Political push-back stalls stock market rally on Wall Street

"The policies that work out best over time are those that strengthen economic fundamentals, not try to influence day-to-day market movements," said Lawrence H. Summers, the president's top economic adviser. "The experience of the past 60 years is that not only working families but also businesses and markets have performed better during periods of progressive governance and sound financial regulation."

The timing of the president's proposals, analysts said, has been far from ideal. With the Republican upset in the deeply blue Massachusetts, the fear in markets is that Bernanke, a central figure in Washington's response to the financial crisis during both the Bush and Obama administrations, could fall victim to escalating anti-Wall Street sentiment among Democrats struggling to address populist anger.

His term expires Jan. 31, and if he is not reappointed, "who are they going to put in Bernanke's place? That is a huge uncertainty, and uncertainty right now is a big negative," said Tom Sowanick, chief investment officer at Clearbrook Financial in Princeton, N.J. "The world, right now, is looking for stability."

The tumult comes as investors are watching closely how and when the Federal Reserve will begin to draw down its emergency lending programs. Senior Fed officials have warned that dragging their feet could trigger inflation, although others have played down such risks. Some economists have raised concerns about a double-dip recession.

Under Bernanke, the Fed has reduced its target interest rate to near zero and pumped billions of dollars into the financial system to guide the economy through the worst crisis since the Great Depression. Although most investors still do not expect the Fed to increase rates until at least this summer, any uncertainty surrounding monetary policy is a strong driver of market volatility. The Fed's next monetary policy meeting begins Wednesday.

At the same time, some in the industry are questioning Treasury Secretary Timothy F. Geithner's standing in the administration after Obama on Thursday announced new restrictions on banks. Paul A. Volcker, an economic adviser, had long championed the proposal, which seeks to limit activities at commercial banks such as proprietary trading, which are investments that are not intended to benefit customers.

"The markets are wondering, 'Who's on first?' " said Mark Coffelt, president and chief investment officer of Empiric Funds. "All of the sudden, these guys are out and Volcker's in. . . . Everyone is scratching their heads and saying, 'What are these guys doing?' It's a pretty ugly picture."

Also driving concern is whether the recent proposals are just the opening salvo of an anti-business campaign from Washington. In a passionate speech Thursday, Obama signaled that he was ready for a showdown with financial lobbyists as he proposed legislation to prohibit large banks from engaging in proprietary trading and owning hedge funds and private-equity groups.

"It only took two days after the special election" for the White House to announce a new proposal, said Sean J. Ryan, a banking analyst for Wisco Research. "God knows what we're in for between now and November."

Ryan and others noted that investors' reactions may have been too strong. They said it's far from certain that the restrictions will pass Congress. The impact on banks' bottom lines is unclear because specifics of the proposal have yet to be spelled out.

"It was a cause for concern, but far from catastrophic," Ryan said. "But what we're seeing today is that if people don't get reassurance over the weekend, Monday could be an ugly day. It's not that people love Bernanke, but he is the devil they know."

Investor uncertainty runs deeper than Washington politics. The financial markets have rebounded dramatically since the depths of the recession, but stocks have teetered routinely on news hinting that the recovery would not be smooth or quick.

Traders are on alert for signs the rally has overestimated the strength of the economy's rebound, particularly as federal measures to prop up the economy are set to run out. This earnings season has been marked by companies meeting profit expectations only to see investors sell off shares because they felt executives could not provide clear revenue guidance for the year.

"The recovery is coming along slowly, but everybody is worried about it being derailed. . . . Derailed by the threat of huge regulation, derailed by the government overextending their reach, and being derailed by the uncertainty that Washington can present," said Andrew Brooks of T. Rowe Price.

Fueling concerns about the pace of the recovery have been actions in China to clamp down on lending in an effort to contain inflation and stave off an asset bubble. China helped propel the global economic recovery during the past year, and a slowdown there would trickle around the globe.

"No one knows what the end game is going to be, including what form tightening in China is going to take," said Doug Roberts of Channel Capital Research. "Investors hate uncertainty."

Staff writer Michael Fletcher contributed to this report.