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MARKETS

Stocks Tumble as Fed Signals Shift on Rates

By Tom Petruno
Times Staff Writer

January 29, 2004

Two words made all the difference Wednesday on Wall Street.

Stocks tumbled and bond yields jumped after the Federal Reserve ended its first meeting of 2004 with a promise to "be patient" with low interest rates — a change from previous statements that pledged rates would stay down for a "considerable period."

But the Dow Jones industrial average's drop of 141.55 points, or 1.3%, to 10,468.37, and deeper losses for other key indexes, failed to shake many experts' belief that the market is headed higher this year even if the Fed begins to tighten credit sooner than later.

"If you get a pullback here, it's a buying opportunity," said Kevin Caron, equity strategist at investment firm Ryan Beck & Co. in Livingston, N.J.

That will be the test of the next few weeks, analysts said: If stocks continue to slide, will more investors step up — or away?

Many would-be buyers have complained that the market's relentless rise during the last 10 months hasn't afforded opportunities to jump aboard, because there have been no significant pullbacks along the way.

The Dow is up 39% since March 11, when it bottomed before the start of the U.S.-Iraq war. The technology-dominated Nasdaq composite index, which slid 38.67 points, or 1.8%, to 2,077.37 on Wednesday, is up 63% in the same period.

"There are a lot of people who haven't participated in this market," said Robert Bissell, chief investment officer at Wells Capital Management in Los Angeles.

At the same time, the lack of short-term declines, or "corrections," in the last 10 months has encouraged many investors who own stocks to hold on rather than take some of their profits.

Some of them may have used the Fed's language change in its official statement as a convenient excuse to sell, analysts said.

Even so, the day's losses suggested that some investors genuinely were taken aback by the Fed's wording. The Dow had been up 32 points just before the announcement. It dived 100 points in a few minutes and continued to decline for most of the rest of the session.

At the close, losers outnumbered winners by more than 2 to 1 on the New York Stock Exchange and on Nasdaq. Trading volume was heavy.

By removing the reference to keeping interest rates low for a "considerable period," policymakers "gave themselves more room to adjust to economic conditions," said Eric Hiller, interest rate strategist at Bank of America in Chicago.

Although it has been widely expected that the Fed would begin to move away from its policy of rock-bottom rates, many analysts have warned that a signaling of that shift would cause at least a short-term hiccup in financial markets.

Wall Street's basic fear is that any increase by the Fed in its key short-term rate, now at a four-decade low of 1%, could force other rates higher and make bonds, bank accounts and similar options more appealing relative to stocks.

Higher rates also could hurt many industries that have benefited from cheap credit. Indeed, among the stocks that declined the most Wednesday were home builders: KB Home slid $4.60 to $66.56, and Centex tumbled $6.82 to $104.98.

Yet the bond market's reaction Wednesday wasn't particularly onerous, many analysts said. The yield on the two-year Treasury note jumped to 1.81% from 1.64% on Tuesday, but longer-term yields rose less sharply.

The yield on the 10-year Treasury note, a benchmark for mortgages, rose to 4.19% from 4.08% on Tuesday but remains well below its recent peak of 4.6% in early September.

Investors began to push bond yields higher last summer as the economy gained steam. Caron, at Ryan Beck, said the 10-year T-note yield could rise to 5.5% this year if the Fed in fact began to tighten credit. "But I think the stock market could live with that," he said.

The bullish case is that the Fed will be raising rates only if the economy is growing at a healthy pace — which would mean that corporate earnings also would be growing, underpinning stocks.

Bearish investors argue that any rise in rates would clip stocks because share prices already are relatively high compared with underlying earnings.

Sam Stovall, chief investment strategist at Standard & Poor's in New York, said he still believed the S&P 500 index would reach 1,230 this year. That would be a 9% rise from Wednesday's closing level of 1,128.48.

"Even if it's less than that, it's certainly going to be better than what 'cash' accounts pay," Stovall said. With money market mutual fund yields at about 0.5% on average, even a 2-point rate increase by the Fed would leave cash-account returns at relatively low levels.

A wild card that could help stocks: A rebound in the dollar, which jumped Wednesday, could attract more foreign investors to U.S. shares, analysts said.

Market Roundup, C7-8