Stocks skid on rate fears, weak home sales

Stocks had their worst day in two months Thursday as a troubled bond market and weak housing report contributed to a triple-digit drop in the Dow Jones industrial average.

The yield on the 10-year U.S. Treasury note -- a benchmark for mortgage rates -- jumped sharply as investors seemed to abandon hope that the Federal Reserve will cut interest rates significantly this year.

“The bad news in the bond market hurt the stock market in a number of ways,” said Brian Wesbury, chief economist at First Trust Advisors in Lisle, Ill. “It increased fears that inflation is not dead and that the Fed will continue to hike” interest rates.

A day after closing at a record high, the Dow skidded 119.21 points, or 0.9%, to 12,502.56, its worst showing since Nov. 27.

The Nasdaq composite index slumped 32.04 points, or 1.3%, to 2,434.24. The Standard & Poor’s 500-stock index eased 16.23 points, or 1.1%, to 1,423.90.

Losers outnumbered winners by more than 3 to 1 on the New York Stock Exchange.

The seesaw action suggests that the stock market is throttling back from last year’s strong performance, said Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, N.Y.

“It’ll be a good year, not a great year [for stocks], and this is what happens,” Johnson said. “You have very good days and very bad days, and this was one of those bad days.”

Meanwhile, with the economy continuing to grow solidly, bond investors are coming to the grudging belief that the Fed will stand pat on interest rates. The Fed’s Open Market Committee, which meets next week, has left its benchmark overnight lending rate unchanged at 5.25% at its last four meetings.

Bill Hornbarger, a fixed-income strategist at A.G. Edwards, predicted that the Fed could cut rates late in the year if the economy slows in the second half.

But “it’s not going to be three or four interest rate cuts like everybody thought,” Hornbarger said.

Bond prices, which move in the opposite direction from yields, were also hurt by lackluster demand in an auction of five-year Treasury notes, which sold at a yield of 4.86%.

The yield on the two-year Treasury note, which is sensitive to investors’ perceptions of the Fed’s plans for its overnight rate, jumped to 4.97%, up from 4.93% on Wednesday and the highest since mid-August.

The two-year T-note was yielding 4.51% as recently as early December.

The bond market sell-off spilled into stocks as investors fretted that higher interest rates could dent corporate earnings and hold back consumer spending.

Stocks also were hit by fresh weakness in the housing market. The National Assn. of Realtors said that after rising for two months, sales of previously owned homes fell 0.8% in December, a greater drop than expected.

For all of 2006, sales slipped 8.4%, the steepest plunge in 17 years.

Experts were divided over the housing report, with some saying there were signs of an emerging turnaround. The number of homes on the market, for example, eased for a second straight month.

It would currently take 6.8 months to sell the entire inventory of homes on the market, a high level. But that figure has hovered around 7.3 to 7.4 for at least the last five months, Goldman Sachs told clients in a research note.

“I don’t think it’s going to recover a lot this year, but it clearly has bottomed,” said Jim Paulsen, chief investment strategist of Wells Capital Management.

Among the bits of good news for the stock market, technology giants EBay and Nokia rose after their upbeat earnings reports. EBay leaped $2.45, or 8.2%, to $32.45, and Nokia climbed 90 cents, or 4.5%, to $21.11

In other market highlights:

* Stocks of home building companies were down sharply after the housing sales report. Toll Bros. fell $1.47 to $32.72. Lennar slid $1.74, to $51.89 and KB Home dropped $1.69, to $52.12.

* Energy stocks sank on lower oil prices. Crude oil futures fell $1.14 to $54.23 a barrel on the New York Mercantile Exchange. Chevron dropped $1.32, to $71.52 and Exxon Mobil declined $1.38, to $73.52.

* Meruelo Maddux Properties shares rose 60 cents to $10.60 on their first trading day. The Los Angeles-based real estate management company sold 40 million shares at $10 each Wednesday, below the range of $12 to $14 it had hoped for.

* San Marino-based East West Bancorp jumped $1.61 to $38.27 on earnings news.

* Brokerage stocks were hammered as the market slumped. Goldman Sachs tumbled $7.03 to $213.07, Merrill Lynch lost $2.31 to $95.22 and Lehman Bros. dropped $3.04 to $80.96.

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Times staff writer Tom Petruno contributed to this report.