- The Washington Times - Thursday, August 9, 2001

Stocks tumbled yesterday on a Federal Reserve report that found the profound weakness in manufacturing spread to other sectors of the economy in June and July.
The market started dropping in the morning on a dismal sales forecast from technology leader Cisco Systems, but the sell-off accelerated sharply with the afternoon release of a Fed staff report describing in gloomy detail a stagnant or declining economy in every region.
The Dow Jones Industrial Average plunged 165 points to 10,294 and the Nasdaq Composite Index lost 3 percent, or 61 points, to close at 1,966 on the Fed's conclusion that "sustained weakness in the manufacturing sector spilled over to other businesses," including office space, trucking and shipping.
"The Fed said in effect that the manufacturing recession is beginning to morph into the rest of the economy. That was the catalyst," said Larry Wachtel, stock analyst with Prudential Securities.
"There had been this fiction in the market that we could have layoffs and contractions on the production side while the consumer side went blithely along. But the Fed report said you can't escape," he said. "The cancer is spreading."
The Fed found "slow growth or lateral movement" in most areas, led by another round of declines in manufacturing, this time because of softening orders from Europe and Asia. "Reports of reduced work hours, lost overtime, forced furloughs, planned shutdowns and layoffs were pervasive," the Fed staff said.
Even consumer spending, which has kept the economy out of recession this year, was sluggish and frequently below expectations despite substantial discounting by retailers, the Fed said. The weak sales have prompted stores to cut back on orders for back-to-school and Christmas merchandise.
Several of the Fed's 12 districts reported layoffs in business services, including advertising, computer services and temporary help. Transportation and shipping declined, while demand slackened for back-office services like accounting, insurance and legal advice.
During the crucial summer travel season, "layoffs and slower economic growth reportedly damped tourism," with bookings down for airlines and hotels that already have been hit by a steep drop in business travel, the report said.
Borrowing by consumers and businesses dwindled, "with both borrower and lenders pulling back in response to economic uncertainty," it said. Only mortgage lending continued to grow, in line with the "stable" conditions in the still-growing housing market.
The report, which the staff will present to Fed governors at their Aug. 21 meeting on interest rates, confirmed the fears of stock investors, who have been eager for any shred of good economic news or earnings after a year and a half of drubbing and $5 trillion of losses.
The dollar also posted big losses against the euro and the Japanese yen, as foreign investors concluded that a U.S. economic recovery is still a ways off.
"Prospects here in the U.S. aren't quite as rosy as some thought they would be," said John McCarthy, a foreign-exchange trader at ING Barings Capital Markets.
Prudential's Mr. Wachtel said investors have grown skeptical of much-publicized predictions that an economic recovery is at hand. Blue-chip forecasters still are predicting a rebound in growth to a 3 percent annual rate by the end of the year — an "ambitious" target at this point, he said.
Economists at the beginning of the year predicted recovery by summer, but now they have pushed it off until spring, he said.
"It's difficult to get a rally going. There's nothing to hang your hat on," he said. "You've had a tax cut, the Fed cut interest rates. But you have this inventory overhang, and only time can work its way through that. This is a slow, grinding process."
David Blitzer, investment strategist at Standard & Poor's, said the stock market wants to be "upbeat" and "look across the valley at the recovery." But it keeps getting knocked down by "gruesome" news about the economy and business — like the forecast from Cisco, a former stock superstar whose revenues have dropped by 25 percent this year.
Investors were unnerved when Cisco's chief executive told CNBC that the outlook for the networking industry remains iffy, he said.
"The market had a rotten day" Mr. Blitzer said. "June was an absolutely horrendous month," and the Fed staff report reflected that.
But the economy was probably hitting bottom then, and "when the economy's at the bottom, that's when it looks the worst," he said.
Like many economists, Mr. Blitzer expects a recovery to take hold and gather strength by the end of the year, when it will be visible to the markets.
"We have to give monetary policy and the tax rebates a little bit of time to work," he said.

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