Double trouble
The Russell 2000 (NYSE: IWM) and the Dow Jones Industrial Average (INDU) stumbled hard for the second day in a row on fears that cheap credit has dried up. The small-cap index fell 13.65 points, or 1.72%, to 777.83. The Dow lost 208.10 points, or 1.54%, to 13,265.47.
The Russell 2000 fell four out of five days this week, dropping a cumulative 58.61 points to its lowest level since March 14.
Credit has been cheap for the past few years, fueling a boom in corporate takeover deals and helping cash-strapped families finance new home purchases.
But fears are mounting that the party is coming to an end.
The U.S. housing sector started to weaken in the second half of 2006, when stagnant prices led to increased delinquencies and foreclosures jumped as borrowers struggled to repay cheap loans.
The pain was first felt by the subprime financial sector, which serves individuals with poor credit histories, but it increasingly appears that there has been a sizeable ripple effect.
A major red flag was raised on June 22 when investment bank Bear, Stearns & Co. (NYSE: BSC) said that it had assumed billions in loans to its hedge fund in order to prevent creditors from seizing its assets. The funds, which had made their investments in debt backed by subprime mortgages, lost practically all their value.
That stung, as did the downgrading of billions of dollars of outstanding bonds, which credit rating agencies did in the following days. The U.S. Federal Reserve reacted, promising to take measures to tighten lending regulations. Government bonds suddenly became more attractive.
By Thursday, the cauldron was already boiling.
When the U.S. Census Bureau announced that new home sales defied more upbeat projections by falling 6.6%, down a breathtaking 22.3% on a year-over-year basis, and major home builders such as Beazer Homes USA Inc. (NYSE: BZH) reported heavy quarterly losses, investors stampeded for the exits.
That same day DaimlerChrysler AG (NYSE: DCX) announced it’s postponing its $12 billion debt offering. Also postponed is the proposed deal to have the German-American carmaker bought by private equity group Cerberus Capital Management.
For now, it appears that the flow of cheap money has been cut off, putting the brakes on the major corporate deals that have inflated stock prices.
And despite Treasury Secretary Henry Paulson’s attempts to calm the mood by insisting that the subprime meltdown is contained and not leaking into the broader economy, investors remain frightened.
Today, the bears took their fears to heart.
On a normal day, stocks probably would have posted gains.
That’s because the U.S. Commerce Department reported that the U.S. economy expanded at an annualized rate of 3.4% between April and June, above the projected rate of 3.2%, and more than the revised pipsqueak pace of 0.6% during the first three months of the year.
Core consumer prices increased at an annual pace of 1.4%, within the U.S. Federal Reserve’s preferred range of between 1% and 2%.
Additionally, the University of Michigan’s monthly index of consumer sentiment increased to 90.4 in July from June’s reading of 85.3, suggesting that the American consumer feels good about spending money.
