Stocks Slump on Rate Worries

Investors again take the market closer to testing March lows.
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Updated from 4:10 p.m. EDT

Stocks rallied late Thursday but couldn't offset an early descent as investors focused on a future environment of rising inflation, higher interest rates, and increasingly difficult retail comparisons losses.

The

Dow Jones Industrial Average

closed down 69.69 points, or 0.68%, to 10,241.26; the

S&P 500

lost 7.57 points, or 0.67%, to 1113.96; while the

Nasdaq

finished down 19.52 points, or 1%, to 1937.74. The 10-year Treasury note traded down 7/32 to yield 4.61%, while the dollar was lower against the euro and higher against the yen.

Despite the late rally, the Nasdaq finished below its 200-day moving average of 1938.52, spurred by losses in biotech, telecom and networking issues.

Volume was light, as investors continue to be tentative ahead of Friday's employment report. About 1.5 billion shares trading on the

New York Stock Exchange

, where decliners outpaced advancers by about 4-to-1. Over 1.7 billion shares changed hands on the Nasdaq, where decliners dominated advancers by about 7-to-3.

"The way we're going right now, it looks like we could be headed for a test of the March lows," said Richard Dickson, senior strategist at Lowry's Reports. "We're not particularly oversold here, so there's a potential for more on the down side."

"I think this is still a correction in an uptrend," he added. "I don't think this is the point where we say 'Okay, put the lifeboats out on your portfolios, the ship is going down.' I think it's still just an interruption in the uptrend, and we are going to see some higher highs in the months ahead. It's unpleasant, but I think it's going to be over in the next couple of weeks before we start heading up again."

Federal Reserve

Chairman Alan Greenspan told a banking conference in Chicago that the federal deficit, estimated to climb above $500 billion this year, will amount to 4.25% of the total economy after being in surplus just a few years ago.

"Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances," he said.

Earlier Thursday, the Labor Department said initial unemployment claims in the week ended May 1 totaled 315,000, well below expectations and down from the previous week's revised figure of 338,000. Separately, the government's preliminary measure of the economy's productivity in the first quarter of 2004 came in as expected, at 3.5%, up from the 2.6% level reported in the first quarter of 2003. Unit labor costs, however, rose 0.5%, which was more than expected, and could be seen as another sign of rising inflationary pressures in the economy.

"We've got this 'good news is bad news' syndrome and rates are dominating psychology," said Larry Wachtel, senior market analyst at Wachovia Securities. "The good economic news doesn't seem to hold any sway."

Wachtel said geopolitical concerns about the outcome of the conflict in Iraq, coupled with rising oil prices and interest rates, are weighing on investors' minds, along with a "peak-momentum" theory that has been going around.

"First-quarter earnings were sparkling, but it's the best you're going to get," he said. "The economy looks very good, but it's going to decelerate. Everything's at a peak. Where do we go from here?"

In Iraq, a suicide attacker detonated a car bomb today near the American occupation headquarters in Baghdad killing five Iraqi civilians and one American soldier, according to media reports. Separately, American troops fought members of a militia loyal to Moktada al-Sadr, the radical Shiite cleric who has been leading an armed resistance to the occupation authority in Najaf. They reportedly killed 41 militia members in a firefight.

In Washington, criticism of Secretary of Defense Donald Rumsfeld was mounting in connection to reports of the mistreatment of Iraqi prisoners by some members of the U.S. military. President Bush affirmed his support of Rumsfeld and apologized for the abuses suffered by the prisoners.

Meanwhile, crude oil futures trading on the Nymex dipped slightly to $39.45 a barrel after earlier reaching as high as $39.97 during Thursday's session.

In the wake of the Fed's statement Tuesday that "policy accommodation can be removed at a pace that is likely to be measured," investors have largely been treading water in anticipation of Friday's April employment report, due out at 8:30 a.m. EDT. Economists are expecting a confirmation of the apparent pickup in hiring reported for March. They're looking for the government to report that nonfarm payrolls rose 175,000, after an increase of 308,000 the prior month. The unemployment rate is expected to stay put at 5.7%. Also, hourly earnings are expected to have risen to 0.2% from 0.1% while the average work week lengthened to 33.8 hours from 33.7.

If April's jobs data comes in as expected, or better, many market watchers expect an interest rate hike in June rather than August, which could potentially provoke a negative reaction from Wall Street.

Jeff Hall, an economist at Thomson First Call IFR, said that an August rate hike of 25 basis points has been fully priced into the market, while the likelihood of a June hike has been priced in at about 50%. Also, he said that fed funds contracts currently show the odds at about 2 in 3 that the central bank's target funds rate will reach 2.25% by February 2005.

"I think that is a little aggressive," Hall said. "Even if we get increased odds of a June tightening, I think we're going to start to throttle back on the odds of a 2.25% funds rate by February. That's 125 basis points of tightening in the next eight-plus months. That doesn't jive with what the Fed's been saying."

Weighing on sentiment Thursday was a decision by the Bank of England to raise official interest rates a quarter percentage point to 4.25%, a move that reflects the same concerns that could lead to a rate hike in the U.S. next month. The increase, which wasn't matched by the European Central Bank, brings U.K. rates to their highest levels in 2 1/2 years.

Concerns about rising interest rates cast dark clouds over an otherwise sunny first-quarter earnings season. Thomson First Call said before Thursday's opening bell that 76% of the 429 companies in the S&P 500 that have reported earnings so far have come in above expectations. Compared with 2003, earnings growth stands at 26.7% for the first quarter of 2004. Meanwhile, since Monday, April 19, when the earnings barrage began, the S&P has lost 1.2% of its value.

In earnings news,

News Corp.

(NWS) - Get Report

earned $465 million, or 32 cents per American depositary receipt, in its third quarter, up from $275 million, or 21 cents an ADR, last year. Excluding items, the company's per-share profit was about 4 cents better than forecasts. Revenue jumped 19% to $5.2 billion. Its shares closed down 84 cents, or 2.2%, to $36.54.

EchoStar

(DISH) - Get Report

suffered widening losses for the quarter, but its revenue rose 16% and it had approximately 360,000 net new subscribers. The satellite-TV company Thursday said it had a net loss of $43 million, or 9 cents a share, compared with a profit of $58 million, or 12 cents a share, in the year-ago period. Its shares closed down $2.04, or 5.9%, to $32.25.

Also, shares of

Calpine

(CPN)

dropped 25 cents, or 6%, to $3.90 after reporting a wider first-quarter loss. The company posted a net loss of $71.2 million, or 17 cents a share, compared with that of $52 million, or 14 cents a share in the same quarter last year.

Meanwhile, April retail sales results poured in ahead of the bell, but brought mixed results, inspiring concerns about comparisons in future months. The biggest retailer,

Wal-Mart

(WMT) - Get Report

, said same-store sales rose 4.4%, roughly in line with estimates. Wal-Mart also forecast same-store sales growth of 4% to 6% in May. Its shares closed down $1.28, or 2.3%, to $54.58.

However,

Target's

(TGT) - Get Report

same-store sales growth of 4.9% missed estimates for a 5.4% rise, while

Gap

(GPS) - Get Report

said same-store sales rose 3%, falling short of a 3.9% increase. Its shares closed down 56 cents, or 1.2%, to $44.15.

The

Retail HOLDRs

(RTH) - Get Report

exchange-traded fund finished down 2%.

Overseas markets closed lower, with London's FTSE 100 down 1.2% to 4516 and Germany's Xetra DAX losing 2.8% to 3909. In Asia, Japan's Nikkei lost 1.6% to 11,571, while Hong Kong's Hang Seng rose 0.5% to 12,010.

Before Friday's opening bell, earnings announcements are due out from

Martha Stewart Living

(MSO)

, expected to report a first-quarter loss of 20 cents a share, down from last year's loss of 9 cents a share;

FirstEnergy

(FE) - Get Report

, expected to report first-quarter earnings of 44 cents a share, up from last year's 39 cents a share; and

Interpublic

(IPG) - Get Report

, expected to report a first-quarter loss of 1 cent a share, up from last year's loss of 2 cents a share.