Stocks Slide as Fed Boosts Key Rate

Wall Street ended the second quarter on a down note Thursday, as the Federal Reserve signaled that short-term interest rates would continue to rise.

But most major market indexes still posted gains in the quarter, in the face of worries about the economy, high oil prices and rumors of financial trouble among hedge funds.

The Dow Jones industrial average finished the quarter by sliding 99.51 points, or 1%, to 10,274.97, as some investors showed disappointment over the Fed’s stay-the-course message on rates.

The broader market was lower as well for the day, but the losses were relatively modest. The technology-dominated Nasdaq composite fell 11.93 points, or 0.6%, to 2,056.96; the Standard & Poor’s 500 dipped 8.52 points, or 0.7%, to 1,191.33.

For the three months, the Dow lost 2.2%. But as in 2004, the blue-chip index in recent months hasn’t been a good proxy for the rest of the U.S. market, and definitely not for the rest of the world.

The Nasdaq index rallied 2.9% in the quarter and the S&P; 500 added 0.9%. The Russell 2,000 index of smaller shares jumped 4%. And gains in foreign markets tended to be even greater, leaving most solidly in the black year to date in their local currencies, if not in dollar terms.

Wall Street, by contrast, still is in the red this year, with the Dow off 4.7%, Nasdaq down 5.5% and the S&P; 500 down 1.7%.

Market bulls saw the second quarter as a start toward lessening what they believe had been an unwarranted reluctance to buy stocks.

“I think the path of least resistance for the equity market is up,” said Al Kugel, senior investment strategist at Stein Roe Investment Counsel in Chicago.

Like many bulls, his optimism is rooted in faith that the economy will continue to expand, lifting corporate earnings as well. The Fed, by continuing to slowly tighten credit, is showing that it isn’t worried about snuffing out the expansion, Kugel said.

James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, said he expected that the economy grew at a real annualized rate of 3.5% to 4% in the second quarter, on par with the government’s 3.8% estimate for the first quarter.

The fear of a so-called soft patch in the economy “has been revised away,” Paulsen said.

Others aren’t so sure. Pessimists say the market can’t get traction because investors believe there is increasing risk to the economy and to stock prices, owing to rising short-term interest rates, near-record oil prices, the threat of a housing bubble and other concerns.

As for corporate earnings, “The biggest part of the recovery is behind us,” said a cautious Tom McManus, chief investment strategist at Banc of America Securities in New York.

Indeed, operating earnings for the S&P; 500 companies are projected to rise 6.9% in the second quarter from a year earlier, based on analysts’ estimates compiled by Thomson First Call. That would be half the first-quarter growth rate and down sharply from nearly 20% growth in the fourth quarter of last year.

Still, the market had been rallying in May and June despite modest near-term earnings growth expectations. By June 17, the S&P; 500 index was within 1% of the 3 1/2 -year high it had set March 7.

The rally was halted last week by another surge in oil prices. But since hitting a record $60.54 a barrel Monday, near-term oil futures in New York have fallen for three straight sessions, ending Thursday at $56.50, down 76 cents for the day.

A renewed slide in long-term interest rates also helped buoy stock prices for much of the second quarter, even though some analysts said the bond market was signaling economic weakness. The 10-year Treasury note yield ended Thursday at 3.91%, down from 3.98% on Wednesday and 4.48% on March 31.

Declining long-term rates helped to make home builders the best-performing stock sector in the S&P; 500 for the quarter, with an average 21.2% gain. Real estate investment trust shares also soared.

Not surprisingly, energy stocks also were strong as oil prices rose.

On the downside, economy jitters triggered selling of many industrial issues, weighing on big-stock indexes like the Dow. Steel stocks suffered the worst sector loss in the S&P; 500, down 23% in the quarter.

Although many factors could affect stocks’ prospects in the second half, many analysts say the Fed still holds the key: Any hint by the central bank that it is nearly done tightening credit is expected to spark a powerful rally -- provided it isn’t accompanied by recession fears.

But investors can’t be sure whether they can count on that hint from the Fed this year, or face a longer wait.

*

(BEGIN TEXT OF INFOBOX)

Mixed market

Most major U.S. stock indexes rose in the second quarter, but many still are in the red year to date.

*--* Index 2nd qtr. YTD Bloomberg REITs +13.3% +3.9% Dow utilities +7.9 +15.4 S&P; midcap +4.0 +3.3 Russell 2,000 +4.0 -1.8 NYSE energy +3.2 +16.3 Nasdaq composite +2.9 -5.5 S&P; 500 +0.9 -1.7 NYSE composite +0.7 -0.5 Dow industrials -2.2 -4.7 Dow transports -6.1 -8.2

*--*

Note: returns don’t include dividends.

Source: Bloomberg News