Stocks slump as bond yields jump

NEW YORK (CNNMoney.com) -- Stocks tumbled Tuesday, as the benchmark 10-year note yield jumped to a five-year high, exacerbating worries on Wall Street that the Federal Reserve may have to raise interest rates later this year.

The Dow Jones industrial average (down 129.95 to 13,295.01, Charts) slid about 130 points, a loss of about 1 percent. The broader S&P 500 index (down 16.12 to 1,493.00, Charts) skidded 1.1 percent and the tech-driven Nasdaq composite (down 22.38 to 2,549.77, Charts) lost 0.9 percent.

The Russell 2000 (down 11.46 to 821.72, Charts) small-cap index slumped 1.4 percent.

The yield on the 10-year Treasury note, which affects rates on mortgages and many other consumer loans, jumped as high as 5.27 percent during stock trading hours. After the close, it went as high as 5.3 percent, the highest in five years.

The dollar jumped versus other major currencies. OIl and gold prices slumped.

Wednesday brings reports on retail sales, business inventories and the Fed's beige book read on the economy. There are no earnings reports of note on the docket.

Stocks had erased the day's losses and briefly turned positive in the mid-afternoon after ex-Fed chairman Alan Greenspan made comments that seemed to question how long the surge in bond yields would last.

But the recovery attempt was short lived, with stocks tumbling anew after the selloff in Treasury prices briefly boosted the yield on the benchmark 10-year note to 5.27 percent - the highest since 2002 and above the Fed's current target for its main short-term interest rate, 5.25 percent.

The 10-year yield stood at 5.26 percent near the close on Wall Street versus 5.15 percent late Monday. At 6 p.m. ET, the yield stood at 5.29 percent.

Bond prices have been tumbling, and yields rising, in the last week on bets that rising price pressures and signs that the economy is picking up mean the Fed may have to raise its rate target, perhaps later this year. Bond prices and yields move in opposite directions.

Higher interest rates make money more expensive and tend to slow economic growth, and act as a drag on corporate profits and thus, stock prices. On Tuesday, bond prices also slumped following a tepid 10-year note auction.

Worries about higher rates sent stocks skidding for three straight days last week, with the major gauges all plunging around 3 percent, before staging a recovery Friday. Stocks ended mixed Monday.

"We've had a big run up in long-term interest rates and that's taken some of the wind out of the market's sails," said Steven Goldman, market analyst at Weeden & Co.

Not only has the rise in bond yields revived concerns about interest rates and inflation, but it makes Treasury bonds and notes more competitive investments.

Yet, stocks were vulnerable to a setback around this time anyway, Goldman said, due to the recent run-up. The jump in rates provided the catalyst.

Prior to last week's battering, the Dow, S&P 500 and Russell 2000 had all hit record closing highs, while the Nasdaq composite ended at a more than 6-year high.

Stocks are also vulnerable this week in the days before Friday's quadruple options expiration, a quarterly event in which stock index options and futures and individual stock options and futures all expire at the same time. The impact can cause volatility in the underlying stocks in the day's leading up to the expiration.

All three major gauges and the Russell 2000 posted losses through early afternoon as investors geared up for key readings on inflation and manufacturing later in the week.

Declines eased in the late morning, thanks partly to the impact of falling oil prices and upbeat earnings from Lehman Brothers.

The Dow briefly turned positive after Greenspan, speaking in New York, said it's unclear whether the rebound in bond yields is a cyclical rise or a longer-term trend. He also said he's not worried about China, a big buyer of bonds, selling Treasurys.

The comments seemed to throw water on worries sparked by PIMCO's influential bond investor Bill Gross, who said last week that the bond market is in a bear market, which would imply the rebound in yields is a bigger, longer-reaching trend.

On a more bearish note, Greenspan also said China's rapid economic growth can't continue and that the rise in global market liquidity is nearing a turning point.

In general, stock investors are coming to terms with higher bond yields and the possibility of higher interest rates, said J. Bryant Evans, portfolio manager at Cozad Asset Management.

But as part of that process, "often there is an initial negative reaction by people at institutions who trade very quickly on the latest news," Evans said. Yet, the longer term outlook for stocks is more positive, he and other analysts say.

In corporate news, Lehman Brothers (up $0.38 to $76.06, Charts, Fortune 500) reported higher quarterly earnings that topped estimates Tuesday morning, due to higher investment banking revenue.

Texas Instruments (down $0.75 to $35.04, Charts, Fortune 500) narrowed its second-quarter revenue forecast late Monday to a level that could miss analysts' estimates. The chipmaker also narrowed its earnings forecast to a level that is in line with analysts' estimates.

Blue chip declines were broad-based, with 27 out of 30 Dow stocks falling, led by Boeing (down $1.07 to $96.48, Charts, Fortune 500), General Motors (down $0.34 to $31.43, Charts, Fortune 500), AT&T (down $1.04 to $39.08, Charts, Fortune 500), Wal-Mart Stores (down $0.90 to $48.91, Charts, Fortune 500) and Merck (down $0.83 to $50.22, Charts, Fortune 500).

Component McDonald's (up $0.23 to $51.48, Charts, Fortune 500) rose after Goldman Sachs added the restaurant chain to a buy list, Briefing.com reported. Intel (up $0.27 to $22.20, Charts, Fortune 500) and Alcoa (up $0.04 to $39.34, Charts, Fortune 500) were the Dow's other two gainers.

A variety of homebuilders, silver, steel and gold stocks all declined.

Market breadth was negative. On the New York Stock Exchange, decliners beat advancers 5 to 1 on volume of 1.61 billion shares. On the Nasdaq, losers topped winners by almost 3 to 1 on volume of 2.09 billion shares.

In currency trading, the dollar rose versus the euro and the yen.

U.S. light crude oil for July delivery fell 62 cents to settle at $65.35 a barrel on the New York Mercantile Exchange.

COMEX gold for August delivery fell $5.90 to settle at $653.10 an ounce.