Uncertainty Reigns on Wall Street

The Dow lost another 208 points, as some key economic data did little to relieve investors' fears after Thursday's plunge

by Ben Steverman

The selling mood prevailed on Wall Street Friday, leaving the Dow Jones industrial average with a two-day loss of more than 500 points. The steep drop was sparked by continuing worries about the health of the mortgage and corporate lending business and weakness in the housing market.

On Friday, the Dow Jones industrial average was off 208.1 points, or 1.54%, to 13,265.47 -- after Thursday's 311.5 point (2.26%) slide. Just last week, on July 19, the Dow closed a fraction above 14,000 for the first time.

The broader S&P 500 fell 23.71 points, or 1.6%, to 1,458.95 -- after Thursday's 2.33% drop. And the tech-heavy Nasdaq Composite was off 37.1 points, or 1.43%, to 2,562.24.

Though bad housing numbers Wednesday and Thursday also alarmed investors, most were blaming the big two-day sell-off on the threat of a credit crunch. Worries about defaults on subprime mortgages spread through wider debt markets, threatening leveraged buyout deals. The high-yield spread - the extra interest borrowers must pay on riskier investments - grew 11% on Thursday and is up 56% from mid-June.

The biggest problem for markets going forward may be uncertainty. If the market got a better handle on the possible impact of subprime and other debt issues, it could "move onto other things," says Douglas Peta, market strategist at J. & W. Seligman. So far the market has no way to quantify how bad things might get. "Until it does that, I think there will be uncertainty and fear," Peta says.

That uncertainty is one reason for the recent extreme volatility on Wall Street. Thursday's declines wiped out the market's big run-up in July. The S&P 500 is now off almost 9% from record highs last week; it's now up just 2.8% for the year.

"The stock market's fear of a credit crunch may be a worse risk for the economy than the credit crunch itself," according to Ed Yardeni, president and chief investment strategist at Yardeni Research. While acknowledging the potential for "much fewer private equity deals," Yardeni wrote in a note Friday that the "greatest global boom of all times" should eventually prop up the market, as earnings and corporate cash flows stay healthy.

On Friday, there was new economic data, a few M&A deals, and more earnings reports, but little to reassure investors obsessing over debt and housing issues.

In the second quarter, the U.S. gross domestic product grew at a 3.4% pace, according to an advance number released Friday morning. The number is slightly above expectations, but the GDP figure is often drastically revised later. First-quarter GDP growth was revised to 0.6%, from 0.7% previously. In the second quarter, residential construction was off 9.3%, nonresidential construction was up 8.1%, and government spending rose 4.2%.

A close look at the GDP data shows "underlying growth was better than what we expected," Bob Ried, president of Ried Thunberg, says. But most traders are looking ahead to the second half of the year, not back. "The question now is: Is the housing sector snowballing down further?" he says.

One puzzling aspect of the turmoil on credit and stock markets is that it's not reflected in economic fundamentals or most corporate profits outside the housing sector. More than a third of the S&P 500 report earnings this week. According to Reuters Estimates, second quarter earnings are expected to come in about 3% ahead of analysts' estimates, which is typical.

Many believe market troubles could prompt the Federal Reserve to cut interest rates. But Ried thinks that's unlikely. The Fed would need to see evidence that market volatility is having an effect on the broader economy, he says. The markets are imagining awful credit crunch fall-out scenarios for which, so far, there's little evidence.

In other economic news Friday, the Reuters/University of Michigan consumer sentiment survey reported a final reading for June of 90.4, down from the survey's preliminary number but above June's index score of 85.3.

After pushing briefly above $77 a barrel on Thursday amid speculation about crude oil shortages, oil prices rose close to that level on Friday. September NYMEX crude oil futures spiked $2 to $76.95 per barrel.