Goldman Moves, Oil Spike Sink Stocks

The firm's downgrades of the brokerage sector and GM helped spark a 3% fall in the Dow. Crude's surge to all-time highs added to the gloom

by David Bogoslaw

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Chalk up Thursday's bloodletting on Wall Street to a gloomy post-mortem on the previous day's Fed policy meeting. In the aftermath of the Fed's decision to hold rates steady and issue a warning on inflation, investors reassesed the condition of the economy and the prospects for the U.S. stocks. And they didn't like what they saw.

Equities were beaten to a pulp Thursday, with the plunger starting after Goldman Sachs (GS) downgraded a handful of high-profile stocks, including General Motors (GM) and Citigroup (C). Oil prices hitting fresh record highs and pessimism about the slowing economy were also damaging investor sentiment.

On Thursday, the Dow Jones industrial average fell 358.41 points, or 3.03%, to finish at a nearly two-year low of 11,453.42. The broader Standard & Poor's 500-stock index broke below the key technical support level of 1,300, closing 38.82 points, or 2.94%, lower at 1,283.15. The tech-heavy Nasdaq composite index dropped 79.89 points, or 3.33%, to end at 2,321.37.

On the New York Stock Exchange, 27 stocks traded lower for every five that were higher, while on the Nasdaq the ratio was 23-6 negative.

Oil prices spiked above $140 a barrel for the first time on Thursday thanks in part to a weaker dollar, which some market observers were blaming on the Federal Reserve's failure on Wednesday to send a strong enough signal that it's willing to raise rates to fight climbing inflation expectations. Others contend, however, that it's the bias toward tightening monetary policy and how that could further hamper economic growth that was helping to exacerbate the bearish sentiment.

Shares of General Motors dropped nearly 11% Thursday -- to their lowest level in 53 years -- after Goldman downgraded the stock to a sell from a neutral rating, citing the need for the automaker to raise capital as it shifts production toward more fuel-efficient vehicles.

Goldman also downgraded its opinion on the entire brokerage group to neutral from attractive, saying it sees no catalysts to send stocks higher over the next few months as economic conditions continue to deteriorate. That pushed shares of Citigroup and Merrill Lynch (MER) lower, too.

"The shrinkage of the financial system is a big deal because the only way out is to raise new capital, which dilutes existing shareholders," says Max Bublitz, chief strategist at SCM Advisors in San Francisco.

With even the most conservative firms having leverage of 10 to 15 times their assets, each writedown of portfolio value means that much less lending investment banks can do, he says. People are wondering who will provide the capital these firms need to stay in business and at what valuation levels they will be attractive to sovereign wealth funds, hedge funds and private equity firms, he adds.

"Both supply and demand for credit are going down at a time when the consumer is hunkering down," he says. "What kind of earnings are these firms going to have?"

A closer focus on that cycle is one reason for the deepening malaise in the market, says Bublitz. Another reason is that investors are starting to grasp the implications for the economy of a retrenchment by consumers, who are under a "full frontal attack" from deteriorating values for their homes and investment portfolios, and higher food and energy prices, he says.

"We might only be in the second inning of a consumer retrenchment and that could play out for a while," he predicts.

Phil Orlando, chief equity market strategist at Federated Investors in New York expects second-quarter earnings for the financial and consumer discretionary sectors to be substantially lower, but says the technology, consumer staple and energy sectors are in fairly good shape. That Goldman's downgrade should weigh so heavily on stocks didn't make sense to him, as he didn't hear anything in the investment bank's opinion that hasn't extensively discussed over the past nine months.