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What a Week: No Energy for Stocks

Inflation jitters, hawkish Fedspeak and a loss of leadership put major averages on their heels.
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Stocks got pounded this week, with major stock proxies falling to three-month lows as inflation jitters and hawkish

Fed

officials fueled concerns about the economy and profits.

A fuzzy -- but better-than-expected -- post-hurricane jobs report helped the market set aside some of these concerns on Friday, even if just for one day. The

Dow Jones Industrial Average

added a mere 5.21 points, or 0.05%, to 10,292.31. The blue-chip average was lifted by the likes of

Exxon Mobil

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,

Caterpillar

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,

IBM

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and

Merck

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.

The

S&P 500

added 4.41 points, or 0.37%, to 1195.90. The

Nasdaq Composite

rose 6.27 points, or 0.30%, to 2090.35.

Those fractional gains paled in comparison with the sharp pullback experienced in the previous four sessions. For the week, the Dow lost 276 points, or 2.6%. The S&P fell 33 points, or 2.7%. The Nasdaq saw the steepest decline, losing 61 points, or 2.8%.

Weakness in crude prices -- which hit a two-month low this week before rebounding Friday -- might have otherwise helped major averages, but they were instead waylaid by weakness in energy stocks such as Exxon Mobil,

Amerada Hess

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,

Occidental Petroleum

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,

Chevron

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and

Valero

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. For the week, the Amex Oil Index fell 7.4%, and the Philadelphia Stock Exchange Oil Service Index shed 7.8%.

Complacency's Comeuppance

What caused the sharp overall pullback in shares? For Cantor Fitzgerald strategist Marc Pado, the market had been too complacent about the economic and profit outlook after the energy shock caused by hurricanes Katrina and Rita. Stocks continued to rise until the end of September, even after the Federal Reserve hiked rates for the 11th time in a row and signaled there was more to come.

Helping to end the complacency, the Fed this week sent the perfect messenger: Dallas Fed President Richard Fisher, made famous for using baseball analogies to wrongly signal that the Fed would soon finish hiking interest rates back in June.

But there's no more talk of ending rate hikes from Fisher. Quite the contrary. Now that soaring energy prices and inflation fears are dominating market sentiment, Fisher now seems to have taken the lead in terms of hawkishness. Inflation, Fisher said, shows "little inclination" of declining, especially as businesses may be more aggressive at passing through higher energy costs. Inflation, Fisher went on, is a "virus" that cannot be allowed to "poison the system," alluding to the 1970s.

Fisher, still a rookie at the Fed, now has markets wondering if the central bank is planning to get more aggressive, perhaps even hiking rates by 50 basis points, instead of the quarter-point hikes it has delivered over the past 15 months.

And a number of companies this week helped illustrate the Fed's concerns that pressures to pass on higher costs are increasing.

Clorox

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lowered its earnings guidance because of higher energy prices. As a result, the maker of cleaning products said it would lift prices on 40% of its household products.

Goodyear

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also warned that higher costs will hit its third- and fourth-quarter results. Meanwhile, Citigroup went ahead and downgraded

Procter & Gamble

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, citing higher raw-materials costs.

The earnings outlook may get a bit clearer over the next two weeks as firms report third-quarter profits. In the meantime, more than a month after Katrina and two weeks after Rita hit the Gulf Coast, the official assessment of the economic damage still feels like a lot of hot air.

Case in point: the September jobs report. Only 35,000 payrolls were lost in September, according to the government data released Friday. That was way below the conservative forecasts of Wall Street economists, who on average expected payrolls to drop by 150,000.

Beyond the reassuring headlines, there was little in the employment report that reflected the impact of the hurricanes.

"Finding who has a job and who doesn't in the Gulf region is not a simple task," notes Joel Naroff, president of Naroff Economic Advisors.

Many firms are still shut down, some have no phone lines, some have delayed letting go of their workers. Naroff notes that the latest payroll report is full of inconsistencies, such as added workers in the oil extraction and health care industries, despite the closings of oil rigs and hospitals in the Gulf region. Likewise, education jobs rose even though many schools remained closed.

"How are these strange things possible?" Naroff wonders. His answer: "As long as people got paid, they were employed, even if they weren't working."

But this means that as basic infrastructure is restored, the hurricane-related job losses are about to get much worse in the months to come, the economist predicts.

The overall job picture remained strong before Katrina. But that's also being threatened by the surge in energy and commodity costs that has fueled inflation fears at the Federal Reserve and on Wall Street.

According to John Challenger, CEO of the outplacement firm Challenger, Gray & Christmas, most of the post-hurricane impact on national jobs in the coming months will be from the rise in the cost of energy. "These price increases impact not only consumers' ability to spend, but they eat into employers' bottom-lines, making it harder to expand and increasing the likelihood of job cuts," Challenger wrote.

Indeed, the market's and consumers' concerns over inflation, as well as the Fed's, are unlikely to abate in the coming months. Inflation expectations often translate into higher prices as businesses start passing on higher costs.

"Fed officials will be watchful whether the apparent increase in inflation expectations translates into higher wage growth in coming months," says Goldman Sachs chief economist Bill Dudley.

All in all, the latest jobs report does little to abate recent market concerns of an aggressive Fed threatening an already weakening economy.

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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