Stocks slump on economic woes

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NEW YORK (CNNMoney.com) -- Stocks tumbled Thursday as investors reacted to Federal Reserve Chairman Ben Bernanke's Congressional testimony that economic conditions are likely to get worse before they get better.

The Dow Jones industrial average (INDU) lost 1.4%, the broader Standard & Poor's 500 (SPX) index lost 1.3% and the Nasdaq composite (COMP) lost 1.7%.

After the close, data networking provider Brocade Communications (BRCD) posted quarterly earnings that fell from a year ago but nonetheless topped forecasts.

Friday brings a host of economic reports, including the NY Empire State manufacturing report before the start of trade and the University of Michigan consumer sentiment report shortly after the start.

Bernanke told the Senate Banking Committee that the outlook for the economy has worsened recently and that the risks to growth remain to the downside. The Fed chief also said the prospects improve later in the year, due in part to the $170 billion fiscal stimulus package and the impact of the Fed's interest-rate cutting campaign.

He also said that ongoing housing market problems and softer employment conditions will drag on consumer spending.

Bernanke said that big banks could end up taking more writedowns due to the problems with bond insurers. This has been a recent fear on Wall Street as Ambac Financial (ABK) and MBIA (MBI) have struggled to maintain their financial strength ratings.

Stocks tumbled in response, with financial, homebuilder and retail stocks leading the decline.

"Bernanke's comments clearly spooked the market, but the reaction is surprising since he's not saying anything different from what the Fed has been saying for months," said Phil Orlando, chief equity market strategist at Federated Investors.

"There is a consistent theme," Orlando said. "They've been saying for some time now that the economy is weak, housing is still a problem, the Fed will keep cutting rates and the economy has a chance of skirting past a recession."

Investors were also digesting commentary from Treasury Secretary Henry Paulson, who along with Bernanke, argued that the economy should be able to avoid a recession, due to the combination of monetary policy and the fiscal stimulus plan. (Full story).

The Federal Reserve has cut short-term interest rates five times since September - and pumped billions into the banking system - in response to the economic slowdown following the onset of the housing and credit market crises.

A pullback after the recent rally. All three major gauges had jumped Wednesday after a surprisingly strong January retail sales report helped counter worries that weakening consumer spending could send the already struggling economy into a recession.

It was the third session in a row that the Dow and S&P 500 had gained and the third out of four up sessions for the tech-heavy Nasdaq.

After such an advance, it wasn't particularly surprising to see stocks retreat as they did on Thursday, Orlando said. The day's economic commentary likely gave investors an incentive to step back.

Economic news. The December trade gap narrowed more than expected, the government reported, causing the 2007 trade gap to drop for the first time in six years. (Full story).

In other economic news, the number of Americans filing new claims for unemployment fell more than expected last week.

And home prices continued to plunge in the last quarter of 2007, posting the biggest quarterly drop ever recorded by the National Association of Realtors.

Company news. Comcast (CMCSA) reported a better-than-expected quarterly profit, announced another big stock buyback plan and said it was providing a quarterly dividend for the first time. (Full story).

Swiss Bank UBS AG (UBS) reported a quarterly loss of $11.3 billion on a writedown of $13.7 billion related to bad mortgage debts.

Hewlett-Packard (HPQ, Fortune 500) said late Wednesday that it reached a settlement with journalists who were spied on as part of its boardroom surveillance scandal.

Intel (INTC, Fortune 500) slumped after Goldman Sachs removed the chipmaker from its "conviction buy" list, according to published reports. Goldman downgraded Micron Technology (MU, Fortune 500) to "sell."

Liz Claiborne (LIZ, Fortune 500) warned that it expects to report a much smaller-than-expected fourth-quarter profit due to weaker sales and higher expenses. Shares fell over 18%.

Market breadth was negative. On the New York Stock Exchange, losers beat winners by nearly 4 to 1 on volume of 1.4 billion shares. On the Nasdaq, losers beat winners by almost 3 to 1 on volume of 2.27 billion shares.

Other markets. Treasury prices fell, raising the yield on the benchmark 10-year note to 3.80% from 3.72% late Wednesday. Bond prices and yields move in opposite directions.

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

U.S. light crude oil for March delivery rose $2.19 to settle at $94.46 a barrel on the New York Mercantile Exchange.

COMEX gold for April delivery rose 60 cents to settle at $910.80 an ounce.