Dow Dives 178 Points on China Interest Rate Hike Fears

stock exchange trader
stock exchange trader

The Dow tumbled Tuesday as part of a global sell-off in stocks fueled by further speculation that China will hike interest rates to fight inflation. Renewed worries over the wobbly finances of Ireland, Portugal and Greece as weighed on equities. The dollar spiked and commodities such as gold, oil and copper plunged.

The Dow Jones Industrial Average ($INDU) lost 178 points, or 1.6%, to close at 11,024.The blue-chip index fell as much as 223 points to drop below 11,000 at one point in the session.

The broader S&P 500 ($INX) declined 19 points, or 1.6%, to finish at 1,178. The tech-heavy Nasdaq Composite ($COMPX) shed 44 points, or 1.8%, to settle at 2,470.

Markets tumbled in Asia overnight after South Korea raised interest rates, feeding anxiety that China could soon follow. Given that China is the largest driver of the global economic recovery, a slowdown in its economic growth rate could leave Wall Street's earlier corporate profit forecasts looking too optimistic.

Retail Holds On, Commodities Dip

Meanwhile, fears that sovereign debt crises are worsening in Ireland, Portugal and Spain added to the selling pressure in Europe, even after Ireland's premier tried to stabilize financial markets by saying his government hasn't asked for a bailout.

But the potential for reduced demand from China weighed heaviest, especially on basic materials and energy stocks, and commodities in general. Aluminum-maker Alcoa (AA), conglomerate 3M (MMM) and energy giants Exxon Mobil (XOM) and Chevron (CVX) were among the Dow's worst-performing components Tuesday.

If there was any strength in stocks, it was to be found in retail shares. Wal-Mart (WMT) and Home Depot (HD) were the only Dow stocks to post gains Tuesday, boosted by better than expected third quarter earnings results.

As for commodities, gold fell to nearly a two-week low, losing 2%, or $27.80, to $1,341 on the Comex division of the New York Mercantile Exchange (CME). Silver lost 3.3% and copper tumbled almost 5%. Crude oil declined 3.1%, or $2.60, to $82.26 a barrel.

If the Dollar Is Up, Stocks Are Down

As has been the correlation for months, the dollar rose as stocks and commodities fell. China worries and European debt fears pushed the dollar index to nearly a two-month high. That reversal is significant because a key to the market's remarkable rally from late August through early November had been a rapidly depreciating dollar, says Joe Greco, managing director at Meridian Equity Partners.

Anticipation of the Federal Reserve's second round of quantitative easing brought a reprise of the reflation trade, where the dollar falls while prices for assets like stocks and commodities climb. "If you want to know what stocks are doing just look at the [dollar index]," Greco says.

The strong inverse correlation between the U.S. Dollar index and the S&P 500 is made pretty clear in the chart below. Notice that ever since the dollar reversed course in early November, stocks have been on an extended losing streak.

Although the dollar has seen a significant bounce over the last week and a half, so far, the action is merely a technical bounce from the bottom to the top of a longer downtrend channel, according to Bespoke Investment Group. But if the dollar can put up another day or two of gains, that downtrend will be broken.

"The action in the currency this week could be a key tell in how things might play out for the remainder of the year," Bespoke analysts say.

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