Oil, Dollar Moves Slam Stocks

The two-headed monster of higher oil prices and a weakening dollar threw a scare into financial markets Tuesday. The session confirmed the loss of momentum that was evident last week, as breadth was decidedly negative and volume solid.

The Dow Jones Industrial Average fell 174 points to 10,611.20, its worst point decline since May 19, 2003, and fell back into negative territory for 2005. Meanwhile, the S&P 500 lost 1.5% to 1184.16 and the Nasdaq Composite shed 1.4% to 2030.32. Decliners led advancers 26 to 7 on the New York Stock Exchange and by 23 to 9 on the Nasdaq. Volume was more than 1.7 billion shares on the Big Board and more than 2 billion shares traded over the counter.

Oil was a chief culprit in the decline, as crude futures rose 5.8% to $51.15 per barrel, their highest level since Nov. 1. The move was attributed to colder-than-normal winter weather in the Northeast and in Europe, as well as speculation that OPEC will cut production. Higher oil prices plus a drop in the Conference Board's consumer confidence index for February -- even if expected -- weighed on retail stocks. The S&P Retail Index fell 2.4%, with notable weakness in Home Depot ( HD), whose results merely matched expectations, and Federated ( FD), whose guidance fell shy.

Notably, energy stocks failed to sustain their recent momentum despite crude's surge. The Amex Oil and Gas Index rose fractionally, thanks largely to strength in Kerr-McGee ( KMG), but the Philadelphia Stock Exchange Oil Service Index fell 1.5%.

The dollar's tumble was the second major contributor to the stock market's weakness, with the greenback falling to 104.065 yen vs. 105.54 Monday, while the euro rose to $1.3253 vs. $1.3068.

The decline was widely attributed to the central bank of South Korea's announcement it would seek to diversify its investments into higher-yielding, nongovernment securities and diversify the currencies in which it invests.

The announcement "is part of the emerging chorus from major central banks wishing to reduce their U.S. dollar exposure, especially in light of an increasingly unfavorable outlook in the greenback," commented Ashraf Laidi, chief currency analyst at MG Financial Group.

But David Gilmore, partner at Foreign Exchange Analytics, observed that South Korea's announcement about its dollar holdings came out Monday -- when U.S. financial markets were closed.

"My read, Tuesday's action is more a function of news chasing price than news making price," he said, noting the euro bounced after hitting a key technical support level just below $1.31 -- a 38% retracement of the decline from its December high at $1.3660.

Rather than South Korea's announcement, the dollar's selloff was due to technical factors and was "a function of people selling dollars and buying won" while South Korea's central bank sat on its hands, Gilmore said. "South Korea said they'd continue to smooth the underlying appreciation of the won, but today did little to stand in the way" of its appreciation to a seven-year high vs. the dollar.

There was a similar development in Taiwan, where authorities weren't buying dollars to stem a rise in the local currency, as had previously been the expected policy response.

"Since an expected revaluation of the Chinese yuan next year will allow Asian currencies to appreciate against the U.S. dollar, central banks are moving ahead of the move in order to minimize any currency losses to their extensive dollar portfolios once foreign exchange markets react to China's eventual decision," Laidi observed.

Because South Korea is the fifth-largest foreign holder of U.S. government securities, with a $69.3 billion portfolio at the end of November, Monday's announcement was treated by some traders returning to work as a sign of the beginning of the long-anticipated "doomsday scenario" of foreign capital fleeing from dollar-based assets.

"I'm sure you can find some to tell you unequivocally that 'today is the first day' of foreign flight but you'd be disingenuous to say you can tell that based on one day's move in Treasuries, stocks, dollar, and commodities," Gilmore said. (Among those "other" markets, the price of the 10-year Treasury fell 5/32, its yield rising to 4.29% -- up from 4.08% a week ago -- while gold futures rose 1.7% to $435.80 in Comex trading.)

Indeed, experience tells us it's a mistake to make too much of any one trading day. Furthermore, hard-core bears have been predicting a dollar-based rout of financial assets for years now, with decidedly mixed results. But the bears were crowing Tuesday and will likely remain in full throat for the near term, given that such a seemingly innocuous remark from the South Korean central bank sent many market participants scrambling for the exits.

Editor's note: Aaron Pressman is on vacation.

Aaron L. Task is the co-executive editor of 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 atask@thestreet.com.

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