Stocks Fall, Yields Rise as Investors Reconsider
Wall Street didn’t like what it heard from the Federal Reserve on Tuesday, as stocks closed broadly lower and bond yields rose.
But as is often the case after a Fed meeting, investors had different ideas about what, exactly, they did hear.
The Dow Jones industrial average crossed 10,000 early in the day and then rallied to within a fraction of that milestone shortly after the Fed’s post-meeting announcement. It was mostly downhill from there: The Dow closed off 41.85 points, or 0.4%, at 9,923.42.
Most other market indexes suffered deeper declines. The Nasdaq composite index sank 40.53 points, or 2.1%, to 1,908.32.
In the bond market, the yield on the 10-year Treasury note, a benchmark for long-term interest rates, rose to 4.35% from 4.27% Monday.
The big question on many investors’ minds since summer has been how soon the Fed might begin to tighten credit as the economy speeds up.
There was broad agreement Tuesday that the wording of the Fed’s announcement indicated the central bank was laying the groundwork for higher interest rates, which could hurt stocks and bonds in the long run.
But whether investors should be worried in the near term depends on when they expect the Fed to raise rates, and by how much, analysts said.
With its key short-term interest rate at 1%, the Fed would have a long way to go in raising rates before returning them to the levels of the late 1990s. And the economy, and stock market, were booming in the late ‘90s even when the Fed’s key rate was mostly 5.5%, experts note.
Some strategists said the Fed’s continued use of the term “considerable period” to describe its timetable for maintaining current interest rates means that Chairman Alan Greenspan and his peers may not tighten credit at all in 2004.
That seemed to be the view in the currency market Tuesday, where the dollar continued to slide against the euro and other rivals. Higher U.S. interest rates would be expected to bolster the dollar’s value.
“The Greenspan Fed moves in measured steps,” said John Caldwell, chief investment strategist for asset manager McDonald Financial Group in Cleveland. “The Fed wants to see several quarters of above-trend growth [in gross domestic product] before it takes action.”
If that’s the case, the stock market rally may have further to run, many Wall Street pros say.
Even though falling stocks outnumbered winners Tuesday by 20 to 13 on the New York Stock Exchange and by 23 to 10 on Nasdaq, a number of stocks whose fortunes are tied to the economy’s trend continued to rally. General Motors, for example, jumped $1.27 to $48.41, and copper miner Phelps Dodge surged $2.05 to $68.98.
The Fed on Tuesday also changed its wording from recent statements, deemphasizing the risk of deflation, a broad-based decline in prices across the economy.
Stock investors, in theory, ought to be happy if deflation fears are waning, because that may signal better pricing power for many companies.
“The Fed kind of put ‘deflation’ in the dustbin,” said Philip Dow, managing director of equity strategy at brokerage RBC Dain Rauscher in Minneapolis. “I welcome that.”
But if the economy strengthens enough that it begins to stoke inflation concerns, the Fed could be compelled to raise interest rates faster than many analysts now anticipate.
Bond investors are particularly fearful of inflation because it erodes fixed-rate returns.
Still, Treasury bond yields rose only modestly on Tuesday. They have been stuck in a narrow range in recent months after soaring in the summer.
The sideways movement in the bond market suggests many bond owners, so far, aren’t too concerned about the risk of inflation or a sharp jump in the Fed’s key rate, analysts say.
James Bianco, head of bond research firm Bianco Research in Chicago, said the Fed could further calm the bond market by sounding tougher about being willing to quash inflation should it reappear.
“If they want to see long-term yields go down, they should be more hawkish” about inflation, Bianco said.
Despite the bond market’s relative placidness, some analysts warn that investors might begin to dump long-term bonds early next year if the economic data continue to be strong.
“It seems like it’s going to be a violent move when it does happen,” said Ralph Axel, government bond strategist at HSBC Securities in New York.
As for stocks, some investors on Tuesday may have used the Fed’s announcement to hedge their bets -- moving out of higher-risk shares that have performed well this year, and into laggards.
The stocks down the most included many of this year’s biggest gainers in technology. The SOX semiconductor index slid 4.1% for the day.
By contrast, the Dow and other blue-chip indexes held up relatively well. The Standard & Poor’s 500 index lost 9.12 points, or 0.9%, to 1,060.18. The Dow’s run for the 10,000 mark briefly lifted it to an 18-month high.
That trend of smaller and riskier stocks giving ground while blue chips hang tough was evident last week as well.
“Investors are interested in protecting the gains they’ve achieved during the year,” said Jack Caffrey, equity strategist at J.P. Morgan Chase’s private bank in New York. “That may be one reason we’ve seen a dramatic change in market leadership” in recent sessions, he said.
Market Roundup, C6-7
