The Market Update

Return to Article

Bernanke Calms Jittery Markets

Liz Rappaport

Wednesday's stock market action was like watching a big hitter step up to the plate, dig his cleats into the dirt, take a couple of practice swings, and then step out of the batter's box just as the pitcher starts his windup.

The market couldn't get off the ground no matter how hard traders tried to make it soar. Weak economic data weighed down enthusiasm for a bounce. But the day could have been much worse, were it not for the soothing words of Federal Reserve Chairman Ben Bernanke.

In the face of dismal new-home sales and a downward revision to the fourth-quarter GDP, the Dow Jones Industrial Average followed up its worst day in over five years by regaining about one eighth of Tuesday's decline. After trading as low as 12,186 and as high as 12,353.47 intraday, the Dow closed up 0.4% to 12,268.63. The S&P 500 finished Wednesday back up 0.6% to close at 1406.82, and the Nasdaq Composite closed up 0.3% to 2416.13.

China's stock market, largely blamed for Tuesday's global selloff, rebounded smartly overnight. The Shanghai Composite gained back 3.9% after its sharp 8.8% decline Monday. But other Asian markets slid further: Japan's Nikkei fell 3%, Hong Kong's Hang Sent fell 2.5% and South Korea's benchmark index fell 2.6%. Britain's FTSE 100 fell 1.8% as well.

"I think it is a healthy bounce," Todd Leone, head of listed trading at Cowen & Co., says of the U.S. markets. But he warns that there may be more weakness ahead. "You always say, 'The market needs a correction,' so we got it, but it takes a while to flush out. It can't go straight up."

Indeed, many who were not defensive prior to Tuesday may become more defensive. And those investors who were defensive may be coming out of hibernation to contemplate a shopping spree. But from both psychological stances, the broad theme is "wait and see" for a few more days. While such cautious tones prevail, most traders acknowledge that liquidity is still out there and valuations are still attractive for stocks in the long run.

The $600 billion reduction in overall stock market value Tuesday is nothing to sneeze at. That's more than Congress has spent since September 2001 on operations in Iraq, Afghanistan and other activities, according to news reports that cite the Congressional Budget Office.

"Losses are losses," says Marc Pado, chief market analyst at Cantor Fitzgerald. "Some funds got whacked yesterday, and portfolio adjustments need to get made, and that will take time."

Buyers will have to overcome some of the weak economic data that has been streaming in of late, with perhaps more to come. Indeed, the market was on a roller coaster until Bernanke testified before the House Budget Committee. It wasn't long into the subsequent Q&A session before Gentle Ben soothed the markets with his calm tones about the economic outlook.

"The Fed has been closely monitoring the markets. They seem to be working well, and working normally," he said. "We have also been closely monitoring the economy to look at new data to see how it impacts our forecast. My view is that taking all the new data into account, there is no material change in our expectations for the economy since I last reported to Congress at the Humphrey Hawkins testimony [on Feb. 14]. We are looking for moderate growth in U.S. going forward."

Earlier Wednesday morning, the Commerce Department said fourth-quarter gross domestic product rose 2.2% vs. the advance reading of 3.5%, a decline that "is more consistent with our view of the overall economy than prior numbers," Bernanke says. "We expect moderate growth going forward. If the housing sector begins to stabilize, and inventories stabilize, we'll see some greater strength in the economy by the end of the year."

A stable housing market is a big if, however. The Census Bureau said Wednesday that new-home sales fell 16.6% in January. Housing inventories grinded higher -- against the grain of the stabilization argument. They grew to a 6.8-month supply, from a 5.7-month supply in December.

Bernanke also said there was no single trigger for Tuesday's market drop, adding that he's not concerned about a plunge in global liquidity.

Leading the Dow (and S&P) higher were gains ranging from 1% to 3.7% in American Express(AXP Quote), Disney(DIS Quote), Merck(MRK Quote), Procter & Gamble(PG Quote) and Verizon(VZ Quote).

The Dow's rebound was restrained by losses of 1% or greater in Alcoa(AA Quote), McDonald's(MCD Quote), DuPont(DD Quote) and IBM(IBM Quote).

Yields on U.S. Treasury bonds also moderated on Bernanke's words, as traders backed off their pessimistic bets. The 10-year yield, which moves in opposition to its price, ended at 4.55% from 4.51% Tuesday.

But even soothing words from Bernanke can't completely erase doubts about the economy. Consider that much of the data reported since his Feb. 14 Humphrey Hawkins testimony has been soft or inflationary.

On Feb. 16, the day after Bernanke's second day of testimony, housing starts were reported falling to their lowest level in 10 years. Also, the core consumer price index for the month of January ticked up, boosting the year-over-year inflation rate to 2.7% from 2.6%.

More recently, on Tuesday, the Commerce Department reported durable goods orders dropped 7.8% in January, after a 2.8% rise in December. This gauge of weak business spending was echoed by Wednesday morning's revision to fourth-quarter GDP.

Business investment was revised dramatically lower, to a 2.4% annualized drop from an initial 0.4% drop. The February Chicago PMI, a measure of economic activity in the region, also came in lower than expected Wednesday, at a reading of 47.9 vs. expectations for 50. More worrisome was the jump in prices paid to 63.2 from 54.9 in January.

"This cuts to the core of what worried some in the markets [Tuesday], the idea that business spending will weaken at a time when the consumer is not in the best of shape to carry the weight of the economy," he writes.

Also, investors have been plagued by increasing worries about the subprime mortgage market, where delinquencies have increased, risk premiums on related derivative securities have widened dramatically, and headlines about banks in trouble have multiplied.

Thursday brings more potential headwinds for the market -- the ISM manufacturing index and the core personal consumption expenditures index, the Fed's favorite inflation gauge. With such reports in the hopper, we'll see if this is the little bounce that could ... or couldn't.