Fears that the budget talks in Washington may break down for good sent interest rates higher and stocks sharply lower Wednesday, the second straight day of steep losses.
Last year’s bond and stock rallies were predicated in part on the notion that President Clinton and congressional Republicans would strike a deal to balance the budget in seven years. The possibility that such a deal might not come to pass has rattled investors, say analysts.
“The market is sour,” said Nancy Kimelman, chief economist at Technical Data in Boston. “The market has been fixated on the budget.”
But most stock watchers Wednesday said the almost 165-point drop in the Dow Jones Industrial Average over the past two days should not be interpreted as the beginning of the end for the stock market. They pointed out that after last year’s spectacular gain in stocks, a normal correction of 3 to 8 percent had to be expected.
“I don’t think anything significant is going on,” said James McCall, chief investment officer at Keystone Investment Management Co., a mutual fund firm. “The longer term outlook is still favorable.”
Tuesday’s 67.55-point loss was concentrated mainly in technology stocks. A few high-profile technology companies, including Motorola Inc., have reported disappointing earnings and fears are growing that more disappointments are waiting in the wings. Late Wednesday, Apple Computer Inc. said it would report a loss for its most recent quarter.
Still, technology stocks in general did not fare all that badly Wednesday, when the Dow lost another 97.19 points. The Nasdaq, which has a heavy dose of technology companies, fell 8.60 to close at 990.21. Some big name technology stocks, however, managed to eke out gains Wednesday.
In the broader market, gains were hard to come by. The chief culprit, said analysts, was the news on the budget.
Most economists agree that eliminating the federal budget deficit would drive interest rates lower. The rationale is straightforward: If the federal government borrowed less money, there would be less demand for funds, a prescription for lower rates.
Because the financial markets are always looking ahead, interest rates fell late last year when it looked like a deal on the budget was at hand. By the end of the year the yield on the 30-year Treasury bond dropped to 5.94 percent, close to a two-year low.
On Tuesday, budget talks recessed without any definite plans for starting up again. Republicans say the next step is up to Clinton. The White House has said much the same thing. David Wyss, senior economist at DRI/McGraw-Hill in Lexington, said a complete breakdown in talks could send rates considerably higher.
Most money managers don’t expect that to happen. They note that even after the talks failed Tuesday, the two sides refrained from harsh criticism of one another. And Wednesday afternoon, Senate Republican Leader Robert Dole said he remained hopeful an agreement could be reached. “I’m very positive about getting an agreement,” he told Cable News Network.”
But the budget is not the stock market’s only worry. The soft economy could depress earnings in key sectors, say some money managers. Along with falling interest rates, rising profits were a key to last year’s stock rally.
Edward Riley, chief investment officer for the Private Bank, expects weak earnings to make life difficult for the market for the first half of the year. Riley thinks slow growth will persuade the Federal Reserve to cut interest rates several times this year, which should ultimately help the markets.
James McCall is more optimistic. He expects growth to be moderate, yet respectable in 1996. He also looks for rates to stay low and for inflation to remain in check. He also thinks budget negotiators will eventually strike a deal.
“When that happens, whether it is next week or next months, it will rebuild confidence,” he predicted.