he doesn't expect the strengthening dollar to have a meaningful negative impact on multinational companies' sales until the first half of 2009. He predicted the 9% tailwind in multinationals' sales that the dollar provided during the first half of 2008 will flatten out in the third quarter and be a slight drag in the fourth quarter before becoming a minor headwind of 2% to 4% in the first six months of next year, assuming no further greenback appreciation.

"A dramatic change in export trends will take longer to play out given that competitiveness and sourcing decisions are more complex and do not shift on the basis of short-term foreign exchange fluctuations," he wrote.

It's still difficult to call a bottom for the economy even though many of the risks to further economic slowing have already been priced into the market, says Ihab Salib, portfolio manager and head of international fixed income at Federated Investors in Pittsburgh. He sees Commerzbank's AG announcement that it will acquire Dresdner Bank AG from insurer Allianz SE in a two-part, stock-and-cash deal valued at $14.3 billion as a good sign. A cash-infusion deal for Lehman Brothers (SCRX) would be another indication that even if the market isn't putting in a bottom, "at least people are comfortable taking on those risks [with the confidence that] valuations are somewhere near reality," he says.

The only argument for equities now is there's a lot of money around that investors want to put to work, says Andres at Investnet. But given his view that there's more bad news for equities still to come, he sees the bond market being the benficiary of the stronger dollar, since "Europeans investors are better off owning two-year or other short-end Treasuries and benefitting if the dollar goes up [further]," than buying equities.

On the economic data front, the U.S. Institute for Supply Management index slipped to 49.9 in August from 50.0 in July, offering little clarity on the state of the U.S. economy in the third quarter.

Construction spending fell 0.6% in July, double the anticipated decline, and the first time spending has dropped in three months. Unlike in May and June, the continued sharp decline in residential investment was not offset in July by solid gains in nonresidential spending. Although this report is a lagging indicator, it suggests that the construction sector got off to a weak start at the start of the third quarter, John Ryding at RDQ Economics wrote in an email note.

The most watched numbers this week will be the Labor Dept.’s employment report for August, due out on Friday. Economists predict another moderate drop in payrolls of 70,000 workers, close to the 66,000 average monthly decline from January to July. They expect the unemployment rate to hold steady at July’s 5.7% reading. Those numbers, if realized, would imply the economy remains weak but would not suggest any additional deterioration.

Among other stocks in the news on Tuesday, Google (GOOG) announced the beta launch of its own web browser, Google Chrome, which will seek to take market share from Microsoft's (MSFT) Explorer. Google also unveiled a new video application called Google Video. Standard & Poor's reiterated its hold rating on the stock.

Sciele Pharma (SCRX) agreed to be acquired by Shionogi & Co. Ltd. for about $1.1 billion, or $31 per share cash. There is no financing condition to the tender offer or subsequent merger. S&P downgraded the stock to hold from buy due to its higher valuation.

Suncor Energy (SU) said that production at its oil sands facility during August averaged about 260,000 barrels a day as expected, but said the proportion of low-sulphur crude oil products was lower than planned due to the unscheduled shutdown of a plant that supplies a portion of the hydrogen used to remove sulphur from synthetic crude oil and diesel fuel.

International Shipholding Corp. (ISH) received a cash buyout proposal of $25.75 per share from Liberty Shipping Group LLC.

Major European indexes were trading higher Tuesday. In London, the FTSE 100 index was up 0.32% at 5,620.70. In Paris, the CAC 40 advanced 1.50% to 4,539.07, while Germany's DAX index gained 1.51% to trade at 6,518.47.

In Asia, Japan's Nikkei 225 shed 1.75% to end at 12,609.47, while Hong Kong's Hang Seng index rose 0.65% to 21,042.46.

Treasury market

Treasury yields reversed lower on soft manufacturing numbers and the fizzling of the equities rally. The 10-year note moved up to 102-06/32 for a yield of 3.73% and the 30-year bond climbed 1-05/32 to 102-13/32 for a yield of 4.35%.

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