Yields Surge on Inflation Report; Stocks Tumble

Wall Street is fearing a substantial pullback in stocks soon, after a nasty surprise on inflation Friday triggered the biggest one-day surge in bond yields in nearly three years.

The stock market also tumbled Friday, but many experts were less concerned with those losses than with what might be ahead for the seemingly eternal bull market.

Several stock strategists predicted a drop of at least 10%, or 1,100 points, in the Dow Jones industrial average soon.

On Friday, the Dow slid 193.87 points, or 1.8%, to 10,913.32. The broad market also was lower. The Standard & Poor’s 500-stock index, which hit a record Thursday, dropped 2.2% to 1,337.80.

The Nasdaq composite slid 2.1% to 2,527.86, with headline tech names Microsoft down $2.25 to $76.88 and Intel down $2.06 to $58.

Losing issues outnumbered gainers by nearly 4 to 1 on the New York Stock Exchange. Still, trading volume was muted.

Friday’s shocker was a government report indicating that consumer prices in April rose 0.7%, the largest increase in nine years.

Because inflation is bond investors’ worst nightmare--it erodes their fixed-rate returns--traders immediately demanded higher bond yields Friday to compensate for inflation risk.

That drove the bellwether 30-year Treasury bond yield to 5.91%, up from 5.75% on Thursday and the highest since May 21, 1998.

Analysts said the upswing in inflation, coupled with other recent reports showing a surging U.S. economy, would probably cause the Federal Reserve to adopt a bias in favor of raising short-term interest rates when it meets Tuesday.

Short-term rates are controlled by the Fed, while long-term bond yields are set by the market.

Abby Joseph Cohen, the influential strategist for Goldman, Sachs & Co., attempted to calm markets Friday with a statement that inflation fears are overblown. She said the April data reflected a sharp but probably temporary spike in energy, apparel and tobacco prices.

But inflation now isn’t the greatest danger, one expert argues. Even if inflation stays moderate, explosive U.S. economic growth will keep pushing interest rates higher, said bond analyst James Bianco of Bianco Research in Barrington, Ill.

Even with the recent rise in rates, “yields remain way too low relative to the economy,” he said.

So far this year the stock market overall has advanced despite rising yields. But at some point rates will finally get high enough to choke off stocks’ rally, Bianco said.

And if stocks then should slump, Fed Chairman Alan Greenspan may not be able to help out the way he did last fall, when the Fed cut short-term rates three times in two months, observers noted.

“This time, the stock market’s on its own,” said Christine Callies, strategist at CS First Boston.

Callies predicted that the yield on the 30-year T-bond would peak between 6.10% and 6.25%--levels not seen since the fall of 1997.

The higher rates, in turn, will lead to a stock market decline of about 15%, she said. Year-to-date, the S&P; 500 is up 8.8%.

Tony Dwyer, market strategist at Ladenburg Thalmann & Co., is calling for a market pullback of “10% minimum,” he said Friday. A 20%-plus tumble, like the one that occurred late last summer, wouldn’t be surprising, he said, calling the market “overextended.”

Likely to be hardest hit in any drop are shares of interest-rate- sensitive businesses such as banks and brokerages, as well as stocks with especially high valuations--the tech and drug sectors, for example, Callies said.

Among bank shares, Citigroup dropped $2.44 to $71 on Friday.

But if “cyclical” stocks--raw materials and capital goods producers that usually benefit from a stronger economy--seem like a good place to hide, be careful, some say. Their recent rally may already be over, warned Charles Pradilla, chief investment strategist at S.G. Cowen.

Aluminum giant Alcoa is up 110% from its 52-week low; Phelps Dodge, the copper miner, is up 54%; and International Paper is up 44%, Pradilla said, adding: “Alcoa is not a growth stock.”

Nevertheless, cyclical stocks were among Friday’s best performers. Union Carbide, for example, led the Dow, up $1.69 to $54.25. Alcoa rose 50 cents to $62.50.

Market Roundup, C4

* INFLATION FEARS: Consumer prices had their biggest one-month gain in nine years. A1