Inflation, Financial Woes Drag Down Stocks

Stocks declined for a second straight day Tuesday as an inflation report agitated a market already rattled by worries about the financial sector.

The Dow Jones Industrial Average slipped into bear-market territory during intraday trading but thinly escaped by the closing bell. The blue-chip index shed 130.84, or 1.1 percent, to close at 11348.55, less than 20 points above the bear mark. The S&P 500 lost 0.9 percent and the Nasdaq skidded 1.4 percent.

"It seems like this inflation data really threw cold water on whatever party we had brewing this summer," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "I think investors' main concern is that there is no certainty -- people are looking around waiting for some other shoe to drop," he said.

At times like this, you may be tempted to wait back on the porch but market pros do have some tips for playing defense in a brutal market.

Producer prices shot up 1.2 percent in July, double what was expected. Of course, that was largely due to a sharp jump in energy costs. But the core PPI, which excludes volatile food and energy components, rose 0.7 percent. This latest jump puts producer prices up 9.8 percent from a year earlier, the highest since 1981. (Dig in to the numbers.)

Some market pros said inflation from July is old news, particularly given that commodity prices have begun to come down since then. But what's worrisome to the market about this report, Ablin said, is that it shows inflation in volatile components such as energy have begun to seep into the core rate, which generally doesn't go down. Energy prices may rise and fall but "once you get a price increase at your store, they don't back down," Ablin explains.

Crude oil settled at $114.53 a barrel as the dollar weakened. Analysts said traders were cashing in on profits from foreign-exchange trading amid the weakness in U.S. stocks.

Meanwhile, housing starts fell by 11 percent, slightly less than the 11.8-percent drop that had been expected. Building permits, a gauge of future building activity, fell by 17.7 percent.

Homebuilders skidded after the report, with Hovnanian and Lennar ending down more than 4 percent.

Financials got clobbered again, sliding more than 3 percent, amid more dire forecasts for the sector. Analysts and economists say the year-old financial crisis -- is not only far from over but -- could actually get much worse.

The latest comment to rattle the market came from IMF chief economist Kenneth Rogoff, who said a large U.S. bank will fail in the next few months.

AIG and American Express were the top two drags on the Dow.

AIG shares tumbled 5.9 percent after Goldman Sachs cut its price target on the stock to $23 from $30, saying the nation's biggest insurer faces a "downward spiral" of credit losses.

American Express fell 4.2 percent.

Fannie Mae and Freddie Mac started the day higher but quickly succumbed to the selling pressure. Fannie ended down more than 2 percent, while Freddie fell 5 percent.

Even the big brokerage firms were hit: Morgan Stanley and JPMorgan ended off more than 3 percent.

Lehman Brothers lost 13 percent after JPMorgan Securities forecast that Lehman will take another $4 billion in writedowns in the third quarter due to mortgage-related losses. Lehman is said to be mulling a sale of its entire investment-management unit as the fate of CEO Dick Fuld -- and the entire firm -- hangs in the balance.

Earnings today were all about the retail and it was a mixed bag: Home Depot and Target beat expectations, while Staples and Saks missed their targets.

Shares of Dow component Home Depot fell 3.7 percent after the home-improvement retailer topped profit forecasts as consumers took on summer renovation products during what is typically the strongest quarter for the chain. However, same-store sales fell 7.9 percent and Home Depot said it still expects a 24-percent drop in full-year profit.

The results come a day after rival Lowe's reported it surpassed profit and sales expectations, helped by the tax-rebate checks. The company also sees a slowdown in the second half but raised its full-year outlook due to the robust second-quarter results. Shares of Lowe's dropped 2.8 percent.

Target also exceeded expectations but same-store sales slipped amid a strong year-earlier comparison and the cheap but chic retailer is working on strategies that focus more on the cheap than the chic to keep up with rival Wal-Mart .

Staples said its second-quarter sales fell short of expectations due to a 7 percent drop in North American business as small businesses cut back on spending. Shares fell 4.2 percent.

Saks posted a wider-than-expected loss and forecast a drop in its 2008 operating margin, offering the latest indication that even wealthier shoppers are starting to tighten the strings on their designer handbags. Same-store sales are expected to be flat or down in the low single digit percent rate for the second half, a critical period for retailers that includes the holiday-shopping season. Shares tumbled 8.3 percent.

That seems to be the message across the board: All companies, including those that beat second-quarter forecasts, are warning about the rest of the year. A weak second half would surely rattle the market, making the summer rally seem more like a head fake than a market bottom.

Hewlett-Packard shed about 2 percent ahead of the computer maker's third-quarter earnings, due out after the bell. Analysts expect HP to report earnings of 83 cents a share on revenue of $27.41 billion, according to Thomson Reuters, and will be watching closely for any insight on the fourth quarter, which could take a hit from strength in the dollar. Last quarter, 70 percent of HP's revenue came from overseas.

In mergers and acquisitions news, CME Group's stranglehold on the futures market grew tighter with the approval of its $7.7 billion purchase of energy and metals trading market NYMEX Holdings .

THIS WEEK:

TUESDAY: Earnings from HP and Analog Devices after the bell
WEDNESDAY: Weekly mortgage applications; crude inventories; Videogame conference in Leipzig, Germany; Earnings from BJ's Wholesale and Limited Brands
THURSDAY: Jobless claims; leading indicators; Philly Fed survey; GM announces investment plans for Ohio plant; Earnings from Gamestop, Heinz, Hormel, Aeropostale, Gap and Intuit
FRIDAY: Fed conference in Jackson Hole begins; Earnings from WPP, AnnTaylor

WATCHERS: Obama is expected to select a running mate this week ahead of the convention

Send comments to .

© 2009 CNBC.com