Remember a few weeks back when no news, no matter how good, could give stocks a lift?

Early today, optimistic market participants were taking heart that stocks were able to side-step two potentially damaging events: Standard & Poor's putting four major Wall Street firms on CreditWatch with negative implications and a much weaker than expected Philadelphia Fed manufacturing survey.

But as the day progressed, the combination, particularly the Philly Fed report, did take a bite out of major averages' early gains. As of 2:10 p.m. EDT, the Dow Jones Industrial Average was up 0.2% to 8759.57 vs. its earlier best of 8854.21 -- a move that had bulls cheering the "breaking" of resistance at 8800. The S&P 500 was lately up 0.5% to 924.03 vs. its earlier high of 933.28 while the Nasdaq Composite was higher by 0.1% to 1336.28 but down from its earlier best of 1350.92.

Given the weak Philadelphia Fed survey on July 18 was the start of a series of negative economic data, today's report was closely watched. It was also clearly disappointing as the overall business conditions index dropped to minus 3.1 from plus 6.6 in July, its first negative reading this year. Expectations were for a rise to 7.2, according to Reuters.

Additionally, the new-orders index fell to minus 2.7 in August from plus 6.6 in July, while the employment index fell to minus 13.4 from minus 6.8 in July. The prices paid index did rise -- to 23.9 from 17.9 -- but that's not necessarily a "good" thing.

In other economic news, industrial production reportedly rose 0.2% in July, its slowest pace in three months and down from 0.7% in June, but ahead of expectations for a flat performance. Capacity utilization rose to 76.1% from 76%, up from a 19-year low of 74.4 in December but still at relatively weak levels. Capacity utilization averaged 81.8% during the record expansion from March 1991 to March 2001, according to Bloomberg.

Some observers tried to dismiss the Philly Fed report as a regional index, which is notoriously volatile or even a meaningless asterisk. However, it was having an effect on the financial markets.

In the immediate aftermath of the report, Art Cashin suggested on CNBC that the stock market held up well in the face of this disappointing Philadelphia Fed data because the bond market didn't rally off of it. The bond market did improve as equities faded but of late, the price of the benchmark 10-year Treasury note was down 8/32 to 101 27/32, its yield rising to 4.15%.

In RealMoney.com's Columnist Conversation, I suggested the bond market didn't rally more dramatically after the Philly Fed because the price paid component of the index was up (again) and oil prices are higher (again). Crude futures were lately up 2.5% after yesterday's report by the American Petroleum Institute of a 9 million-barrel draw of crude inventories, as well as ongoing concerns about potential military action against Iraq. Meanwhile, gold was up 0.8%, while the U.S. Dollar Index was lately down 0.23 to 106.81.

Eyeing this, I wondered again about the potential for a stagflationary environment, characterized by weak economic output but higher inflation. I know such concerns run counter to the prevailing view that deflation is our greatest threat -- and it certainly is in tech and telecom -- but consider the following, which is updated from a story on Aug. 2 :

As of Wednesday's close, the Dollar Index is down 8.5% this year, gold has risen by more the $39 per ounce and crude oil is up more than $8 a barrel. Additionally, the Journal of Commerce-ECRI Industrial Price was up at an annual rate of 9.2% through Aug. 14 while the Economic Cycle Research Institute's Future Inflation Gauge was rising at an annual rate of 14.6% through July. Meanwhile, the government has returned to deficit spending and housing prices continue to soar, as The Wall Street Journal detailed yesterday.

So call me crazy, call me stubborn, (call me cute as a button), but I just don't buy the "inflation is non-existent" rap. The hardcore bears believe the bond market will be unable to withstand another steep decline in the dollar, which is something to watch for if today's Philadelphia Fed report proves yet again to be a precursor of more weak economic data.

It's All About Debt

As mentioned above, S&P today took action against several Wall Street firms. Specifically, the debt rating agency put the AA-minus/A-1-plus long and short-term counterparty credit ratings of Merrill Lynch ( MER), Morgan Stanley ( MWD) and J.P. Morgan ( JPM) on CreditWatch with negative implications.

S&P also put Goldman Sachs' ( GS) A-1-plus short-term rating under review but affirmed its A-plus long-term rating and changed its outlook on Lehman Brothers' ( LEH) ratings to negative from stable although it affirmed its A/A-1 ratings.

"The actions are based on the deteriorating environment for the profitability of the investment banking industry," S&P analyst Tom Foley said in the firm's press release. "Although all of these firms have been profitable during the first half of this year, and should remain so, Standard & Poor's anticipates that they will be operating under conditions of sustained revenue pressure and environmental risk."

In a conference call, Foley said the "heightened possibility of shocks to credit or equity markets, which can occur through individual company announcements where investment banks may have exposure, or can occur to markets in general" also contributed to the firm's action today.

S&P analysts took pains to note they are only contemplating one-notch downgrades and that the firms maintain strong liquidity and sufficient capital levels.

"This is profit-driven," said S&P analyst Tanya Azarchs on the call. "The industry has performed laudably given the difficulty of the environment over the past year or two but it may be turning worse. While we don't really expect a disastrous performance going forward -- and expect firms to be profitable by and large -- the continued pressure over a long period may mean we need to adjust the rating."

Thus far, traders were accepting S&P's declaration that "we're not trying to send a signal we're expecting a meltdown," as the Philadelphia Stock Exchange/KBW Bank Index was recently up 0.9% and the Amex Broker/Dealer Index was higher by 1%.
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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