Fresh Fears for Wall Street

Stocks sank Tuesday on weak reports on home prices and consumer confidence. An FOMC warning that housing will drag on growth was the icing on the cake

by Ben Steverman

U.S. stocks took another beating Tuesday, with major market indexes each down over 2% on the session. Investors, seemingly ready to unload equities on any piece of bad news that comes their way, saw the release of weak home-price data, a decline in a closely watched gauge of consumers' mood, and a statement from the Federal Reserve that housing market woes may pose a continued drag on economic growth as a signal to sell. And sell some more.

On Tuesday, the Dow Jones industrial average tumbled 280.28 points, or 2.1%, to 13,041.85. The broader S&P 500 fell 34.43 points, or 2.35%, to 1,432.36. The tech-heavy Nasdaq composite index dropped 60.61 points, or 2.37%, to 2,500.64.

Market sentiment was broadly negative, with 29 issues declining in price for each 4 that posted gains on the NYSE. Nasdaq trading breadth was 24-6 negative. The CBoE volatility index, or VIX, widely regarded as a stock-market fear gauge, jumped nearly 16% Tuesday.

While stocks were solidly in the red for the entire session, the 2:00 pm EDT release of the Fed's minutes from its Aug. 7 policy meeting seemed to send investors into a deeper funk. Policymakers thought there would be a continued drag from the housing market on growth for some time, but doubted the dislocations in the credit market would hurt capital spending.

Like a stage magician that already has the name, address, and telephone number of a random audience member written on a piece of paper, the Fed seemed to be peering into the future in the Aug. 7 minutes: "[A] further deterioration in financial conditions could not be ruled out and, to the extent such a development could have an adverse effect on growth prospects, might require a policy response." That, of course, was the purpose of the Fed's half-point cut in the discount rate on Aug. 17.

The Fed minutes released Tuesday did not cover the Aug. 16 conference call or the subsequent statement on Aug. 17 when the central bank cut the discount rate. The Fed expected a return to "normal" markets after a time, though said they needed to watch the situation "carefully" as the credit market conditions could change rapidly. Fed officials remained unconvinced that the slowdown in inflation would last.

Lehman Brothers economist Drew Matus wrote in an note Tuesday that the Aug. 7 minutes show that the Fed was already concerned about the state of the asset-backed commercial paper and mortgage markets at the time of the meeting. Overall, says Matus, the report suggests the FOMC was concerned about financial market conditions even as it kept its inflation bias. "As such, the report may indicate a slightly higher bar for action than we had previously assumed as the concerns around inflation pressures are clearly widespread", Matus says. But he believes that bar has been reached and looks for the Fed to lower the Fed funds rate by 25 basis points at the Sept. 18 FOMC meeting.

The market has entered "hypersensitivity mode" regarding the Fed, according to Bill Larkin of Cabot Money Management, as investors wonder whether and how much the Fed plans to cut interest rates.

Traders will be watching carefully Friday when Fed Chairman Ben Bernanke gives a much-anticipated speech on housing and monetary policy.

The market was already on the defensive Tuesday before the release of the Fed minutes. Investors were discouraged by a report on consumer confidence, measured by the Conference Board index, which fell to 105.0 in August, from 111.9 in July.

The number matched many analysts' expectations exactly, and Action Economics says a drop in August confidence was to be expected given the recent news. However, "in this context the adjustment is modest and likely signals only limited downside risks" to consumer spending.

Also, data showed housing prices are continuing to fall. According to the U.S. S&P Case/Shiller index, home prices fell 3.9% in June to an index of 199.18.

In other economic news Tuesday, the U.S. ICSC UBS chain stores sales index rose 0.3% last week.