Stocks Tumble on Oil Spike, Economic Fears

With oil prices returning to record highs, investors are growing wary of possible rate hikes that would hurt economic growth

by David Bogoslaw

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U.S. equities took another beating on Wednesday as oil prices resumed their march toward record highs on supply concerns stoked by a larger than expected drop in crude inventories. Adding to the gloom on Wall Street were worries that the Fed's anti-inflation stance may further impede economic growth and signs of further economic weakening in the Fed's Beige Book report.

On Wednesday, the Dow Jones industrial average finished 205.99 points, or 1.68%, lower at 12,083.77. The blue-chip benchmark closed at its lowest level since mid-March. The broader Standard & Poor's 500-stock index ended down 22.95 points, or 1.69%, at 1,335.49. The tech-heavy Nasdaq composite index fell 54.93 points, or 2.24%, to 2,394.01.

On the New York Stock Exchange, 26 stocks dropped for every six that were traded higher, while on the Nasdaq the ratio was 22-7 negative.

Rumors of big writedowns from Goldman Sachs (GS), Lehman Brothers Holdings (LEH) and Royal Bank of Scotland (RBS) were driving financials lower and boosting short-term Treasury prices, S&P MarketScope said.

Merrill Lynch (MER) reportedly downgraded Lehman Brothers to neutral from a buy rating.

Meanwhile, the Financial Times reported that the bank nearly struck a deal with a group of Korean financial institutions as part of its latest $6 billion capital raising effort and may still reach a strategic arrangement by the end of the year.

The S&P Investment Banking & Brokerage index was down 4.1% Tuesday. Lehman shares tumbled 13.6% Tuesday, their fourth losing session in a row. Merrill shares fell 6.6%. Among other financial names suffering losses Tuesday, Washington Mutual (WM) dropped 9.3%.

On the M&A front, Corporate Express NV (CXP) agreed to be acquired by Staples (SPLS) for 9.25 euros per ordinary share. The enterprise value of Corporate Express on the basis of the offer is about EUR 3.1 billion.

The U.S. Mortgage Bankers Association reported that the Market Composite Index, which measures mortgage loan application volume, rose 10.9% in the week ended June 6. The Refinance Index increased 8.4% from the prior week, while the seasonally adjusted Purchase Index climbed 12.8% from one week earlier.

The Federal Reserve's Beige Book report showed economic activity either weaker or growing at a slower pace in late April and May in the majority of regions across the U.S. Consumer spending slowed since the last report as rising energy and food prices took a bigger chunk out of household incomes, while higher energy prices also seemed to be curbing domestic tourism. Manufacturing activity was generally soft in recent weeks, with weak demand for housing-related and some other products partly offset by higher demand for exports.

The U.S. Treasury budget gap widened sharply to a $165.9 billion deficit in May, above the median estimate of a $110 billion deficit.

The dollar index was down as talk of intervention faded and gold prices were climbing, while bonds were gaining strength with help from comments earlier this week by Jurgen Stark, a member of the European Central Bank's executive board, who told Bloomberg that although the ECB is intent on reining in inflation expectations, "we are not talking about a series of rate increases."

Fed Vice-Chairman Donald L. Kohn, speaking in Boston on Wednesday, said that rising inflation expectations would have "troublesome implications," and reiterated that anchoring expectations is "critical." Still, he noted that the inflationary impact of higher oil prices is less than it was 20 years ago, said Action Economics.