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Economic Angst Stymies Rally

The Philadelphia Fed survey provides an excuse for selling as the averages hit technical resistance.

The stock market finally heard the same trees falling in the forest that the bond market has been hearing all summer long. The thud of soft economic data Thursday caused traders to resuscitate the dreaded "R" word: recession.

After struggling through the morning to reach an all-time high, the

Dow Jones Industrial Average

, along with the other major averages, staged an about-face as soon as news of the weak Philadelphia Fed's Business Outlook Survey crossed the tape. But perhaps the bad news was just a welcome excuse for a pullback from the recent rally, which brought the Dow to within 100 points of its all-time high, and the

S&P 500

a fraction away from a five-year high.

"I'd be more inclined to say the rally was a test of the highs," says Louise Yamada, of Louise Yamada Technical Research Advisors. Like many of the year's minirallies, the market's recent advance did not include enormous levels of advancing over declining stocks or sustained strong volume, says Yamada. "We need some proof in the pudding."

Thursday's quick downturn showed that the proof is still elusive. A bad piece of data easily jogged the market off its soft-landing optimism. Suddenly in focus are fears that the sharp decline in commodities and the Treasury yield curve's deep inversion to the fed funds rate mean the economy is headed for dire straits.

The Dow fell 0.7% Thursday to close at 11,533.23, although it closed off its intraday lows of 11,501.77. The S&P 500 fell 0.54% to 1318.03, and the

Nasdaq Composite

dropped 0.67% to 2237.75.


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was the main drag on the Dow, falling 5% amid reports Chief Executive Mark Hurd might have had more of a role than previously thought in a plan to access the phone records of directors and journalists.

All the negativity came rushing in despite a strong earnings report by economic bellwether


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. FedEx beat expectations, but Chief Financial Officer Alan Graf was not ebullient about the future on the accompanying conference call. He said the economy has seen some slowing, but he wouldn't characterize it as a "headwind." The company's shares were down 1.77%.

The Dow Jones Transportation Average fell 1.52% in sympathy, and FedEx competitor


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dropped 2.09%.

Another economic bellwether,

General Electric

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, declined 1% in response to ominous comments from Chief Executive Jeffrey Immelt in a speech Wednesday to the Detroit Economic Club. "The consumer has taken all the debt they can, and we feel it will be difficult to get more robustness out of the consumer," said Immelt, according to a


report. "So we see slower growth and more volatility."

Other laggards included drugstore chains


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Rite Aid

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, after


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said it will sell a month's worth of generic drugs for $4 at dozens of its stores.

Anomaly or Portent?

The Philly Fed survey was the anxiety and selling trigger, though. The index of general business conditions declined to minus 0.4 in September, far below expectations for a reading of 14, and much lower than August's 18.5 reading. The September report was the first negative reading since April 2003, according to Bank of America.

The reading was negative, but an anomaly. "As the September result follows a very strong reading in August and represents only one region of the nation, care should be taken in extrapolating the result geographically or temporally," writes Peter Kretzmer, senior economist at Bank of America. "Still, the surprising decline likely indicates a rise in business caution in recent weeks."

Notably, chief financial officers were the most pessimistic they've been in more than five years, according to the September Duke University/

CFO Magazine

business outlook survey released last week. CFOs' chief concern was weak consumer demand, but rising labor costs are right behind. CFOs also expect cuts to capital spending plans, lower expectations for earnings and less hiring in the next 12 months. One third of CFOs predict a recession within one year, according to the survey, and 21% reported they want the

Federal Reserve

to begin to cut rates soon.

The Philly Fed report followed Thursday morning's report by the Conference Board that showed its index of leading economic indicators fell 0.2% in August. The number was in line with expectations, but the decline marks a 1.1% drop since January.

The stocks that performed well in Thursday's downturn included some defensive names like


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, notes Yamada. Shares in these companies climbed 0.63%, 0.69% and 1.48% respectively.

General Mills

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also climbed 3.26% on the heels of its stronger than expected earnings report Thursday.

The bond market grabbed the bad economic news and ran with it, sending yields plunging further below the fed funds rate. The 10-year benchmark Treasury note added 23/32 in points, to yield 4.64%, its lowest level in six months. The lowest point on the yield curve, the five-year bond, added 16/32 to yield 4.58%.

"The 10-year Treasury yield says the Fed's next move is a rate cut," wrote John Lonski, chief economist at Moody's Investors Service.

Indeed, for the first time in more than two years, the fed fund futures market is putting 0% odds on an interest rate hike in the coming months, according to Miller Tabak. The fed funds futures market has 24% odds of a rate cut at the FOMC's January meeting.

In sum, the market reeled from one piece of economic data, as it ran into technical resistance on the Dow and the S&P 500's rally to major highs -- all this pessimism just one day after the economy seemed peachy, but for the cooling housing market. Maybe Thursday's data were the perfect moment for traders to sell Rosh Hashanah, which starts Friday evening, and set up for buying Yom Kippur, as

the old saying goes.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.