Global Markets Suffer A Hit

Concerns about inflation and rising interest rates drove down stock markets around the world yesterday, including, initially, in the United States.

But the sell-off also sparked a flight to quality stocks perceived as safer investments and helped both the Dow Jones industrial average and the Standard & Poor's 500-stock index finish the day up slightly.

Stock markets in Europe and Asia all plunged Thursday, some by as much as 4 percent, after six national banks, including those of Thailand, India, Turkey and South Africa, raised key lending rates on Wednesday and Thursday. The European Central Bank's increase was expected, but none of the others was.

Federal Reserve Board Governor Donald L. Kohn further rattled morning traders in the United States when he called "the recent inflation data somewhat troubling" during congressional testimony, becoming the latest central bank official to signal that further U.S. interest rate increases are likely.

By just before noon, the Dow had fallen more than 173 points -- and 800 since its most recent high point in mid-May -- and the S&P 500 was down 1.5 percent. Sectors considered most vulnerable to the economic cycle, such as home builders and some industrial companies, were hit hardest.

"People are letting emotion dictate what's happening on a day-to-day basis," said Neil Hennessy, president and portfolio manager of Hennessy Funds, which has $2.1 billion under management.

Hedge funds and other highly leveraged investors may have exacerbated the initial slide because they sustained losses abroad and then sold U.S. stocks to provide more collateral for their loans, said Charles Biderman, president of TrimTabs Investment Research. He noted that for the year, margin debt -- loans that rely on stocks for collateral -- was up more than $20 billion through the end of April after rising only $18 billion in all of 2005.

That sell-off in turn caught the attention of investors -- mostly hedge funds and day traders -- who thrive on short-term price movements. "You have all these momentum players, and once you tip it one way, everything just cascades, and that's what we were seeing," said Wendell L. Perkins, chief investment officer of Johnson Asset Management.

In the past three weeks, $2.75 billion has flowed out of emerging-market equity funds, a drop of more than 3 percent, said Robert Adler, president of AMG Data Services.

But the same concerns that drove many investors out of the foreign markets in the early morning sent them scurrying to newly cheaper U.S. blue-chip stocks in the afternoon. By day's end, the Dow had recovered to close at 10,938.82, up 7.92 or 0.07 percent, its first positive day this week. The S&P 500 rose 1.78, or 0.14 percent, to finish at 1257.93. But the Nasdaq composite index, which includes many more small and higher-risk companies, fell 6.48, or 0.3 percent, to 2145.32.

It is not clear whether the late-day rally will prove to be more than a temporary end to the four-day stock market slide sparked by Fed Chairman Ben S. Bernanke's comments on Monday that led investors to conclude that the central bank will raise its benchmark overnight interest rate to at least 5.25 percent from 5 percent at its next policymaking meeting, June 28-29.

Kohn reinforced that impression yesterday during the Senate Banking Committee's hearing on his nomination to become the Fed's vice chairman after 36 years with the central bank. The inflation data "were higher than I had anticipated, and that raises a warning flag," Kohn said. "At this stage we have to acknowledge . . . that yes, the economy is slowing down," which should weaken inflation pressures a bit, Kohn said. There are "still some danger signs out there we need to be attentive to," he said.