Crude Awakening for Stocks

The averages give up ground as oil and hawkish Fed voices rise.
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The twin specters of soaring oil and

Fed

jawboning on inflation returned Wednesday, giving investors a perfect reason to take profits after the recent run-up.

The

Dow Jones Industrial Average

finished down 45.88 points, or 0.44%, at 10,457.80, off an intraday low of 10,426. The

S&P 500

lost 4.06 points, or 0.34%, to 1190.01, off a low of 1185. The

Nasdaq Composite

fell 11.50 points, or 0.56%, to 2050.12 after trading as low as 2041 intraday.

Breadth was negative, with declining issues outpacing advancing ones by roughly 2 to 1 on both the

New York Stock Exchange

, where 1.3 billion shares exchanged hands, and the Nasdaq, where 1.5 billion shares traded.

Technology and financial shares, the market's recent leaders, took the brunt of the selling. Amid new inflation jitters, the NYSE financial sector index fell 0.53%.

The Philadelphia semiconductor index fell 1.10%. The index has gained nearly 12% since late April. Shares of

Intel

(INTC) - Get Report

helped cushion the losses Wednesday as Lehman Brothers lifted its price target on the stock to $30 from $28. Internet issues also found some support after Goldman Sachs reiterated outperform ratings on

eBay

(EBAY) - Get Report

,

Yahoo!

(YHOO)

and

Google

(GOOG) - Get Report

.

The energy sector, meanwhile, gained as crude oil for July delivery finished up about $2 to $51.66 on bearish inventory data. The Amex oil index rose 0.95%, as oil heavyweights such as

Exxon Mobil

(XOM) - Get Report

and

Chevron

(CVX) - Get Report

posted gains of more than 1%.

For the broader market, seeing crude oil top $50 a barrel again did not bode well and served as a trigger for profit-taking. Adding to the selling pressure, Treasury prices fell after Atlanta Fed president Jack Guynn, normally a moderate, made fairly hawkish comments on inflation.

"Our economy has ample strength to withstand further removal of accommodative monetary policy," Guynn said in prepared remarks. He also noted a "distinct upward tilt" in inflation measures, in part due to higher commodity prices.

Guynn's remarks came as the market digested news of a rebound in orders for durable goods in April and of more evidence that the housing market remains red-hot. New-home sales rose less than expected in April, but the year-on-year increase is at a record high.

The benchmark 10-year Treasury fell 14/32 on Wednesday while its yield, which moves inversely to price, rose to 4.08%. The yield of the benchmark note had been falling steadily back toward 4% amid expectations that inflation remains contained. Fresh evidence of economic resilience -- in April employment and retail sales -- so far has been countered by an equally tame April consumer price index.

But Thursday's revision of first-quarter growth could remind the market of pent-up inflationary pressures. Economists on average expect first-quarter GDP growth to be revised to 3.6%, from its preliminary read of 3.1%. The revision mostly comes from a narrowing March trade deficit.

Guynn's remarks echoed those of Chicago Fed President Michael Moskow -- a noted hawk -- who said on Tuesday that rates need to move higher to prevent stronger energy and other asset prices from becoming "permanently embedded in the inflationary mentality of firms and households."

After the tame April consumer price index, investors have been discounting the possibility that the Fed may hike its key rate in two more quarter-point increments and be done. But the comments from the Fed officials show the central bank wants to convey it means business, perhaps more than the market currently believes.

The remarks also reverberated in investors' minds as oil prices came back above the $50 mark. The steady decline of crude oil prices from above $57 in late April also has helped ease investor concerns over inflation.

The catch is that upwardly revised growth expectations -- even in the first-quarter GDP -- also are underpinning new-found strength in crude oil prices, according to Wachovia energy analyst Jason Schenker.

Worse, perhaps, is that the recent bull run in the dollar appears to be nearing its end. A weak dollar has been fueling higher commodity prices over the past few years. To be sure, the greenback remains supported by weak growth in Europe and by higher U.S. interest rates. But those factors already are discounted in the current level of the dollar. Meanwhile, there are ongoing downside risks attached to the huge twin U.S. deficits and increasing pressures on China to loosen the yuan's peg to the dollar.

Going back to 2001, Wachovia's Schenker found that the direction of the dollar and of crude oil prices is about 84% inversely correlated. He expects a gradual depreciation of the dollar going forward and an equally gradual rise in the price of crude oil. "The era of cheap oil is over," Schenker says, adding that given current dollar levels, there is an implied floor to the price of crude at $42.

And that's absent other factors that may influence oil prices, such as global growth, supply disruptions and petroleum product bottlenecks.

Demand from China is still providing strong support to crude oil prices. Chinese oil imports surged by 22.5% in April. And on Wednesday, the Chinese National Development and Reform Commission predicted China would consume 170 million tons of refined oil products in 2005, 8% more than it did last year,

Reuters

reported.

In corporate news,

Ford

(F) - Get Report

announced that it would take over 24 plants and offer buyouts to 5,000 hourly workers at its parts supplier

Visteon

(VC) - Get Report

. Visteon rallied on news of the deal, which should help weather a funding crunch that threatened the parts maker with insolvency.

To view Aaron Task's video take on today's market, click here

.

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 appreciates your feedback;

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to send him an email.