Stocks Drop as Economic Fears Worsen

The biggest drop in nonfarm payrolls in five years fanned recession fears and raised expectations of a large Fed rate cut

by David Bogoslaw

A brutal week for the battered U.S. stock markets ended grimly, as investors began to come to grips with the growing likelihood of an economic recession. As of Friday's close, major U.S. equity indexes have lost more than 16% of their value since their peaks in mid-October.

Selling in the equities market intensified Friday afternoon, before a modest recovery into the market close as investors digested weaker than expected employment figures for February that compounded worries about the state of the credit markets and confirmed investors’ worst fears about the U.S. economy. New record high oil prices suggest growing inflation risks, but Fed fund futures are projecting a 75-basis-point rate cut by the Federal Reserve in March to try to contain the economic downturn.

On Friday, the Dow Jones industrial average closed 146.70 points, or 1.22%, lower at 11,893.69. The broader S&P 500 index fell 10.97 points, or 0.84%, to 1,293.37. The tech-heavy Nasdaq composite index shed 8.01 points, or 0.36%, to finish at 2,212.49.

The financial stocks gave back early gains as members of Congress grilled top executives such as Countrywide's Angelo Mozilo on executive compensation, S&P MarketScope said. On the New York Stock Exchange, 21 stocks were down for every 9 that traded higher, while the ratio on the Nasdaq was 18 to 9 negative amid moderate trading volume.

Capping a week of discouraging economic reports, February nonfarm payrolls dropped 63,000, more than double the 30,000 decline that economists had expected on average and the largest decline in five years. January's drop was revised lower to 22,000 from 17,000, while December's growth in payrolls was halved to 41,000 from 82,000.

"One of the big surprises in the report was the unemployment rate moderating to 4.8% (median 5.0%) from 4.9%," said Action Economics. "The moderation, however, masked underlying weakness in the household survey, as this survey's employment measure fell 255,000, but was overwhelmed by a hefty 450,000 drop in the workforce."

The numbers put new pressure on the Federal Reserve to cut rates by 50 to 75 basis points at the March 18 policy meeting even though the Fed expanded its Term Auction Facility to ease the liquidity crisis in the credit markets, S&P MarketScope said.

"The jobs picture dimming could potentially force homeowners to sell their homes," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "This is a liquidity situation. There’s no bid for anything. Anything that forces people to sell is just making things worse, whether for a bank or for an individual."

Even as the market eagerly awaits another hefty rate cut, conflicting signals from various Federal Reserve officials was causing more uncertainty. Fed vice-chairman Donald L. Kohn continues to favor rate cuts but suggested that a bigger-than-expected inflation risk from oil and other commodity price spikes could curb the Fed's wilingness to ease monetary policy.

San Francisco Fed president Janet Yellen indicated she was worried more about inflation in the near-term than over the longer term. But Dallas Fed president Richard Fisher told the market not to continue to expect rate cuts, saying the Fed needs to be careful to take a steady, measured approach to new economic events.

The Fed's announced that it was increasing the Term Auction Facility to $100 billion from $60 billion in March, with the first auction being a $50 billion auction on March 10, followed by a second $50 billion auction on March 24. That extra capital is intended to give the banks more confidence to continue making loans without fear that their funding lines will dry up.

Despite Fed Chairman Ben Bernanke's claim to the contrary, it wasn't a coincidence that the TAF injection was announced around the same time as the grim February payroll report came out, says Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, N.J.

"Their vehicles of choice is the term auction facility to try to prevent an intermeeting rate cut," he said. "