Stocks Fall On Service Sector Weakness

By MADLEN READ, AP Business Writer

NEW YORK – Stocks slumped for the second straight session Tuesday, after an unexpected contraction in the service sector rekindled investors’ worry that the economy is headed for recession.

The Dow Jones industrial average fell more than 250 points, while bond prices surged. The Institute for Supply Management’s January report on the service sector, which accounts for about two-thirds of the economy, came in well short of Wall Street’s forecast.

The index dropped to 44.6 last month from a revised reading of 54.4 in December. A reading below 50 indicates contraction; it was the first service-sector contraction in more than four and a half years.

Economists had been expecting another month of growth. It’s possible the service sector could bounce back in February, like the manufacturing sector did in January after its troubling contraction in December.

The benefit of the Federal Reserve’s two big interest rate cuts in the latter part of January could also help spur the service sector back into growth mode later this year.

Still, the data was particularly worrisome given last week’s Labor Department report, which showed that the U.S. economy lost jobs in January for the first time in more than four years.

Together, the two reports indicate that the ongoing credit crisis is dragging down the actual economy.

“The report drives a nail into the coffin from investors’ minds that we’re in a recession,” said Todd Salamone, director of trading at Schaeffer’s Investment Research.

“That doesn’t mean stock prices in the months ahead will be lower. But when you see headline numbers like this, there tends to be a reactionary sell,” Salamoneadded.

An announcement from Fitch Ratings that it plans to lower the rating on more than half of the $220 billion wrapped up in bond funds called collateralized debt obligations added to the host of concerns plaguing Wall Street.

Further downgrades would mean the securities – many of which are backed by mortgages – are worth even less than many investors thought. That could cause more problems for strugging banks, brokerages, and bond insurers.

In early afternoon trading, the Dow fell 256.14, or 2.03 percent, to 12,379.02, after falling 286 points in earlier trading.

The blue-chip index is more than 12 percent below its Oct. 9 record close of 14,164.53. Broader stock indicators also dropped sharply.

The Standard & Poor’s 500 index fell 28.43, or 2.06 percent, to 1,352.39, while the Nasdaq composite index fell 41.55, or 1.74 percent, to 2,341.30.

Bond prices jumped as investors sought the safety of government-backed debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, sank to 3.56 percent from 3.64 percent late Monday.

Over Monday and Tuesday’s trading, Dow has given up nearly half of the the gains it made last week, when it jumped 4.39 percent.

It’s not surprising that the market, which has been volatile for months now, would pull back as it has given last week’s huge gains. Many analysts claim stocks should be near their bottom given how low sentiment is right now.

According to JPMorgan equities analyst Thomas J. Lee, the three worst readings on record in the ISM’s service sector index are associated with stocks rising in the ensuing three months – on average, by 6 percent.

The biggest losers in the stock market were banks, which already suffered huge losses in their investment portfolios last year and are now socking billions of dollars away to prepare for debt-burdened consumers to stop making payments.

Dow component Citigroup Inc. fell $1.56, or 5.3 percent, to $27.66, while JPMorgan Chase & Co., another Dow component, fell $1.69, or 3.7 percent, to $44.53.

Washington Mutual Inc. fell 85 cents, or 4.4 percent, to $18.31; Bank of America Corp. fell $1.18, or 2.7 percent, to $42.85; and Wachovia Corp. fell $1, or 2.8 percent, to $34.53.

“When you have the financials in intensive care such as they are, for any economy like ours, they must heal,” said Quincy Krosby, chief investment strategist at the Hartford. “They drew us into this; they must lead us out.”

GMAC Financial Services said Tuesday it posted a loss during the fourth quarter as many homeowners failed to keep up with mortgage payments. GMAC, the former lending arm of General Motors, is now co-owned by GM and Cerberus Capital Management LLC.

Meanwhile, Wall Street’s enthusiasm over Microsoft Corp.’s bid for Yahoo Inc. – which had helped investors brush aside Friday’s wretched jobs data – started to dissipate.

Banc of America Securities lowered its rating on Yahoo to neutral from buy, saying the proposed acquisition could run up against regulatory challenges, according to Dow Jones. Yahoo fell 23 cents to $29.10. Microsoft fell 56 cents to $29.63.

Light, sweet crude oil declined $1.46 to $88.56 a barrel on the New York Mercantile Exchange, as traders bet that a slower economy would dampen energy demand.

An extended drop in energy prices could buoy businesses that are finding their supply costs are rising, but that their customers are having trouble taking on price increases. The dollar rose against other major currencies, while gold prices fell.

The Russell 2000 index of smaller companies fell 10.40, or 1.44 percent, to 713.06. Stocks overseas also retreated.

Japan’s Nikkei stock average fell 0.82 percent and Hong Kong’s Hang Seng index fell 0.89 percent. In afternoon trading, Britain’s FTSE 100 fell 2.63 percent, Germany’s DAX index fell 3.36 percent, and France’s CAC-40 fell 3.96 percent.

(Copyright 2008 by The Associated Press. All Rights Reserved.)