Wall Street's rally is back on hold as General Motors took another step toward bankruptcy court and investors grew worried about rising borrowing costs.
The Dow Jones industrial average fell nearly 175 points Wednesday, erasing most of a rally from the day before as a jump in government bond yields fanned worries that higher interest rates will sap strength from the economy before it has a chance to recover.
A steep drop in the price of the benchmark 10-year Treasury note pushed its yield up to 3.72%, up from 3.55% late Tuesday and the highest level since last November. That increase touched off fears that the government won't be able to hold down interest rates long enough to allow the economy to recover.
Along with increasing borrowing costs for the government, rising yields on Treasury debt could hamper an economic recovery since they are used as benchmarks for home mortgages and other kinds of loans. Higher mortgage rates could delay a recovery in the battered housing market.
"The equity market is getting worried about the 'green shoots.' I think the deer have nipped off a few and I think a few turned out to be weeds," said Hank Herrmann, chief executive of Waddell & Reed. Herrmann was referring to early positive signs in the economy that Federal Reserve Chairman Ben Bernanke has called "green shoots."
Investors are becoming concerned that even strong demand at times for government debt isn't leading to improvements in Treasury prices. The Federal Reserve has said it would buy up to $300 billion in Treasury debt this year as part of its efforts to keep borrowing costs low.
The drop in bond prices followed a well-received auction of $35 billion in five-year notes, part of the $101 billion in debt the government is issuing this week. Some traders fear demand could weaken as the government issues massive amounts of debt to fund its financial and economic rescue programs.
"Stocks are following bonds," said John Brady, senior vice president of global interest rate products at MF Global. "Will the economy grow and expand vigorously in the face of sustained higher interest rates?"
The Dow fell 173.47, or 2.1%, to 8,300.02 after rising 196 points on Tuesday. The broader Standard & Poor's 500 index fell 17.27, or 1.9%, to 893.06, and the technology-laden Nasdaq composite index fell 19.35, or 1.1%, to 1,731.08.
On Tuesday, stocks soared on the Conference Board's surprisingly high reading of consumer confidence. The May index was the highest since September. Consumer sentiment does not always correspond to consumer spending, but the data nevertheless fueled investors' hopes for an economic rebound later this year.
The Dow is 26.8% above the lows it reached in early March, but still 41.4% below the record high it hit in October 2007.
Wednesday's retreat also came as General Motors said not enough bondholders agreed to swap their debt for company stock, meaning the automaker is almost certainly headed for bankruptcy protection. GM has until Monday to either finish restructuring outside of court or file for Chapter 11.
GM slid 29 cents, or 20.1%, to $1.15.
The prospect of a GM bankruptcy also made it more likely that the company would be plucked from among the 30 stocks that make up the Dow industrials. The price of a stock factors into its weighting in the Dow so GM's low share price means it hasn't been dragging as much on the blue chips lately. But its tumble has hurt the index as GM shares fell from as high as $18.18 last June.
Many investors have been expecting GM to enter Chapter 11 for some time, but the reality of it happening could still deal Wall Street a psychological blow. Any remaining value in the shares, which are currently trading just above $1, would be wiped out.
Some analysts say the market should be able to withstand an eventual GM bankruptcy filing. Mark Coffelt, portfolio manager at Empiric Funds, thinks Wall Street's recovery since hitting 12-year lows in early March leaves stocks better suited to shrug off GM's troubles.
"The market has come a long way in a short period. I would expect it to settle out a little bit," he said, predicting more back-and-forth days rather than more big gains in a short period.
Investors on Wednesday also worried about housing and financial stocks.
The National Association of Realtors said sales of previously occupied homes rose from March to April as buyers hunted for bargains. But the 2.9% increase in sales came as the number of unsold homes on the market at the end of April rose almost 9% to nearly 4 million. That's a 10-month supply at the current sales pace.
Some analysts worry that rising prices could prompt homeowners who had been on the sidelines to put their homes on the market. The increase in available homes could short-circuit a recovery in prices and trip up the economy's recovery by hurting consumers and banks that hold mortgages.
Financial stocks fell after the Federal Deposit Insurance Corp. said the number of troubled banks jumped to the highest level in 15 years.
Agricultural products maker Monsanto fell $5.37, or 6.3%, to $79.88 after saying it expects to meet the low end of its fiscal 2009 earnings forecast.
Flash-memory maker SanDisk renewed a licensing agreement with South Korea's Samsung Electronics. SanDisk jumped $1.94, or 14.3%, to $15.52.
In other trading, the Russell 2000 index of smaller companies fell 10.45, or 2.1%, to 489.86.
About two stocks fell for every one that rose on the New YorkStock Exchange, where volume came to a light 1.3 billion shares compared with 1.4 billion shares Tuesday.
The dollar was mixed against other major currencies. Gold prices fell.
Light, sweet crude rose $1 to settle at $63.45 per barrel on the New York Mercantile Exchange.
Overseas, Britain's FTSE 100 rose 0.1%, Germany's DAX index rose 0.3%, and France's CAC-40 added 0.8%. Japan's Nikkei stock average rebounded 1.4%.