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.