Traders were admiring a long line of Harley-Davidson motorcycles displayed in front of the New York Stock Exchange Tuesday afternoon, presumably a scene much more interesting than the one unfolding inside of the exchange. Shares of Harley-Davidson, whose new CEO rang the closing bell Tuesday, fell in the final hour of trading to close down 5 cents or 0.1% to $50.22 after trading as high as $50.53 intraday. Yup, it was more exciting outside. After failing to sustain an early rally Monday, major stock averages also seesawed amid low volumes Tuesday, before heading lower in the afternoon. The absence of optimism was helped by a bigger-than-expected decline in existing-home sales. Crude oil prices also continued to weigh on sentiment, with the October contract briefly topping $66 per barrel before settling at $65.70, up 35 cents on the day. The Dow Jones Industrial Average fell 50.31 points, or 0.5%, to 10,519.58. Citigroup ( C) led the blue-chip average lower after news that CEO Charles Prince asked Marjorie Magner, the respected head of the bank's consumer division, to leave. The S&P 500 fell 4.14 points, or 0.3%, to finish at 1217.59 and the Nasdaq Composite dipped 4.14 points, or 0.34%, to 2117.59. The S&P closed below its 50-day moving average just below 1220, an important technical support level the index heretofore managed to close above. But it remains to be seen whether Tuesday's marginal break of that moving average will give way to more aggressive selling and low August volumes undermine the significance of market moves, up or down. Only 1.3 billion shares traded on the NYSE and 1.4 billion on the Nasdaq. Breadth on both exchanges was negative, with decliners outpacing gaining issues 9 to 7 on the NYSE and 16 to 13 on the Nasdaq. Still, there was more evidence that the economic and profit outlook is worsening by the day. On the one hand, existing-home sales dipped a larger-than-expected 2.6% to 7.16 million in July, compared with Wall Street economists' average forecast that sales would fall only 1.1%.
The numbers seemed to confirm the bond market's anticipation of a slowdown in economic growth. The benchmark 10-year Treasury bond rose 8/32 in price while its yield fell to 4.18%. Since reaching 4.39% in late July, the yield has been steadily falling back. While economists are still debating, it seems consumers, already hit by high energy prices, have not waited for a confirmation that the economy and real estate may be cooling down. After Wal-Mart ( WMT) shocked Wall Street last week when it said that surging gasoline prices were hitting consumers' wallets and its sales, there are signs that retailers linked to the housing boom also are feeling pinched. On Tuesday, La-Z-Boy ( LZB), for one, said that both high energy prices and rising interest rates were hitting demand for furniture. Pier 1 ( PIR) warned about its second-quarter earnings, noting it had to offer discounts to fight declining consumer traffic. Even sales at the higher-end Willams-Sonoma ( WSM) fell short of estimates. It may be clear to the bond market that the economy is poised to slow going forward, but there is still a lot of delusion about this and the outlook for corporate profits, according to Richard Bernstein, Merrill Lynch's U.S. strategist. The Federal Reserve, Bernstein says, is going to continue raising short-term interest rates past market expectations, even as long-term rates remain stubbornly low. This raises the risk that the yield curve, the difference between yields of short- and long-term Treasuries, will invert. Normally, long-term rates are higher than short-term ones, reflecting the increased risks -- such as inflation -- brought by keeping money parked in fixed-income assets for longer. An inverted yield curve, when short-term rates are higher, has historically been a harbinger of an economic recession. But Fed Chairman Alan Greenspan believes this time is different (aka "the most dangerous words on Wall Street"), and so does the stock market, says Bernstein.
"Whereas inverted yield curves in the past have not always led to economic recessions, they have always led to profits recessions," he says, referring to a scenario in which overall S&P 500 earnings growth turns negative. "We strongly doubt that a rising probability of a profits recession is being adequately discounted in current equity valuations," says the oft-skeptical Bernstein. The strategist last week raised the cash portion and dropped the stock allocation in Merrill's model portfolio for the first time in two years, saying that rising money market rates are now competing with equities. Bernstein now recommends 15% cash, from 10% previously, and 40% stocks, from 45% previously. He kept his bond allocation at 45%. To view Gregg Greenberg's video take on today's market,
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