Stocks Sink as Oil Soars

Major U.S. stock indexes closed solidly lower Wednesday as investors grappled with crude oil topping $123 per barrel for the first time and a mixed bag of economic reports. The spike in oil prices was depressing transportation issues along with the broader market. It occurred even though the Energy Dept. said crude and oil inventories rose in the U.S. last week.

Finance and homebuilding stocks were taking a hit from news of a 1% drop in the National Assn. of Realtors March index of pending home re-sales. Finance stocks also were affected by reports the SEC is scrutinizing the liquidity of investment banks it supervises.

Investors also weighed earnings reports from Disney (DIS) and Cisco Systems (CSCO), and news that Qatar Airways is seeking compensation from Boeing (BA) for delays in shipment of 787 aircraft.

Yahoo (YHOO) shares were lower amid indications Microsoft (MSFT) chairman Bill Gates was closing the door on a further offer to acquire the Internet portal.

There was little reaction to a report that nonfarm productivity rose by a more than expected 1.9% in the first quarter.

Bonds rose as stocks fell. Gold fell as the dollar index rose.

On Wednesday, the Dow Jones industrial average dropped 206.48 points, or 1.59%, to finish at 12,814.35. The broader S&P 500 index fell 24.90 points, or 1.76%, to close at 1,392.57. The tech-heavy Nasdaq composite index shed 44.82 points, or 1.79%, to end the session at 2,438.49.

Along with the Street's oil-fueled inflation worries, Wednesday's sell-off in the stock market reflects profit taking following big gains from the Apr. 15 lows, says S&P MarketScope.

After a brief holiday, volatility returned to the market Wednesday, with losses accelerating in the final hour. The lack of any short covering by this late in the session indicates the bears are in firm control of the market, said S&P technical analyst Chris Burba in a note.

Ironically, the latest jump in oil prices has put stocks back under pressure and pulled [bond] yields down to session lows, despite the inflationary implications that continue to haunt the Fed, says Action Economics.

The combination of oil prices approaching $124 per barrel and hawkish remarks on May 6 by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, spurred renewed concerns among investors about the inflation risk and the likelihood that the Fed will have to raise interest rates to fight it, says Diane Dercher, chief economist at Waddell & Reed Financial in Overland Park, Kan.

I think the market is perhaps overreacting to that risk as far as what the central banks reaction to inflation will be in near term, she says. Fed Chairman Ben Bernanke said on Tuesday that he remains focused on the downside risk that the housing slump poses to the U.S. economy, which suggests hes not close to raising rates anytime soon.

If anything, rising energy prices are acting to depress economic growth, putting a strain on consumers purchasing power but not being passed through to wages and not feeding the inflation wage price spiral, she says. The U.S. imports more than half of the oil it consumes and those imports increased to a record 3.24% of gross domestic product in the first quarter of 2008, surpassing the prior peak of 3.22% of GDP set in 1980, Dercher says. With oil prices now over $120, she thinks that will continue to impose a drag on economic growth and doesnt see a risk of interest rates rising over the next six to 12 months.

On the economic front Tuesday, productivity in the nonfarm business sector rose 1.9% in the first quarter, above the consensus estimate of 1.6%, while unit labor costs were up 2.2%, slightly below the consensus estimate of 2.4%. Over the last four quarters [since these data are highly volatile quarterly], productivity is up 3.2% and unit labor costs a meager 0.2%.

While we believe that inflation will continue to remain elevated due to easy money, the Fed's hope that core inflation will remain constrained should keep the FOMC from raising rates while economic conditions remain weak, wrote Bear Stearns economist John Ryding in a note Wednesday..

The U.S. pending home sales index fell 1% to 83.0 in March, a new record low, compared to a revised 83.8 index in February [84.6 previously]. The index is down 21.7% year-over-year, vs. -18.1% in February. The pace of decline has picked up again after slowing into the new year, and continues to reflect hard times for housing, says Action Economics. Declines were registered in three of the four regions, with the Midwest off 10.4% on the month, with the West down 1.4%. The Northeast bucked the trend and rose 12.5%.

The Kansas City Fed's Hoenig said in a speech late Tuesday that the Fed must be ready to raise benchmark interest rates in a timely manner given the "troublesome" inflation outlook. "If inflation gets too high, the economy will suffer dramatically," a Reuters dispatch from Denver quoted Hoenig as saying. Hoenig strongly hinted that he would not support more cuts to the Fed's benchmark interest rates at a time higher inflation could be getting entrenched, given prospects for growth to pick up in the second half of 2008. "The current accommodative stance should be sufficient to cushion the economy from a deeper slowdown and the risks that financial disruptions could spill over to the broader economy," Hoenig said.

According to a Wall Street Journal report, Paulson said U.S. financial markets are emerging from the credit crunch that many economists believe has pushed the country to the brink of recession. "I do believe that the worst is likely to be behind us," Paulson told the newspaper in an interview. The Journal said Paulson's comments appear to be the Bush administration's most optimistic assessment yet about the financial turmoil that began last year with defaults on subprime home loans and spread through financial institutions that owned tens of billions of dollars in mortgage-backed securities. In the interview, however, the Treasury Secretary predicted there would be further "bumps along the road," and that it would take "some months longer" for the market distress to fully dissipate.

Fed Governor Randall Kroszner said rising mortgage foreclosures are an "urgent problem" and called on Congress to pass a Fannie Mae and Freddie Mac regulatory bill. Speaking at the NeighborWorks America Symposium in Cincinnati on Wednesday, Kroszner said foreclosures lead to a loss of one-fifth to one-half of an individual's loan, according to a Canadian Economic Press dispatch.

Oil futures soared to record levels Wednesday on a speculative binge even though a weekly Energy Dept. report showed crude stocks rose more than expected 5.7 million barrels, gasoline stocks rose 800,000 barrels and distillate stocks fell 100,000 barrels. June NYMEX crude last traded up $1.76 per barrel at $123.60, after ranging between $120.54 and a new record high of $123.80. Speculators continue to pour into the market following Goldman Sachs' forecast oil prices will rise to $150 to $200 a barrel within the next two years.

Among Wednesdays stocks in the news, Boeing shares were following a Dow Jones report that Qatar Airways, which has 60 Boeing 787 Dreamliners on order, is seeking compensation from the U.S. planemaker as delivery of the aircraft is delayed by 12 months and may order more Airbus A380 aircraft as part of its expansion plans, the airline's chief executive said. Dow Jones reports Qatar Airways joins other airlines including Air New Zealand, Air India, Japan's Nippon Airways and Japan Airlines seeking redress after Boeing announced in April a further six-month delay for its new 787 Dreamliner plane.

Microsoft Chairman Bill Gates said the company isn't pursuing other deals following the withdrawal of its $47.5 billion takeover bid for Yahoo, according to an AP report. He said in Tokyo that the company put "a lot of effort" in the talks with Yahoo and has decided the two should pursue "independent paths." Over the weekend, Microsoft withdrew its 3-month-old unsolicited bid for Yahoo after seeing the impasse with Yahoo's board over a mutually acceptable sales price.

Disney said Tuesday it earned $1.13 billion, or 58 cents per share, in the quarter ended March 29, compared with $931 million, or 44 cents per share, a year earlier. Revenue grew 10% to $8.71 billion. Analysts expected earnings of 51 cents per share on $8.47 billion in revenue, according to Thomson Financial.

Cisco's profit fell 5% in its fiscal third quarter but beat Wall Street's expectations. The company reported late Tuesday it earned $1.77 billion, or 29 cents per share, during the three months ended April 26. That represents a drop of 5.4 percent from the $1.87 billion, or 30 cents per share, that Cisco earned during the same period a year ago. Stripping out 9 cents per share in one-time charges for acquisition and employee stock-based compensation, Cisco earned 38 cents per share. That's 2 cents per share above the average estimate on the same basis from analysts polled by Thomson Financial.

Sprint Nextel (S) and Clearwire Corp. (CLWR), Google (GOOG), Comcast (CMCSA), Time Warner Cable (CSCO), and Bright House Networks collectively agreed to invest $3.2 billion in the new company.

European indexes were trading higher Wednesday. In London, the FTSE 100 index gained 0.75% to 6,261.80. In Paris, the CAC 40 index climbed 0.81% to 5,081.55. Germanys DAX index rose 1.01% to 7,087.82.

Asian markets finished mixed. Japans Nikkei 225 index advanced 0.38% to 14,102.48. In Hong Kong, the Hang Seng index slumped 2.48% to 25,610.21.

Treasury market

Treasuries recovered sharply from early losses to close higher, as investment capital flowed out of equities into the safe haven of bonds. The 10-year note rose 15/32 in price to 97-04/32 for a yield of 3.85%. The 30-year bond rallied 27/32 to 96-06/32 for a yield of 4.61%.