By Ariana Eunjung Cha and Neil Irwin
Wednesday, March 16, 2011; 10:44 AM
U.S. stocks fell in early trading Wednesday despite large gains in Japan's Nikkei stock index overnight.
Investors in U.S. equities were reacting to a slew of bad news that came in the hours before the market opened: that rescue crews may have to be evacuated because of increasing radiation in the area around the damaged Japanese nuclear plants; that violence in Bahrain was increasing; and that U.S. housing construction and wholesale costs were worse than expected.
The Dow Jones industrial average was down 0.61 percent, the Standard & Poors 500 was off by 0.47 percent, and Nasdaq dropped 0.26 percent.
The Commerce Department reported Wednesday that housing starts had fallen 22.5 percent in February to an annual rate of 479,000 units--the steepest decline in 27 years. Building permits, which indicate future construction demand, were at record lows, signaling what some analysts said was more underlying weakness in the housing sector.
But Ian Shepherdson, chief U.S. economist for High Frequency Economics, said he believes the numbers may be a fluke because other indicators have been positive. "Home builder sentiment has been flat in recent months, but consumer confidence has improved, and payrolls have been picking up," he said.
Surging food prices and energy costs drove wholesale costs in the United States more than forecast last month. The Labor Department said the producer-price index was up 1.6 percent from the previous month to the highest since June 2009.
John Ryding and Conrad DeQuadros of RDQ Economics said this number suggests "significant acceleration in prices."
"We do not buy the Fed's reassurance that these pressures will be temporary, and we believe the public, seeing these strong increases in food and energy ... will not be marking back down their inflation expectations," Ryding and DeQuadros wrote in a research note.
On Tuesday, the Federal Reserve said that it considers the U.S. economic recovery to have achieved a "firmer footing." Fed officials also acknowledged a risk of inflation as prices for oil and other commodities have spiked in recent months, but said they expected the increases caused by the political turmoil in the Middle East to be transitory.
Analysts are generally predicting that the Japanese earthquake and tsunami will have only a modest impact on the economies of the United States and Japan's other major trading partners. But the risk of a significant blow to the world economy has been increasing as Japan struggles to stabilize the now-dangerous reactors.
The economic cost to Japan itself is certain to be massive, though it's too early to gauge the exact toll. Estimates of the direct damage - the cost of rebuilding homes and factories - range from $160 billion to $200 billion.
Early forecasts also predict that the disasters could reduce the nation's economic output by half a percentage point this year, an additional $25 billion hit. Analysts say it could be much larger if Japan suffers prolonged power outages or if one or more of the reactors goes into total meltdown.
In the three trading days after the earthquake struck, the drop in stocks in Japan was equal to a 2,000-point drop in the Dow Jones industrial average. The Nikkei average rebounded Wednesday, closing at 9,093.72, a gain of 5.7 percent. The Bank of Japan also pumped money into the financial markets, injecting 3.5 trillion yen, or $43 billion, after having put in 23 trillion yen, or $283 billion, over the past two days.
The damage has spread to markets worldwide, with the Standard & Poor's 500 closing Tuesday down 1.1 percent. The losses in U.S. markets were deeper earlier in the day, before the Federal Reserve's announcement after its policy committee meeting. Money gushed into U.S. Treasury bonds as global investors sought haven.
Essentially, world investors were beginning to price in the risk of some catastrophic possibilities.
Mark Luschini, chief investment strategist at Janney Montgomery Scott, said he believes the drop in the markets has been caused by panic selling as investors ponder the worst-case scenario: If "the radiation impacts someplace with a dense population like Tokyo" or elsewhere in the world, Luschini said, "all bets are off." Traders, he said, are acting like "armchair nuclear physicists."
For the United States and the rest of the world, the risks are hard to predict. The direct economic impact on such things as trade flows is likely to be modest. Japan accounts for less than 5 percent of American exports, and U.S. exporters could even get some advantage as they ramp up output to make up for production shortfalls while Japan is recovering.
More worrisome is that the disaster in Japan could affect consumer and business confidence in the United States. For example, the European financial crisis last spring had little obvious direct impact on the U.S. economy, but it coincided with a slowdown in growth here.
The uncertainty over the extent of Japan's nuclear disaster "may add to a sense that global events are spinning out of control," said Nariman Behravesh, chief economist at IHS Global Insight."This can make consumers - and, perhaps, businesses, too - more fearful," he said, and slow down purchasing and hiring.
"Such reactions to natural disasters are usually short-lived, but we cannot yet know when events in Japan will stabilize," he said.
Luschini said it's worth recalling the effect of the Kobe earthquake in 1995. In the week after that disaster, the Nikkei fell almost 7 percent. It continued to fall as much as 25 percent before fully recovering its losses by year's end.
The major difference between that disaster and the current one is the risk of a nuclear catastrophe, which has exacerbated fears in Japan and beyond.
"There is still a great deal of uncertainty how bad the human and economic toll will be in Japan," said Bernard Baumohl, chief global economist at the Economic Outlook Group. "The tragedy has certainly been horrific, but there is still no sense the nuclear crisis is over."