Stocks flipped and somersaulted Thursday as worries about capital constraints at Fannie Mae and Freddie Mac overshadowed a drop in jobless claims, merger activity and encouraging retail sales.
"Right now, on a short term basis, it’s painful," Sean Clark, investment chief of Clark Capital Management, said on CNBC. "Investor sentiment is pathetic right now," he added. "We're looking at levels of pessimism not seen in three decades."
Initial jobless claims fell by 58,000 last week, the largest decline since September 2005. Economists had expected a more modest 9,000-claim drop. The four-week moving average also fell. However, continuing claims jumped to 3.2 million, much more than expected.
Economists point to the fact that this is the time of year for auto-retooling shutdowns, which often skew the jobless numbers, and the surprise may have been a case of off-target seasonal adjustment.
"It would seem reasonable to expect a big rebound over the next week or two; the underlying trend in claims is upwards and today's number is noise, nothing more," Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote in a note to clients.
Financials opened firmly in the red, had a quick pop and then got hammered amid worries about the potential need for a bailout of government-backed mortgage lenders.
Fannie Mae and Freddie Mac plummetedamid concerns that the mortgage-finance firms may have to raise more capital to in order to survive.
Bush administration officials are meeting with regulators to try to develop a contingency plan in case the firms are unable to raise the money they need, according to a report in the Wall Street Journal.
Fanning the flames, former St. Louis Federal Reserve President William Poole said Fannie and Freddie were "insolvent'' and may need a U.S. government bailout, according to Bloomberg.
Offering fresh evidence of how bad things are in the housing market, RealtyTrac reported that U.S. home foreclosure filings jumped 53 percent in June from a year earlier, although they were down 3 percent from May, and are expected to rise further.
Amid the firestorm, a Freddie Mac spokeswoman shot back that the firm "absolutely" has enough capital.
Lehman Brothers , which has already been pummeled over concerns about the need for more capital, took a fresh beating that sent the stock down more than 12 percent. The culprit was likely dangerous rumors that firms don't want to do business with Lehman anymore.
The Lehman speculation was so rampant that Pimco and SAC Capital came out and said that they continues to trade with Lehman, despite rumors that they are among the firms cutting off trading with the brokerage, CNBC's Charlie Gasparino reported.
Wachovia took a hit after the regional bank said mortgage and legal problems will result in a $2.6 billion to $2.8 billion second-quarter loss, much larger than expected, and named a new CEO. Its shares dropped more than 9 percent.
Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson were on Capitol Hill, testifying before a House panel on the need for a safety net on Wall Street.
Bernanke said new laws may be neededto help better supervise big Wall Street firms and protect the economy from its turmoil.
Merrill Lynch and BlackRock are scheduled talks over Merrill’s possible sale of at least part of its 49 percent stake in the money management firm, sources familiar with the situation told CNBC, adding that the discussions are likely to continue through the end of the week.
The market was buzzing with deal news.
Dow Chemical announced plans to buy rival Rohm & Hoss for $18.8 billion. The deal represents a 74 percent premium on Rohm & Hoss's $44.83 market close Wednesday, sending shares up more than 60 percent . Dow shares fell 1.5 percent.
June retail-sales reports are trickling in and the results have been strong, helped by good weather and the tax rebates.
Wal-Mart said its same-store sales rose 5.8 percentand raised its second-quarter earnings forecast.
Hipper rival Target reported its same-store sales rose 0.4 percent, when analysts had expected a decline.
Wholesaler Costco reported better-than-expected same-store sales, rising by 9 percent in the five weeks to July 6 in the U.S., while internationally like-for-like sales were 11 percent up, boosted by the weak dollar.
The Bank of England kept its main interest rate steady at 5 percent, as widely expected, despite rising inflation.
As for U.S. rates, the Federal Reserve should raise its target to a "neutral" setting as quickly as reasonably possible to prevent high inflation taking root, Federal Reserve Bank of Kansas City President Thomas Hoenig said.
Asian stocks closed mixed, as credit concerns persisted, while European stocks fell because of uncertainties over the economy.
Still to Come:
THURSDAY: Monthly retail sales; Bernanke and Paulson go before House panel to discuss Wall Street safety net; Fed's Yellen speaks; Marriott earnings; Chevron interim report
FRIDAY: Import/export prices; international trade; consumer sentiment; Treasury budget; GE earnings; Apple's iPod 3G hits store shelves
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