The relentless rise in oil prices caught up with the stock market Wednesday when crude climbed above $123 a barrel and drove the major indexes to their worst day in almost a month.
Stocks had for weeks largely shrugged off the oil price surge, in part out of relief that the global financial system had withstood what appeared to have been the worst of the credit crunch.
The wake-up shock was the latest record set on the New York Mercantile Exchange for the benchmark grade of U.S. crude, which closed at $123.53 a barrel and traded after hours as high as $123.93.
"Oil kind of snuck up behind the market," said John Bollinger, head of Bollinger Capital Management in Manhattan Beach. "Now it's kind of climbed up on the radar and people are starting to pay attention to it."
The Dow Jones industrial average sagged below 13,000, falling 206.48 points, or 1.6%, to 12,814.35. The Standard & Poor's 500 index skidded 25.69 points, or 1.8%, to 1,392.57. And the Nasdaq composite index gave back 44.82 points, or 1.8%, to 2,438.49.
Last week, the indexes narrowed their 2008 losses. But the high price of oil -- and predictions that it will hit $150 or $200 a barrel -- threatens to short-circuit any rallies, said A.C. Moore, chief investment strategist for Dunvegan Associates Inc. in Santa Barbara.
In fact, stocks fell despite good news on corporate productivity as companies pared staff and trimmed hours to hold costs down.
"Inflationary expectations act as a check on markets and will keep rallies from extending very far," Moore said. "It'll be a stop-and-start type of affair for some time to come."
Oil gained $1.69 a barrel, or 1.4%, even though the Energy Department reported that U.S. oil supplies had grown by a bigger-than-expected 5.7 million barrels last week to 325.6 million barrels. Demand for gasoline has begun to drop nationwide because of record high prices at the pump, and that has contributed to an increase in U.S. gasoline supplies.
The value of oil for next-month delivery has more than doubled on the Nymex in the last year.
"How high will it go? It will go as high as our political system and our foreign policy will allow," said Fadel Gheit, senior oil analyst for Oppenheimer & Co., who thinks President Bush should stop adding to the Strategic Oil Reserve and instead release enough oil from it to calm the frenzied market.
"That kind of bold gesture would help bring prices down, but it hasn't happened," Gheit said.
Just the potential for bad news added fuel to the price rise Wednesday.
A magnitude 6.8 earthquake off the Japanese coast raised concern that nearby nuclear power plants might be shut down as a precaution, as they were after an earthquake last July, raising the possibility that fuel-oil consumption might increase.
"It's just a frenzy," said Tom Kloza, chief oil analyst of Oil Price Information Service in New Jersey. "This is one of those times when no one is willing to sell even when there is a turnaround in fundamentals. But the biggest fundamental of all is money, and it continues to pour into oil."
Oil and other commodities have become increasingly attractive given the poor performance of the stock market and other investments. The weak dollar has contributed to the price run-up because it makes oil, which is priced in the currency, cheaper for foreign investors.
The dollar strengthened Wednesday, however, with the euro falling to $1.540 from $1.553 on Tuesday.
Andrew M. Lipow, a former trader turned industry consultant, said there were solid reasons for record oil prices, for example production declines in Russia, Nigeria, Mexico, Venezuela and Indonesia.
Although demand is falling somewhat in the U.S., it is high in China, India and other booming economies, said Lipow, president of Lipow Oil Associates in Houston.
"Overall, the supply-demand balance is shifting to those countries," Lipow said.
In other market highlights:
* Bond yields fell as investors pulled money out of stocks. The yield on the 10-year U.S. Treasury note slipped to 3.88% from 3.92% on Tuesday.
* Financial stocks took a hit on inflation concerns. Citigroup retreated $1.39 to $24.48. Morgan Stanley dropped $1.84 to $47.21 and Goldman Sachs gave up $7.85 to $189.76.
* Disney gained 97 cents to $34.70 a day after reporting a 22% jump in second-quarter net income.