Stocks Near Bear Market Territory

Anxiety lessened only slightly on Wall Street today following the Dow's dismal drop Thursday of nearly 360 points. Selling continued in major indexes as traders weighed whether the U.S. consumer can endure another round of record-setting energy cost increases.

Friday's declines were less pronounced thanks to a bit of good news on U.S. income and spending, which rose in May in part because of some $48 billion in government stimulus checks issued so far. Incomes rose 1.9 percent, the best since September 2005, while personal spending climbed 0.8 percent, a bit above forecasts.

Consumer spending remains solid despite heightened uncertainty about jobs, inflation, and the economy. The latest Reuters/University of Michigan's consumer confidence index fell to a 28-year low in June, led by worries about inflation. Rising food prices coupled with energy costs mean that inflation-adjusted income growth is now basically flat compared with a year ago. The question remains whether consumers' grumbling will translate into a deeper downturn in sales.

"There's still a lot of concern we could have a slowdown in the economy given all the headwinds against the consumer," says Michelle Meyer, an economist at Lehman Bros.

Still, the economy appears to be in less dire shape than many had feared. Revised gross domestic product data show the economy expanded by 1 percent in the first quarter.

But that seems to be little comfort to investors as the latest round of red floods their portfolios.

So are we in a bear market? It's close. At its Thursday close of 11,453, the Dow Jones industrial average was down 19 percent from its October threshold and as of late this morning was just 60 points away from being down 20 percent. That's the typical point at which most investors agree a bear market has begun. By now, though, the distinction is fairly arbitrary.

"To me a bear market is an extended period of time where it's hard to make money in stocks. I think this qualifies," says Ken Tower, chief market strategist with Covered Bridge Tactical.

More attention is being given to the S&P 500, which is heavy with bank stocks, to see if the index can hold on. The S&P is still testing March lows near the 1273 level. If that level is breached, the next leg is likely to be down, analysts say.

"If yesterday was a capitulation, where are the buyers today?" asks Peter Boockvar, equity strategist at Miller Tabak. "They're scared because we're breaking important levels. The path of least resistance is lower. This is not irrational behavior. It's what happens when you're in a major economic dislocation like we're in."

Thursday's brutal sell-off was largely a continuation of the same problems that have hampered stocks all year: falling home prices, soaring oil prices, and looming trouble in the banking sector.

Oil: Oil rose again today after topping $140 a barrel this week. It added another dollar per barrel at the opening on the New York Mercantile Exchange, reacting to threats Libya might cut production and to continued weakness in the dollar. Oil is up more than 45 percent so far this year, triggering higher costs for everything from jet fuel to gasoline.

Housing: This week two big builders, KB Home and Lennar, issued abysmal earnings reports, and the latest Case/Shiller 20-city home price index showed a 15.3 percent yearly decline.

Banks: It's downgrade season among the big investment houses. Analysts are scrambling to slash their outlooks on one another's firms. Today, Lehman Bros. said Merrill Lynch will suffer $5.4 billion in second-quarter writedowns from its exposure to insurers recently hit with credit downgrades. Goldman Sachs predicted writedowns and losses for Merrill and also advised clients to sell Citigroup.

The Federal Reserve isn't offering stocks any more help. Central bankers ended almost a year of rate cutting this week, leaving the federal funds rate at 2 percent. That removes another pillar of support for stocks, which benefit from lower borrowing costs. In its statement, the Fed hinted that it is shifting more of its attention back to fighting inflation, a hint that the next move in rates is likely to be a hike. Also, even if the Fed decides more cuts are warranted, stocks won't see much benefit. Any more rate cuts this year will signal that the already slow economy has gotten much worse.