This column was originally published on RealMoney on Oct. 5 at 1:59 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.There has been a sudden weakening of the stock market over the past few days. It appears to be related to worries about interest rates, which have escalated over the past week following numerous warnings from Federal Reserve officials about the likelihood of continued rate increases. This is apparent in the behavior of various sectors of the stock market and other asset classes. Also contributing to the slide was Wednesday's release of the Institute for Supply Management's monthly index for the nonmanufacturing sector. The index, which was much weaker than expected, suggests that the recent signs of resilience in the economy were largely confined to manufacturing -- an unfavorable mix because of its implications for continued job growth and the chances for a sustained expansion (more on this later).
Homebuilders WeakEvidence that Wednesday's stock market weakness relates at least partly to concerns about interest rates can be found in the slide in homebuilders' shares. Pressures are coming to bear on the sector for the many reasons I pointed out
Loss of LeadershipIn addition to the weakness in homebuilders' shares, the two-day decline in oil and oil services stocks has left investors with scant leadership. Given the lack of confidence in other sectors, liquidations of shares in these leading groups leaves the overall market weaker, as there is no rotation occurring.
Emerging MarketsEmerging markets have been weak as well, with Brazilian shares down almost 3% and Russian down over 3% (using the Templeton Russia Fund as a proxy, a weak opening appears likely Thursday). The emerging markets tend to underperform markets in industrialized countries when the Fed is raising interest rates. This hasn't been the case recently, largely due to the benefits that some of these countries have had from high energy prices. Nevertheless, the Fed's persistence in its rate-hike campaign and the level to which it now appears headed may be taking the edge off emerging markets. Weakness in emerging markets often spills over into industrialized markets.
Commodity-Based Currencies WeakenThe Australian, Canadian and New Zealand dollars all are lower as of midday Wednesday, perhaps also due in part to the threat of further interest rate hikes. The more the Fed raises interest rates, the less likely it is that commodities will rally. This hurts these so-called commodity-based currencies, as well as basic materials stocks, which were down 2% on the day (using the S&P basic materials index as a gauge).
ISM Reading Is Bad Sign for EmploymentThe weak ISM nonmanufacturing index reading indicates that the recent signs of resilience in the U.S. economy have been disproportionately skewed toward the factory sector. In other words, data such as durable goods orders and the ISM index sent a misleading signal with respect to the economy, and it now appears that there has been an unfavorable shift in the composition of the growth in the economy toward the factory sector and away from the services sector. A typical spread between the ISM's nonmanufacturing index and its factory index is about 5 points; it was 7 points over the past year. Now the nonmanufacturing index is below the factory index. This is unfavorable because of its implications for job growth: Of the 133 million people employed in the U.S., 110 million work in the services sector. If the factory sector is grabbing more of the spending dollars in the U.S., it will hurt the services sector, where most jobs are created. That said, the concerns that investors are expressing with respect to the ISM index are likely excessive. Some of the recent shift to factory-related activity relates to the automakers' employee-discount programs, which grabbed a large share of consumer spending. Car sales are now cooling, so money will skew back toward the services sector. P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
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