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GDP Data Help Spark Rate Fears, Sending Dow Down 235

Bond yields rise. Some analysts think the stock market is in the midst of an overdue correction.


NEW YORK — Fears that the Federal Reserve is soon to raise interest rates sent blue-chip stock indexes steeply lower Thursday, with the Dow Jones industrial average falling 235.23 points, or 2.2%--for its worst percentage drop since March 23.

Bond prices also fell Thursday, and the dollar suffered its worst decline against the Japanese yen in a month.

Some analysts think that the stock market is in the midst of an overdue correction that could bring the Dow, now at 10,466.93, down 10% to 15% from its May 13 peak of 11,107.2. A 10% pullback would bring the Dow to 9,996, and a 15% drop would leave it at 9,441.

Sparking the interest-rate fears, in part, was a U.S. Commerce Department report showing that the U.S. economy expanded at a 4.1% annualized rate in the first quarter. Although that was slower than the government's original prediction of a 4.5% annualized growth rate, it still means that the economy continues to expand far more quickly than the Fed's target rate of 3.0% to 3.5%.

Oddly, it was voracious consumer spending on imported goods that dampened the economic growth slightly by boosting the U.S. trade deficit. A trade deficit is subtracted from the gross domestic product to arrive at a final figure.

All but two of the 30 Dow industrials lost ground. The Standard & Poor's 500-stock index fell 23.35 points, or 1.8%, to 1,281.41.

Declining stocks outnumbered gainers by more than 2 to 1 on the New York Stock Exchange. Bank stocks were particularly hard-hit. Wells Fargo fell $2.13 to $39.25, Citigroup fell $1.25 to $63.44 and J.P. Morgan fell $3.75 to $135.13.

Cyclical stocks, which had been the stars of the market over the last few months, were heavily sold off. The Morgan Stanley cyclicals index, up 31% between late March and mid-May, dropped 2.5% on Thursday. Analysts said some cyclical issues had advanced so far so fast that there appeared to be little room left for them to rally, especially if the Fed tries to rein in economic growth.

Among the Dow cyclicals, AlliedSignal dropped $3.06 to $56.25, and Caterpillar fell $2.44 to $55.38.

Technology shares held up better, with the tech-heavy Nasdaq composite losing only 8.02 points, to 2,419.15. But the best-known Internet stocks continued their recent slump. fell $6.38 to $114.56, America Online dropped $4.69 to $115.63 and Yahoo fell $7.50 to $133.38.

"I think the market needs it [the correction]," said Charles J. Gradante, chief investment officer at Hennessee Group Hedge Fund Advisory in New York.

The key to whether the Fed will raise short-term interest rates at its next policy meeting, June 29, will lie in the next report on hourly wages, due June 8, Gradante said. If wages appear to be rising too fast, the central bank will probably raise short-term rates by 25 basis points, or one-quarter of a percentage point, he said.

The bond market, also experiencing nervousness about the Fed, had a bad day. The yield on the benchmark 30-year Treasury bond rose to 5.84%--near a one-year high--from 5.80% the day before.

The biggest impact of rate-hike fears was in securities with shorter maturities. Two-year Treasury notes fell sharply, sending yields to 5.42%, their highest level in more than nine months.

The stock market's malaise spread to international currency markets, where the dollar slumped against the Japanese yen. Computerized sell orders pulled the dollar as low as 119.62 yen on Thursday, from 122.38 the day before. By evening, the dollar had recovered to 120.38 yen, but that still marked a 1.8% drop, the biggest since Feb. 2.

The euro, the European common currency, was little changed at $1.042, although at one point during Thursday's trading it dropped to a record low of $1.0408. Traders believe European economic growth will be slower than that of the U.S., which would boost the dollar, as would higher U.S. interest rates.

Alan Skrainka, chief market analyst for Edward Jones in St. Louis, said the interest rate fears are overblown. The worst the Fed is likely to do is a "tap on the brakes"--a single rate cut of 25 basis points, rather than a series of cuts, Skrainka said.

He said there is enough worry in the market about the central bank, however, that some investors have moved into defensive stocks such as utilities, accounting in part for the weakness of the cyclicals, which had been rallying lately.

A more profound "rotation" from high-priced large-capitalization stocks into cheaper mid-cap issues remains underway and will be a continuing theme perhaps years into the future, said Charles F. Henderson, chief investment officer at Chicago Trust Co. This broadening of the market away from the handful of blue-chip names that outperformed everything else over the last year is a healthy sign, Henderson said. The same would be true of a 10% to 12% correction in the major indexes, which would help let some of the air out of the overvalued part of the market, he said.

Market Roundup, C8

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