Stocks Plunge, Dow Drops Nearly 200 Points on Interest Rate Spike

Stocks closed sharply lower as rising bond yields signaled a tougher global credit environment.

"It was a pretty ugly day," said Tom Schrader, managing director of U.S. listed trading at Stifel Nicolaus. "The market needed a washout, and we got one. It was caused by higher rates, which is not good for the carry trade, LBOs and M&A. Those factors had been supporting the market."

The Dow Jones Industrial Average closed lower by nearly 200 points, while the S&P 500 and the Nasdaq Composite each fell more than 1%. It was the third straight down day for the major markets, which have declined approximately 2.9% in the last four days.

Bonds sold off sharply and the yield on the benchmark rose above the psychologically significant 5% level, effectively erasing investors' hopes for an interest rate easing from the Federal Reserve. It was the biggest one-day move in the 10-year Treasurys since March 2005.

"People are rethinking what the interest rate outlook will be and I think that's what's weighing on the market," said Kevin Cronin, head of investments at Putnam Investments. "People have grown accustomed to extremely low rates."

Thursday's jump in bond rates also heightened concerns regarding corporate earnings.

"With rates getting higher, it's going to be very, very difficult for (price-to-earnings ratios) to expand further, which means you're going to be totally relying on earnings," said Dan Genter, chief investment officer at RNC Genter Capital Management.

Thursday's selloff was extremely broad-based with decliners outpacing gainers by a staggering 10-to-1 margin on the NYSE. Every S&P 500 sector closed with losses of 1.2% or worse. The interest-rate sensitive utilities sector fell a whopping 3%, leading stocks to the downside.

The influential financial sector tacked on further losses as declines in brokers such as E*Trade Financial helped weigh on the major indexes.

"We've all been looking and screaming for a correction," said Stephen Porpora, managing floor broker with William O'Neil. "Is this the 5% correction? It's too early to tell, but the prudent investor certainly right now is looking at his portfolio and maybe nailing down a couple of profits."

Bond strategist Bill Gross of Pacific Investment Management raised his forecast on the 10-year Treasury, taking a bearish slant on the fixed income market for the first time in 25 years.

"Several high profile Wall Street strategists threw in the towel on their Fed rate cut scenario," said Fritz Meyer, senior investment officer at AIM Investments. "I think the consensus opinion has been shifting gradually and increasingly in the last few days toward the notion that 'Maybe the Fed is stuck here, but maybe the Fed is getting prepared to raise rates.' I think that has spooked the market."

Bond traders reacted to a surprise rate hike from the Reserve Bank of New Zealand, which raised interest rates a quarter percentage point to a record 8% to contain inflation.

"If you are a bond investor, you can now get an interest payment that's about 10% greater than it was just three months ago," said David Dietze, chief investment strategist at Point View Financial Services. "Meanwhile, looking at the stock market, I have to pay 15% more for the same merchandise I could have gotten three months ago. It's certainly in the cards here for a reallocation."

Shares of Dow component Proctor & Gamble fell after the stock was downgraded to "equal weight" from "overweight" at Lehman Brothers, which said it will be tough for the consumer products giant to deliver above-average returns.

Apple Computer was one of Thursday's lone bright spots, hitting an all-time high after Piper Jaffray raised its 12-month price target on the stock to $160. Apple, which is set to release the iPhone on June 29, is forecasted by Piper Jaffray to sell 45 million iPhones in 2009.

On the retail front, May chain stores sales results got off to a positive start with Costco topping analysts' expectations with a 7% rise in sales at stores open at least a year. That's higher than the 5.6% rise analysts surveyed by Thomson Financial predicted.

However, Wal-Mart Stores narrowly missed Wall Street expectations, citing weakness in its apparel and home merchandise business. The world's largest retailer said May same-store sales rose 1.3% in May, just below the 1.4% increase expected by analysts polled by Thomson Financial. Wal-Mart also issued a cautious June sales forecast.

Macy's said same-store sales were down 3.3% in May, lower than the company's guidance for sales to be between flat and down 2%.

Applications for unemployment benefits dipped for a second straight week, indicating the labor market remains healthy despite a yearlong slowdown in economic growth. The Labor Department said jobless claims fell by 1,000 to 309,000 last week.

In the energy market, New York light sweet crude futures rose to trade around $67 a barrel after traders became concerned about a decline in U.S. refinery activity last week.

European Stocks Close Lower

European stocks closed lower as interest rate concerns weighed on those markets as well.

The London FTSE-100, the Paris CAC-40 and Frankfurt DAX all finished lower.

The Bank of England left its core interest rate on hold at 5.5%, as widely expected by economists.

In corporate news, Vodafone came under pressure to present plans for its restructuring options from activist shareholders of the mobile network operator. ECS Assets PCC sent a letter to Vodafone outlining proposals it would present at the company’s shareholder meeting next month, including giving investors shares reflecting the company’s 45% stake in Verizon wireless.

Meanwhile, a fall in first-quarter net profit for Ahold didn't keep investors from lifting the shares, as the Dutch retailer said it was on track for a recovery.

Asian Markets Mixed

Asian stocks were mixed in the afternoon session Thursday. Japan finished just a hair higher after trading mostly in negative territory this session while South Korea set its eighth consecutive record close.

Tokyo's Nikkei 225 Average closed slightly higher as investors bought Komatsu and other machinery stocks ahead of machinery orders data on Friday, while Softbank gained as industry data showed it added the most users in May. But Sony ended down after its game unit said it plans to cut jobs in the United States. Fujitsu slid after the computer maker said it had found fictitious transactions at a subsidiary.

South Korea's Kospi Index hit an eighth record close in a row, with brokerages such as
Daewoo Securities up as the market's rally is expected to carry on after data continues to show an improving domestic economy. Exporters such as Hyundai Motor also extended recent gains after the won currency weakened amid speculation foreign investors were unwinding yen carry trades.

Australia's S&P/ASX 200 Index finished lower as worries about higher interest rates at home and overseas hit rate-sensitive banking stocks, while further weakness in metal prices weighed down on mining firms. Dealers said market sentiment was dampened by steep falls in U.S. stocks on rate concerns and by strong Australian jobs data that fuelled speculation of a hike in interest rates at home in coming months

In markets still trading, Chinese stocks were over 3% higher as institutions, their confidence returning after the market's plunge early this week, bought banking, coal and construction-related shares. However, many retail investors who were burned by the tumble continued to
sell into strength, and shrinking turnover at the market's highs suggested an extended rise was not beginning, traders said.

Hong Kong stocks were lower tracking declining global equities, with the latest U.S. economic data fanning interest rate worries, prompting investors to sell rate-sensitive property stocks. But the market capped its losses, thanks to the mainland's stabilizing yuan-denominated A-share market, while blue-chip oil producer CNOOC resumed its ascent following recent broker upgrades.