the sum of all fears

Sum of All Fears: Stocks Slump But Bond Woes Are the Real Concern

The stock market's recent winning streak came to a screeching halt Thursday, with the Dow falling 226 points, or 2.7% while the S&P and Nasdaq shed 3.3% and 3.2%, respectively.

While the market doesn't move in a logical fashion on a day-to-day basis, some of the fundamental reasons cited for the decline include:

1. More grim economic news, including record-setting jobless claims, record-low new home sales and lousy durable goods orders.

2. Renewed concerns about financials, which led the recent advance, after Oppenheimer's Meredith Whitney criticized the "bad bank" proposal and said she "remains cautious on the group".

3. More disappointing earnings and/or guidance, most notably from Qualcomm, Smith International, Royal Caribbean Cruise Lines, Citrix Systems and Textron. (Strong reports from 3M, AutoNation and Amazon.com post-close were notable exceptions.)

4. More mass layoff announcements, including from Eastman Kodak and Allstate.

5. And the most important... A disappointing 5-year Treasury note auction was a less obvious, but potentially more insidious, contributor to the market's malaise. The record $30 billion auction priced with a yield of 1.82% well above expectations and up from 1.54% at last month's five-year auction, Bloomberg reports.

Prices of Treasuries with maturities of two-years and longer fell sharply in reaction to the lackluster demand for the 5-year auction, which "may signal investors will have trouble absorbing the as-much-as $2.5 trillion in debt the U.S. is likely to issue this year to pay for a $1 trillion budget deficit and programs to spur the economy," Bloomberg says.

That sentence is notable for its understatement. If the government has to pay higher yields on debt sales, the various bailouts and stimulus packages will turn out to be even more expensive than currently contemplated. And don't be fooled into the "what's bad for bonds is good for stocks" mindset; a big reason the Fed stands ready to buy longer-term Treasuries is to help keep rates down, and their failure to be more specific about those plans also contributed to weakness in fixed-income.

Then there's the scenario where the U.S. government is forced to pay extremely high interest rates - or is simply unable to sell Treasuries - because foreign buyers go on strike. We're a long way from that "sum of all fears" outcome, but comments from Chinese Premier Wen Jiabao at Davos critical of U.S. economic policy suggest it's getting closer - especially in the wake of Tim Geithner's "manipulation" comment.

Posted Jan 29, 2009 04:58pm EST by Aaron Task