The biggest jump in inflation in two years and fears of higher interest rates kicked the stock market into its worst tumble this year, with the Dow Jones industrial average falling 42.50 points Wednesday.
The drop, the biggest one-day slide since a 47.66-point decline Nov. 11, raised concerns among some analysts that the heady rally of January and early February may finally be over and that a long-anticipated correction has finally arrived. The market's strength this year was based in part on beliefs that interest rates would soon peak, inflation would not get out of hand and corporate profit gains would remain robust. But the latest figures, along with new statements from the Federal Reserve, raised further doubts about that scenario.
"You cannot run a bull market on tight money," said Charles Allmon, editor of Growth Stock Outlook, a Chevy Chase, Md., newsletter.
On the other hand, some analysts called the latest inflation numbers an aberration and said stocks should soon resume their 1989 rally.
Wednesday's drop left the widely watched Dow at 2,283.93. New York Stock Exchange volume totaled a moderate 163.14 million shares, up from 141.95 million on Tuesday.
Analysts blamed the fall largely on a federal government report, released early Wednesday, suggesting that inflation is worsening. The Labor Department report showed that the consumer price index jumped 0.6% in January, the largest monthly increase in two years. That amounts to an annual inflation rate of 7.2%, compared to the rate of below 5% for last year.
Further depressing equity prices were statements by Federal Reserve Chairman Alan Greenspan expressing concern over inflation. Analysts speculated that the Fed may soon hike its discount rate--the interest rate charged member banks who borrow from the Fed--from the 6.5% level it has stood at since last August.
The Fed already has been hiking short-term interest rates to cool off the economy, resulting in short-term Treasury issues yielding more than 9%. That has drawn investment money away from stocks. Prospects of still higher interest rates and tighter money also raised fears of a recession--not a good sign for equities, some analysts said.
"There's a tremendous potential on the downside for this market," said Jon Groveman, head of equity trading at the New York investment firm of Ladenburg, Thalmann & Co. "The problem is that the economy is stronger than the Fed wants it to be. . . . But if the economy slows down, it is unrealistic to think it will be a soft landing. So we're really in a negative Catch-22."
"Any surprises in this market will be on the downside," newsletter editor Allmon said. He contended that at 6.5%, the discount rate is at its largest spread versus the bank prime lending rate, which is 11%. But if the Fed were to raise the discount rate to 8.5%--where historically it should be in relation to an 11% prime--"you'd see the Dow drop to 1,400."
Market watchers also said a major correction has been overdue, given the Dow's 7.3% gain since Jan. 1 and 33.8% gain off the low after the October, 1987, market crash. "With the market at lofty levels, corrections of this kind are to be expected," trader Groveman said.
But other analysts said investors overreacted to the inflation news. Michael Sherman, chief investment strategist at the New York investment firm of Shearson Lehman Hutton, contended that January's CPI number was an aberration. The CPI during the past three months, including January, points to a more modest annual inflation rate of 4.5%, about the same as in the past 2 1/2 years, he said.
"We have a growing economy, growing profits, low inflation. Investors have lots of cash," Sherman said in making his case for a continued rally in stocks.
But Wednesday's decline was clearly broad-based. Declining issues outnumbered advancing ones among NYSE-listed stocks, with 332 stocks gaining, 1,197 falling and 446 unchanged.
Among actively traded stocks, Champion Spark Plug fell 7/8 to 21 3/8. Champion said Tuesday that it had signed an agreement to be acquired by Cooper Industries for $21 a share, persuading some investors that a bidding war for the company was over.
Other Indexes Drop
Petrolane Partners gained 1 1/2 to 25 3/4. Panhandle Eastern, which has made a tender offer of $53 a share for 80% of Texas Eastern, said it intends to sell Texas Eastern's 43% share to Petrolane if successful.
Among blue chip stocks, General Motors fell 21/ 1/4 to 86 3/4, International Business Machines lost 2 1/8 to 123 3/8 and General Electric dropped 1 3/8 to 45 5/8.
As measured by Wilshire Associates' index of more than 5,000 actively traded stocks, the market lost $40.54 billion, or 1.4%, in value.
The NYSE's composite index of all its listed common stocks fell 2.51 to 163.55.
Standard & Poor's industrial index fell 6.11 to 335.96; its 500-stock composite index fell 5.07 to 290.91.
The NASDAQ composite index fell 3.89 to 402.49; the American Stock Exchange index closed at 322.07, down 2.79.
At the Tokyo Stock Exchange, prices closed sharply higher across a broad front in active trading Wednesday, boosting the key Nikkei index to a new high. The 225-share average surged 331.85 to close at 32,311.93.
In London, persistent concern about inflation and the course of worldwide interest rates, combined with the weak early performance on Wall Street, drove stock prices sharply lower. The Financial Times 100-share index fell 27.3, or 1.3%, to close at 2,033.7, the day's lowest level.