Signs of rally snuffed out as Dow drops

Stocks lose earlier gains as economic outlook worsens

Seeking to reassure investors, Fed chairman Ben S. Bernanke said the financial rescue plan that has taken shape over the past few days will need time to work. (Mark Lennihan/Associated Press)

The battered Dow Jones industrial average yesterday suffered its second-largest one-day point drop to date, giving up the lion's share of the gains from its 936-point rally on Monday amid fresh signs of weakening in the New England and national economies.

The Dow resumed its October nosedive, tumbling 733.08 points, or 7.87 percent, to 8,577.91 after a dismal report on national retail sales. The market rout raised concerns that Monday's historic gain may have been a "dead-cat bounce," a rally with no life, and stocks are heading lower.

Yesterday morning's Commerce Department report showed the biggest falloff in retail sales in years , down 1.2 percent. It was followed by the release of the Federal Reserve's Beige Book, which confirmed that steps to unclog credit markets haven't halted a slide in the broader economy.

In New England, "the pace of activity softened in the third quarter, and in some cases deteriorated sharply in September," the Fed's report said, citing the housing slump and revenue declines in the retail, manufacturing, and business services sectors. Of particular concern was a finding that tight credit had frozen nonresidential construction and scaled back other investments in the region.

"We're in a swamp of uncertainty," said James T. Swanson, chief investment strategist for Boston mutual funds company MFS Investment Management. "There's still some rough patches to go."

The giant Dow loss was second only to its 777.68-point plunge on Sept. 29, the day the House of Representatives rebuffed President Bush's first bailout plan. Other indexes lurched even lower yesterday. The tech-heavy Nasdaq exchange retreated 150.68 points, or 8.47 percent, to 1,628.33, while the Standard & Poor's 500 gave up 90.17 points, or 9.03 percent, finishing the session at 907.84.

Seeking to reassure investors, Federal Reserve chairman Ben S. Bernanke told the Economic Club of New York yesterday the financial rescue plan that has taken shape over the past few days, including the injection of $250 billion into US banks, will need time to work. Even when credit begins flowing again, "broader economic recovery will not happen right away," Bernanke acknowledged.

Last month's retail pullback underscored dimmer prospects for staples ranging from consumer electronics to home furnishings. The Beige Book, meanwhile, pointed to weaknesses in every one of the dozen Federal Reserve districts across the United States. Oil prices also skidded on recession fears yesterday, with crude oil trading below $75 per barrel, its lowest level since August 2007.

Some investment professionals pointed to signs the stock market may be bottoming out, while others said it could fall further.

"I don't know where the exact bottom is, but I'm seeing a lot of bargains out there," said John Dorfman, portfolio manager for Dorfman Value Fund and chairman of Boston money management firm Thunderstorm Capital LLC. "A lot of small and mid-cap stocks are selling for below book value," a measures of corporate net worth equivalent to a company's assets minus its liabilities per share.

Dorfman said revised figures will likely show the US economy has been in recession for most of this year.

Because no post-World War II recession has lasted more than five quarters, he said, the economy is likely to rebound next year and the stock market - historically a leading economic indicator - even sooner. "We still have a lot of pain to live through in this economy," said Dorfman. "But I think we've lived through most of the pain in the stock market."

Another investment adviser, Jim Weiss, president of Weiss Capital Management Inc. in Concord, said Monday's stock price jump looks to have been a "relief rally" after US and foreign governments agreed on an approach to restore liquidity to the capital markets.

"The question is how deep the recession will be and the impact on corporate profitability," Weiss said. "The credit markets are going to thaw out slowly. The freeze was based on a lack of confidence and trust. And confidence and trust don't come back in a week."

David Sowerby, portfolio manager and chief market analyst for Boston investment management firm Loomis Sayles & Co., agreed that Monday's surge in the Dow was "too easy, too soon, too fast." But he said he sees signs a "bottoming-out process" has begun.

"As painful as it is, avoid capitulation trading," Sowerby said. "Think of this quarter and maybe this month as a rebalancing period. Nobody ever retired better off by selling at a bottom."

Robert Weisman can be reached at weisman@globe.com.