Investors Back Out Of Bullish Dow

Stocks pulled back sharply Friday, erasing most of the week’s gains, as a pristine outlook for inflation, interest rates and corporate profit growth developed a few blemishes.

The Dow Jones industrial average fell 130.31 to 7,890.46, leaving the blue-chip barometer with a loss of 31.36 for what turned into the busiest week in Wall Street history.

Broad-market indexes also suffered steep losses as investors moved to secure some gains from this week’s record-setting advance, which on Wednesday had put the Dow above 8,000 for the first time.

In truth, the chief culprits behind Friday’s selling weren’t all that disheartening, leading many observers to conclude that investors were looking for a reason to pull some money out of the market.

Interest rates edged a little higher in the bond market, but remained near their lows for the year, after an economic report with some potential inflationary implications.

And although Microsoft reported late Thursday that it nearly doubled its profit for the June-April quarter, meeting most analyst forecasts, the results failed to satisfy the inflated expectations that had sent the software giant’s shares soaring earlier in the week. Microsoft, which plunged 8-15/16 to 140-1/2 in heavy Nasdaq trading, also issued a cautious forecast about the coming quarters.

“A market that lives by earnings and interest rates can die by them too,” said Charles G. Crane, director of research at Spears, Benzak, Salomon & Farrell, noting that virtually all the news of the past week has been encouraging. “The market was like a forest that hadn’t received any water. It doesn’t take much of a spark to start a little fire.”

Bonds stumbled in Friday morning after a University of Michigan report unexpectedly revealed a sharp improvement in consumer sentiment during the first half of July.

The markets have been rallying since mid-April amid signs that the vigorous pace of the economy was slowing enough to keep a lid on inflation. A sharp pickup in consumer activity, however, could force the Federal Reserve to raise its key lending rates, easing inflationary pressures, but potentially hurting company profits.

The consumer sentiment data “was the first July numbers we’ve had a look at, and it surprised nearly everyone,” said Hugh Johnson, chief investment officer at First Albany Corp.

“The worry is that the economy will pick up in the third quarter,” said Johnson. “Everything has looked so perfect. It’s looked as though the economy is growing at very moderate pace. It’s looked as though inflation is very benign, and so it’s led us to believe the Fed will not raise interest rates any time soon. But today we got a little bit of a wrinkle, and that led to a round of profit-taking.”

Declining issues outnumbered advancers by a 7-to-3 margin on the New York Stock Exchange, where volume was very heavy again at 585.61 million shares as of 4 p.m. For the week, about 2.96 billion shares were traded on the NYSE, and some 3.66 billion were traded on the Nasdaq Stock Market, the biggest tallies ever for both markets.