Stocks Not Flying Now

Weak economic data weighs on stocks amid thin trading and worries about 'red flags.'
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"Rocky Balboa" is getting good reviews. But Thursday's Philadelphia Fed index makes you wonder if they are sympathy votes for that city's favorite celluloid son.

The stock market, which may be in the process of finding reasons to go down after a five-month rally, reacted sharply to December's reading of negative 4.3. But, Philly's problem isn't news, nor is the notion that manufacturing is weak nationwide. The November Institute of Supply Managers' manufacturing index showed contraction in the sector for the first time since 2003. But looking at other regions, the Philadelphia weakness simply counterbalances the recent above-average New York Fed's Empire State Index, which came in at 23.1.

"Average them out, you've still got soft landing," quips John Lonski, Moody's Investors Service chief economist.

Still, the markets didn't react in a balanced manner. The

Dow Jones Industrial Average

fell 0.3% to close at 12,421.25. The

S&P 500

slipped 0.4% to close at 1418.31, and the

Nasdaq Composite

dropped 0.5% to close at 2415.85. The three major indices are all down on the week, with the Nasdaq off 1.7%. The S&P is down 0.6% and the Dow has slid 0.2%.

"The survey reminded us of the things that are wrong in the economy," says Randy Diamond, a trader at Miller Tabak.

In addition to the Philadelphia index, the government revised its final estimate of third-quarter GDP to 2% from its prior estimate of 2.2%. Metals prices also continued to fall Thursday, which dragged down basic materials stocks. Shares of

Phelps Dodge

(PD) - Get Report

and

Freeport McMoRan

(FCX) - Get Report

, fell 2.1% and 6.1% respectively as copper fell another 3.5% to $2.86 per pound.

The Morgan Stanley Cyclical Index fell 0.9%, while shares of

Caterpillar

(CAT) - Get Report

,

Deere Co.

(DE) - Get Report

,

FedEx

(FDX) - Get Report

and

Goodyear Tire & Rubber

(GT) - Get Report

fell between 0.9% and 3%.

Diamond says the bad news data reminded investors of what some call divergences, such as the Dow Jones Transportation Average's refusing to confirm the Dow Industrials string of recent highs. Other potential red flags traders are watching include the CBOE Market Volatility Index falling below a reading of 10 recently, and the inverted Treasury yield curve, historically a harbinger of economic weakness. These red flags could point to a pullback in the near future, if not a full-blown correction, something the major averages haven't had since 2003.

Diamond also notes the housing market, which was the third quarter's largest drag, has its biggest test ahead. If the homebuilders don't sell down their inventories in the slower winter months, the typically strong springtime housing market could show yet another batch of weakness. That's not to mention the absence of construction jobs that might pressure the payrolls data in the winter months when weather prevents building in certain parts of the country.

If it wasn't enough for stocks to worry about economic growth, the FOMC's dissenter, Richmond Federal Reserve President Jeffrey Lacker, came out warning of rate hikes.

"The risk that core inflation surges again, or does not subside as desired, clearly remains the predominant macroeconomic policy risk," Lacker said in a speech at the annual economic conference of the Charlotte Chamber of Commerce in Charlotte, N.C. "The longer core inflation persists above 2%, the greater the danger of inflation becoming entrenched at too high a rate."

Bonds ignored the hawkish talk (as usual), and rallied on the growth worries. The 30-year bond gained 9/16 to yield 4.69%, while the 10-year gained 3/8 to yield 4.55%, and the two-year note added 1/8 to yield 4.65%. Bond prices move inversely to yields.

Friday's release of the core personal consumption expenditures deflator within the government's report on November personal income will be telling for the bond market. Traders will be watching to see whether the Fed's favored measure of consumer inflation confirmed the flat November core CPI report, or whether it reveals that the higher-than-expected 1.3% rise in core producer prices was more on target. The core PCE is currently running at 2.4% year over year. Analysts expect a 0.1% increase for the month.

The Conference Board provided the lone piece of good news for the thinly traded markets Thursday. Its index of leading indicators rose 0.1% in November, meeting with consensus expectations. The report marked the index's third consecutive increase, suggesting that "economic growth has troughed," writes Peter Kretzmer, senior economist at Banc of America Securities.

Still, the index of leading indicators -- along with stronger-than-expected earnings from

Nike

(NKE) - Get Report

,

ConAgra

(CAG) - Get Report

,

General Mills

(GIS) - Get Report

and (after the close)

Research in Motion

(RIMM)

-- was overshadowed Thursday by the Philly Fed and GDP data. But all this negativity was shown on very light trading volume as the Christmas holiday weekend nears. So, don't run and hide just yet.

And don't forget Philly is...well, Philly, where residents live on cheesesteaks and boo their home teams.

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

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