Good News Doesn't Last

Early excitement over the Treasury TIC report fades, setting a tone for the session.
By Nick Godt ,

Stocks and bonds fell Tuesday as markets got unwelcome news on several issues: An anthrax scare at the Pentagon, foreign interest in U.S. assets, higher Treasury yields and higher crude prices.

The

Dow Jones Industrial Average

fell 0.6% to 10,745.10, the

Nasdaq Composite

dipped 0.8% to 2,034.98 and the

S&P 500

lost 0.8%, to 1,197.75, breaking what had been key support at 1200.

The indices were mostly hit by higher bond yields and higher oil prices. Crude oil for April delivery gained 10 cents to close at $55.05 on the New York Mercantile Exchange, not far from its recent record close of $55.17. Traders are apparently dubious of the announced major boosts in production by members of the Organization of Petroleum Exporting Countries.

The day started with a seemingly positive surprise from the

Treasury Department

, which reported an unexpected surge in foreign long-term net capital flows into the U.S. in January. Capital flows rose to $91.5 billion from $60.7 billion in December, the second highest month on record and significantly above economists' expectations for flows of $61.3 billion.

Although the data were two-months old, the bond market and the dollar got an early lift from the report. It was welcome news amid growing concerns that countries like South Korea and Japan may pull out of some of their U.S. assets -- "diversification of holdings" being the favorite euphemism among policymakers.

But the bond market's relief was short-lived. It turns out that the biggest jump in capital inflows came from hedge funds based in the Caribbean. Meanwhile, China barely increased its positions, which are already considerable. China held $194.5 billion in Treasury bonds in January, up from $193.8 billion in December.

The 10-year Treasury fell 8/32 to 95-11/16 on the day, and its yield rose to 4.54%.

"There's still worry about whether global central banks are going to continue financing our deficit," says Barry Hyman, market strategist with Ehrenkrantz King Nussbaum. "It wouldn't have to be outflows, just new dollars going elsewhere could have a dramatic effect as yields will have to move even higher to be attractive

to foreign capital again."

Besides hedge funds, mutual funds also showed interest in bonds in January. Taxable bond funds reported net cash inflows of $10.3 billion in January, the largest inflows of any month since March 2004, according to AMG Data Services, which tracks funds' inflows and outflows. Of course, those inflows came as the stock market struggled in January and could have merely reflected individual investors' desire for safety, perceived or actual.

The interest rate situation -- and bond prices -- have gotten worse, of course, since January. After hitting a low of 3.98% in early February, the yield on the 10-year Treasury now trades above 4.50%.

According to Morningstar, long-term government bond funds lost 3.23% over the past month alone. Returns at American Century Target Maturity Funds, for one, fell between 6.35% and 6.92% during the period. "It's hard to make a strong case for adding money here," says Lynn Russell, fund analyst at Morningstar. "Current market conditions don't seem to favor the group."

And there seems to be little standing in the way of yields moving higher going forward.

That, in turn, may have restrained some of the enthusiasm over

Lehman Brothers'

(LEH)

first-quarter earnings, which easily topped Wall Street's estimates, thanks largely to strong results from its fixed-income trading group. Trading mortgages and other interest-rate derivatives was a big part of that performance. The higher interest rate outlook may shave off demand for mortgages going forward but Lehman says it's not worried. Actually, a lot of its strength came from Europe. Lehman shares rose 3.1% to $96.19.

However, the Amex Broker/Dealer Index rose just 0.3% as market participants waited to hear from the other major broker-dealers reporting this week, including

Bear Stearns

(BSC)

,

Goldman Sachs

(GS) - Get Report

and

Morgan Stanley

(MWD)

.

In other earnings news, shares of

Comverse Technology

(CMVT)

jumped 8.2% to $25.58 after reporting better-than-expected fourth-quarter results. On the flip side, shares of

GrafTech International

(GTI)

tumbled nearly 27% to $6.60 after the company offered weaker-than-expected 2005 guidance. More than 12.9 million shares of the manufacturer of graphite electrodes and cathodes were traded vs. its 30-day average of just 865,300.

Among other stocks in the news, shares of

TiVo

(TIVO) - Get Report

shot up nearly 75% to $6.70 after

Comcast

(CMCSA) - Get Report

announced an agreement that would make TiVo's digital video recorder widely available to its customers.

Blast from the Past

The bond market's downside was buffered Tuesday as some investors sought the safety of the fixed-income arena after an anthrax scare at the Pentagon. Government officials said some samples collected from the Defense Department's mail center had tested positive for the deadly bacteria.

Meanwhile, February retail sales showed only modest growth.

Retail sales rose 0.5% last month, less than the consensus expectation of 0.7%. Excluding autos, sales were also lower than expected, rising 0.4%. Auto sales rose 0.7%. The February results, however, were offset by an upward revision in January sales, which rose 0.3%, compared with previous estimates of a 0.3% gain.

Retail sales did not add to market concerns that inflationary pressures were coming from the consumption-side of the economy. Other concerns, such as high oil prices, a weak dollar and lower productivity, remain.

But even with these concerns aside, the fundamentals of the current economic growth require rates to move higher, says Tony Crescenzi, Miller Tabak's chief bond strategist and a

RealMoney.com

contributor.

Crescenzi expects the yield of the benchmark 10-year Treasury will likely touch 4.75% and trade between 4.25% and 4.75% for the year. The

Fed

, he says, will still raise rates by 25 basis points at its March 22 meeting. But it will likely drop its "measured pace" to give itself flexibility going forward, he said.

Fed Chairman Alan Greenspan, meanwhile stuck to his script during a speech on Social Security to a Senate subcommittee and didn't speak about monetary policy. That much should have been expected as the politicians in Washington seemed to want to hear Greenspan's opinion on everything except the thing he (ostensibly) controls.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send

your feedback.

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