"It's the economy, stupid," has become the cliche du jour. Thanks to a string of disappointing economic data, the saying was as relevant to Wall Street this week as it was during Bill Clinton's 1992 presidential campaign.

The Dow Jones Industrial Average rose 0.6% for the week while the S&P 500 gained 1.3%. The Nasdaq Composite shed 1.1% and the Russell 2000 lost 1.5%.

Weekly gains for the Dow and S&P were largely due to Monday's blockbuster rally. By week's end, however, the optimism evident in that session had given way to consternation about the economy, and the market suffered in concert.

A flurry of lackluster economic reports was highlighted by Tuesday's July consumer confidence report, Wednesday's weak second-quarter GDP and accompanying downward revisions to the first quarter and first half of 2001, plus Thursday's much weaker-than-expected ISM Manufacturing Index.

Friday's employment report did little to disabuse traders of the notion the economy is slipping. The unemployment rate held steady at 5.9%, as expected, but nonfarm payrolls grew by just 6,000 in July, the weakest since April's decline and approximately one-tenth the expected level. Manufacturing jobs were lost for the 24th consecutive month, albeit at a much slower pace of 7,000.

The construction sector lost 30,000 jobs, a decline presaged by Thursday's unexpected 2.2% drop in June construction spending. Meanwhile, the average workweek fell to 34 hours from 34.3 and overtime slipped as well, suggesting reduced demand for laborers.

Faced with the jobs data, and a larger-than-expected drop in June factory orders, the Dow and S&P each lost 2.3% Friday, and the Comp shed 2.5%.

Other issues weighing on shares this week included profit warnings from tech firms such as National Semiconductor ( NSM), KLA-Tencor ( KLAC) and Adobe Systems ( ADBE). The first two coincided with a breakdown in the Philadelphia Stock Exchange Semiconductor Index, which had demonstrated relative strength during the broader market's recent swoon. This week, the SOX fell 4.3%.

Other corporate news included disappointing earnings from Exxon Mobil ( XOM), Royal Dutch Shell ( RD) and Disney ( DIS), as well as a rash of blow-ups among retailers. Additionally, regulatory woes hounded AOL Time Warner ( AOL) and Citigroup ( C), while Cisco ( CSCO) had to deny rumors that either its CFO or CEO was leaving before singing off on the firm's financial statements.

Still, the dominant issue this week was the economy, as upbeat reports on auto sales and personal income/spending were overwhelmed by the prevailing negativity. Predictably, such developments renewed scuttlebutt about the potential for an easing by the Federal Reserve, perhaps prior to the scheduled Aug. 13 meeting of its rate-setting committee.

Desperate Times, Desperate Rumors

The rumor circulating Friday was that the Fed was going to imminently cut rates in conjunction with European central banks. That seems unlikely given the European Central Bank and Bank of England met Thursday and each left rates unchanged. Additionally, there's concern about what impact a rate cut would have on the dollar, which resumed its downward path late this week.

There's also the (forgive me) potential inflationary implications of further rate cuts. Worrying about inflation runs counter to renewed concerns about a deflationary spiral but consider: The dollar has fallen more than 10% this year, gold has risen by $25 per ounce this year, even after its recent fall, crude oil is up more than $6 a barrel year to date, the Journal of Commerce-ECRI Industrial Price Index is up at an annual rate of nearly 11%, the prices-paid component rose in Thursday's ISM report, and the Economic Cycle Research Institute reported Friday its Future Inflation Gauge rose to 106.4 in July, its fourth-consecutive monthly increase.

"Despite the mildness of the recovery, U.S. inflationary pressures are clearly gathering steam," the ECRI said.

Furthermore, a rate cut now would be an unprecedented admission of error by Fed Chairman Alan Greenspan, who was mainly upbeat in his congressional testimony in mid-July, as discussed here. The psychological impact of such an admission might do more harm than good, presuming another rate cut would have some positive effects at this juncture.

Still, fed funds futures are now forecasting more than 75% odds of Fed rate cuts by the end of the year, and rumors circulated of an intermeeting ease.

The scuttlebutt stems not so much from the declining stock market -- indeed major averages ended Friday above key levels of Dow 8000, S&P 800 and Nasdaq 1200, much less last week's lows -- but of dislocations in the bond market.

The yield on the two-year Treasury note fell below 2% intraday Friday before settling at an all-time low of just above 2%. Meanwhile, the corporate bond market is "half frozen," according to Pimco's Bill Gross.

"The cost of capital for corporations is nowhere near the 1.75% fed funds rate or even that 6% level available to first-time borrowers in the mortgage market." Gross wrote at Pimco's website. "The cost of capital for Baa- and lower -rated corporations is in double digits while Aa- and A- rated companies can barely come to market. You Mr. Greenspan, have a problem."


Not only does Greenspan have a problem, the downward revision to 2001's GDP confirmed that a recession occurred, putting "New Economy" theorists on the defense.

Even those not in the "New Era" camp were forced to ratchet back expectations in the wake of this week's data. On Friday, Goldman Sachs economists cut their GDP forecast for the next six quarters. Additionally, the firm predicted the Fed will ease by 50 to 100 basis points in the fourth quarter.

Separately, Morgan Stanley chief U.S. economist Richard Berner conceded Friday: "I now agree with Steve Roach -- at least for the balance of this year -- that a period of subdued growth lies ahead."

Berner and Roach, Morgan's chief economist, have long been at odds about the economy's fate. Berner still contends the economy will not suffer a "double dip," which is something Roach has long warned about.

What's instructive is that the bullish guy ratcheted down expectations rather than the bearish one raising his. There was a lot of that going on this week.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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