Stocks drop on service sector weakness

By MADLEN READ, AP, Feb. 5, 2008

NEW YORK - Stocks pulled back sharply for the second straight session Tuesday, after an unexpected contraction in the service sector rekindled investors' worry that the economy is headed for recession. The Dow Jones industrial average fell more than 200 points, while bond prices surged.

The Institute for Supply Management's January report on the service sector, which accounts for about two-thirds of the economy, came in well short of Wall Street's forecast. The index dropped to 44.6 last month from a revised reading of 54.4 in December.

A reading below 50 indicates contraction; it was the first service-sector contraction in more than four and a half years. Analysts had been expecting another month of growth.

It's possible the service sector could bounce back in February, like the manufacturing sector did in January after its troubling contraction in December. The benefit of the Federal Reserve's two big interest-rate cuts in the latter part of January could also help spur the service sector back into growth mode later this year.

Still, the data was especially worrisome given last week's Labor Department report, which showed a net jobs loss in the U.S. economy in January — the first in more than four years. Together, the two reports indicate that the ongoing credit crisis is dragging down the actual economy.

"The report drives a nail into the coffin from investors' minds that we're in a recession," said Todd Salamone, director of trading at Schaeffer's Investment Research. "That doesn't mean stock prices in the months ahead will be lower. But when you see headline numbers like this, there tends to be a reactionary sell."

In mid-morning trading, the Dow fell 223.79, or 1.77 percent, to 12,411.37.

Broader stock indicators also dropped sharply. The Standard & Poor's 500 index fell 25.39, or 1.84 percent, to 1,355.43, while the Nasdaq composite index fell 33.07, or 1.39 percent, to 2,349.78.

Bond prices jumped as investors sought the safety of government-backed debt. The yield on the benchmark 10-year Treasury note, which moves opposite its price, sank to 3.53 percent from 3.64 percent late Monday.

The biggest losers in the stock market were banks, which already suffered huge losses in their investment portfolios last year and are now socking billions of dollars away to prepare for debt-burdened consumers to stop making payments.

Citigroup Inc. fell 98 cents, or 3.4 percent, to $28.24; Washington Mutual Inc. fell $1.30, or 6.8 percent, to $17.86; Bank of America Corp. fell 93 cents, or 2.1 percent, to $43.10; and Wachovia Corp. fell $1.50, or 4.2 percent, to $34.03.

"When you have the financials in intensive care such as they are, for any economy like ours, they must heal," said Quincy Krosby, chief investment strategist at the Hartford. "They drew us into this; they must lead us out."

Meanwhile, Wall Street's enthusiasm over Microsoft Corp.'s bid for Yahoo Inc. — which had helped investors brush aside Friday's wretched jobs data — started to dissipate. Banc of America Securities lowered its rating on Yahoo to neutral from buy, saying the proposed acquisition could run up against regulatory challenges, according to Dow Jones. The bank said regulatory difficulties could be steepest in the European Union.

Yahoo slipped 13 cents to $29.20. Microsoft fell 49 cents to $29.70.

Light, sweet crude oil was down $1.61 at $88.40 a barrel on the New York Mercantile Exchange, as traders bet that a slower economy could dampen energy demand. An extended drop in energy prices could buoy businesses that are finding their supply costs are rising, but that their customers are having trouble taking on price increases.

The dollar rose against most other major currencies, while gold prices fell.

The Russell 2000 index of smaller companies fell 8.63, or 1.19 percent, to 714.83.

Stocks also retreated overseas. Japan's Nikkei stock average closed down 0.82 percent and Hong Kong's Hang Seng index fell 0.89 percent. In afternoon trading, Britain's FTSE 100 fell 1.84 percent, Germany's DAX index fell 2.54 percent, and France's CAC-40 fell 2.72 percent.