A jump in interest rates and possible weakness in the housing sector had investors in a downbeat mood on Thursday. Even a fresh batch of merger confirmations and strength in the manufacturing sector couldn't pull the broader averages out of an afternoon slide.

The

Dow Jones Industrial Average

was least affected, rising 0.1% to 10,705.64, as

Johnson & Johnson

(JNJ) - Get Report

gained 4% on its $25 billion offer for

Guidant

( GDT), which slid 0.5%. The deal also helped pull J&J's fellow Dow components

Merck

(MRK) - Get Report

up 4% and

Pfizer

(PFE) - Get Report

up 2%.

Energy, homebuilding and financial shares pulled down the broader indices. The

S&P 500

finished down 0.2% to 1203.16, and the

Nasdaq Composite

shed 0.8% to 2146.15.

Symantec

(SYMC) - Get Report

, which fell 8% on its offer to buy

Veritas Software

(VRTS) - Get Report

, a 0.4% loser, didn't do much to ignite buying in the software sector. In the case of both the Symantec and Johnson & Johnson deals, rumors had led to a run-up in previous sessions, so the pop from the official announcements was somewhat reduced.

Homebuilders, which have been on tear since

Toll Brothers

(TOL) - Get Report

upped its 2005 guidance last week, took a tumble as the number of new-housing starts in November posted a surprise plunge. Toll lost 0.3%,

Lennar

(LEN) - Get Report

dropped 2% and

Ryland

(RYL)

fell 1%.

Builders started 1.77 million homes at an annualized rate, a 13% drop from October's near-record rate of 2.04 million. Permits for new starts declined only 1.5%, with the apparent conflict between the data possibly due to hurricane-related gyrations, Wachovia Securities economist Gina Martin wrote.

"November's decline in starts only puts builders under more pressure to complete homes already sold to keep up with strong demand," she wrote.

However, keep in mind (again) that the inventory of unsold homes rose to 417,000 in October, the fifth straight monthly increase and the highest level since August 1979. Real estate bulls note that the inventory represents a modest 4.1 months of supply at the current rate of sales. But the rate of sales is running at a near-record pace and the rate of turnover is at an all-time high.

One month surely does not a trend make, but builders may be getting more cautious than their recent earnings release statements have indicated.

The builders' stocks were also no doubt hurt Wednesday by the surprisingly sharp drop in Treasuries. The yield on the benchmark 10-year note rose to 4.18% vs. Tuesday's low of 4.07%. Weekly first-time claims for unemployment insurance dropped more than expected, and bonds got no help in the afternoon when the Philadelphia Fed's regional manufacturing index came in stronger than expected.

Banks were doubly in the red with the damage of higher interest rates compounded by the weaker housing market, which implies lower demand for mortgage loans. The Philadelphia Exchange's banking index lost 0.3%, with

Wachovia

(WB) - Get Report

down 2% and

Citicorp

(C) - Get Report

down 0.6%.

The dollar rallied on unconfirmed rumors of European intervention to weaken the euro. The reported third-quarter current account deficit, or the amount by which payments leaving the country exceed money coming in, also helped. It hit a record $164.7 billion but that wasn't quite as bad as the $170 billion analysts had forecast.

Research by Morgan Stanley analyst Henry McVey shows a strong correlation between a weaker dollar and rising inflation with a one-year lag. Comparing the change in the Fed's trade-weighted dollar index with the following 12-month changes in the consumer price index for the past 14 years, McVey found that currency accounted for about half of the moves in prices one year forward. (For the more statistically inclined, McVey found the R-squared relationship between the two variables was 48%.)

"This makes sense as it takes time for the pricing changes and selection patterns to shift course," he writes.

Unfortunately, of course, there's no clear relationship between the overall stock market averages and modest changes in inflation. Looking for individual stocks with significant international revenue exposure, he recommended

Altria

(MO) - Get Report

, which gained 0.2% Thursday;

Yum! Brands

(YUM) - Get Report

, up 0.2%;

ConocoPhillips

(COP) - Get Report

, which fell 6%; and

Tyco

(TYC)

, up 0.3%.

Navigating the Noise

Conflicting economic data can be a headache for investors, traders and columnists but for members of the Federal Reserve's Open Market Committee, they're a nightmare. The Fed's recently released minutes of the committee's Nov. 10 meeting reveal that members are growing increasingly conflicted about uncertain data. The weak dollar and high oil prices put upward pressure on inflation while underused factories and weak job growth keep prices in check, for example.

So with signs that labor markets were weakening or strengthening, that inflation was contained or might break out, and that business spending was healthy or lagging, the committee members debated whether to drop the language in their statement that the pace of future rate increases was likely to be "measured."

"Several members commented that policy actions would likely become increasingly dependent on incoming data and their implications for future activity and prices," the minutes stated. "This might imply a more gradual path of tightening going forward than that of the last several months, as for example now seemed to be built into the term structure of interest rates, or it might mean that the Committee on occasion would need to firm policy more rapidly."

But with overall confidence that their economic call was correct -- the economy looked like it was on a positive and sustainable path -- they stuck with the measured language.

"For now, most members agreed that the current statement language provided considerable flexibility with regard to the Committee's future actions and that market participants understood that flexibility."

As an aside, the minority view questioning the strength of the labor market in the October payrolls report appears to have been vindicated in the weak November report. But the committee kept the measured language again this week, so confidence in Greenspan's ability to read the data tea leaves remains high -- at least on the Open Market Committee. In the bond market, it may have faded a bit on Thursday.

In keeping with TSC's editorial policy, Pressman 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

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