Stocks plunged Wednesday, as yet another Federal Reserve official issued a late-afternoon warning that inflation risks outweighed concerns about growth in the wake of hurricanes Katrina and Rita. The warning came after fresh evidence that the U.S. economy is feeling the pinch of a post-hurricane surge in energy prices and an accompanying plunge in consumer confidence. With its leading sectors down for the count -- the energy sector dropped again as crude oil fell and homebuilders remain pressured by a rising rate outlook -- the market has nowhere to go but down, says Marc Pado, a market strategist at Cantor Fitzgerald. "It's an accumulation of all these factors coming into play, and now the market is reversing the complacency it showed in September" over the impact of the hurricanes and soaring energy prices. The result: The three main stock proxies plunged to three-month lows. After losing 94 points Tuesday, the Dow Jones Industrial Average fell by another 123.75 points, or 1.19%, to 10,317.36, a three-month low. The index broke through important technical resistance at 10,550. Likewise, the S&P 500 fell 18.08 points, or 1.49%, to 1196.39, also at three-month low, after breaking through key resistance at 1200, its 200-day moving average. The losses were even steeper for the tech-heavy Nasdaq Composite, which dropped 36.34 points, or 1.70%, to 2103.02. The Comp was weighed down by weakness in big-cap tech names such as Apple ( AAPL), as well as large percentage losses on heavy volume for smaller components such as ADC Telecommunication ( ADCT) and Human Genome Sciences ( HGSI). Echoing Dallas Fed President Richard Fisher on Tuesday, Kansas City Fed President Thomas Hoenig on Wednesday reiterated the view that inflation remained enemy number one for the central bank, catalyzing the market's current concerns. The market had already given in to some selling pressure earlier, after the Institute for Supply Management said that its non-manufacturing index plummeted in September. Contrary to Monday's ISM report showing that the manufacturing sector remained strong after the hurricanes, the service-sector survey, which represents over 80% of the economy, revived concerns over economic weakness.
But perhaps worse for investors, both surveys' gauges of inflation soared in September, all but guaranteeing that the Fed will continue to raise interest rates. A surge in inflation expectations from consumers and businesses has also prompted Citigroup chief economist Robert DiClemente to ratchet up his rate-hike forecasts. He believed until now that the Fed would deliver one more rate hike -- taking the Fed funds rate to 4.0% -- this year and be done. He now believes the Fed will go to 4.5%. "Earlier rate hikes were viewed as unwinding an unnecessarily accommodative stance. Recently, there are hints that the task now has turned to pre-empting a more tangible inflation threat," DiClemente wrote. Those same reconsiderations are leading the market to abandon "complacent views" about the state of the economy and the outlook for profits, says Cantor's Pado. "A lot of people thought the market was being very resilient in September, but it was in fact complacency," he says. "There was a wait-and-see attitude about the post-Katrina economy, especially as the Fed was still saying a slowdown would be just a blip, and that long-term inflation remained under control." And it's not only that economic data are raising concerns about slowing growth and rising inflation, and that the Fed is vowing to continue restricting the flow of money. Ahead of the third-quarter earnings season, profit warnings have been scarce. That has fueled further complacency among investors. But many companies -- aside from the retail sector for which every week counts -- had already booked most of their profits for the latest quarter when the hurricanes struck. Other firms may have been unable to fully assess the impact of the hurricanes by Sept. 30, meaning warning season has been extended into October.
On that note, Wendy's ( WEN) said Wednesday that same-store sales were hurt by store closings after Hurricanes Katrina and Rita, high gasoline prices and lower consumer spending levels. The restaurant-chain operator also lowered its earnings forecasts. A number of companies, including Clorox ( CLX) and Goodyear ( GT) on Tuesday, have also lowered their earnings guidance because of rising energy and commodity costs. "It's guidance that's going to be very important now," Pado says. Meanwhile, most oil companies are expected to post stellar earnings as their refining profits have continued to surge, even as crude oil prices appear to have stabilized. If there's any buying opportunity from market weakness over the coming weeks, it might very well be in that sector. On Wednesday, the energy sector was among the heaviest pressures on the broad market, with the Amex Oil Index losing over 4%. Valero ( VLO) lost 6%, Amerada Hess ( AHC) fell 6.5%, and Marathon Oil ( MOR) lost 5.8%.