Foreign Flight Helps U.S. Stocks
By Brooke A. Masters and Nell Henderson
Washington Post Staff Writers
Friday, June 9, 2006
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.
The Fed's benchmark rate influences other borrowing costs throughout the economy, particularly short-term rates such as the prime rate for businesses, adjustable rates on mortgages and credit card rates. But U.S. long-term rates, such as those for fixed-rate mortgages, are determined by worldwide financial markets and have dropped in the past week as investors have pulled money out of stocks and commodities and parked them in the safer haven of U.S. Treasury securities.
"There's been a flight to quality out of stocks and risky assets and into primarily Treasurys, but also corporate bonds have held up pretty well," said James C. Cusser, who manages two bond funds for Waddell & Reed Inc.
The flood of cash into Treasurys has pushed up prices, causing yields (which move inversely) to fall. The yield on the 10-year Treasury bond, a benchmark for 30-year mortgages, fell yesterday to 5 percent. The rate on a 30-year, fixed-rate mortgage fell to 6.62 percent this week from 6.67 percent last week, Freddie Mac said yesterday.
The extra demand for Treasurys has also bolstered the value of the dollar, causing big losses for many hedge funds that had been betting both that emerging market asset prices would keep climbing and that Treasury prices and the dollar would go down, traders said.
Market analysts and economists predicted that equity investors should prepare for more volatility, although they sharply disagreed about where the markets will go next. The Dow and the S&P 500 are each down more than 5 percent since their highs in early May.
Citigroup economist Steven Wieting is optimistic: "We have faced some excesses in risk-taking in emerging markets and commodities . . . but is there any reason to believe the U.S. is at the end of its rope? No."
But Bob Doll, president of Merrill Lynch Investment Managers, said he thinks investors have only seen the first half of a 10 percent correction. Yesterday's recovery "is just another rally attempt in the middle of a correction," he said. And Elizabeth Weymouth, global investment specialist for the J.P. Morgan Private Bank, said she is telling clients to expect another drop: "We don't think this is necessarily the dip we've been waiting for."
Staff researcher Richard Drezen contributed to this report. Masters reported from New York.
MoversIntel fell 28 cents, to $17.11. Analysts said a price war with Advanced Micro Devices could cut into profits.
Advanced Micro Devices fell 97 cents, to $27.03.
McDonald's rose 37 cents, to $33.69.
General Motors fell 16 cents, to $24.83.
IndexesNew York Stock Exchange composite index fell 44.57, to 7992.49.
American Stock Exchange index fell 15.93, to 1894.41.
Russell 2000 index of smaller-company stocks fell 0.25, to 706.53.
VolumeNYSE: 3.65 billion shares, up from 2.68 billion on Wednesday. Decliners outnumbered advancers 4 to 3.
Nasdaq: 3.01 billion shares, up from 1.95 billion. Decliners outnumbered advancers 3 to 2.
CommoditiesCrude oil for July delivery: $70.35, down 47 cents.
Gold for current delivery: $609.10 a troy ounce, down from $627.40 on Wednesday.
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