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Market Takes Pessimistic Turn

Aaron Task

On Wednesday, bulls took solace as the stock market mainly shrugged off news of a higher-than-expected CPI report, the Bank of Japan's somewhat surprising rate hike and even a harsh sell-on-the-news reaction to Hewlett-Packard's (HPQ Quote) earnings, as detailed in my podcast.

On Thursday, conversely, bulls were hard-pressed to find much to cheer about outside of the chip sector. Major averages ended mixed despite better-than-expected earnings from Newmont Mining (NEM Quote), news of a Cisco (CSCO Quote)-Apple (AAPL Quote) détente over the iPhone moniker, and the Whole Foods (WFMI Quote) buyout of Wild Oats (OATS Quote).

Whole Foods and Wild Oats each soared on their merger, and positive comments from Analog Devices (ADI Quote) gave a boost to the chip sector. Analog Devices rose more than 10%, while Linear Technology (LLTC Quote) and Maxim Integrated Products (MXIM Quote) soared as well. The Philadelphia Stock Exchange Semiconductor Index climbed 2.5%.

But just as the Whole Foods-Wild Oats deal didn't spur more "who's next" speculation, neither did the chip rally spur a significant tech advance, much less a broader market advance. The Dow Jones Industrial Average fell 52 points to 12,686, while the S&P 500 slid 1.25 to 1456. Buoyed by the chips, the Nasdaq Composite did manage to rise 6.5 to 2525, its highest level in six years.

A 52-point drop in the Dow is no big deal, much less a 1.25-point decline in the S&P. But Thursday's session was noteworthy since chip stocks are a key bellwether for the tech sector and the favorite "tell" of many momentum players.

That being the case, the lack of broader "pin action" in the wake of the chip rally could be a sign of a market ready to rest after a big run.

To be sure, cautious comments and disappointing guidance from Toll Brothers (TOL Quote) and J.C. Penney (JCP Quote) were discernible negatives, as was Iran's missing a deadline to halt uranium enrichment. But the point is that the market chose to accentuate the negatives on this day, which may simply be a function of a market that is technically extended and famously hasn't experienced as much as a 2% correction since June.

Some media reports attributed stocks' malaise to rising commodity prices. But gold finished down $1, and crude rose less than it did on Wednesday.

On the other hand, Treasury prices did fall further Thursday than the prior day, and rising yields could explain the stock market's stumble. The 10-year note fell 11/32, and its yield rose to 4.74%.

The Treasury selloff came in the wake of a 5-year note auction, the results of which were "not nearly as stellar as the strong results of Wednesday's two-year note auction, which suggests that the enthusiasm for bidding Treasury yields lower is not nearly as great as some might have previously thought," writes Tony Crescenzi, chief bond market strategist at Miller Tabak and RealMoney.com contributor.

Additionally, perhaps investors came to grips with the credibility issue facing the Federal Reserve in the wake of Wednesday's stronger-than-expected CPI report, as my colleague Liz Rappaport described. For the moment at least, the CPI report belied the Fed's recent message that inflationary pressures are abating, making the likelihood of a near-term rate cut less likely.

But at the same time, the bleak 2007 outlook from Toll Brothers suggests the much-anticipated housing bottom might still be a ways away. In addition, even as weekly jobless claims unexpectedly fell, the four-week moving average of claims rose to 328,000 Thursday, its highest level since December.

To date, the Fed has been encouraged by ongoing strength in consumer spending and sentiment despite the housing correction. That is largely a function of the fact we're still in an environment of "full employment," with the unemployment rate at 4.6%.

If, however, more layoffs are afoot and the jobless claims rate rises, the consumer undoubtedly will be crimped. The Fed, then, will be in the position of wanting to cut rates but risking its credibility as an anti-inflationary force.

In other words, the Fed will find itself between the proverbial rock and hard place. So, too, does the market find itself there heading into Friday's session, which offers nothing on the economic or earnings calendar likely to drive trading.

That being the case, Friday's session could determine whether Wednesday's prevailing optimism or Thursday's undercurrent of negativity will prove a better harbinger of the market's next phase.