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updated: 8/20/2013 4:41 PM

Why the stock market is having a chilly August

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  • In this Tuesday, Aug. 13, 2013 photo, specialist John O'Hara, left, works with traders at his post on the floor of the New York Stock Exchange. U.S. stock futures are edging higher Tuesday, Aug. 20, 2013, after a four-day sell-off that shaved more than 300 points off the Dow Jones industrial average.

      In this Tuesday, Aug. 13, 2013 photo, specialist John O'Hara, left, works with traders at his post on the floor of the New York Stock Exchange. U.S. stock futures are edging higher Tuesday, Aug. 20, 2013, after a four-day sell-off that shaved more than 300 points off the Dow Jones industrial average.

 
Associated Press

NEW YORK -- It's been a chilly August for the stock market.

At the start of the month, the Dow Jones industrial average and Standard & Poor's 500 index hit all-time highs. Now the market is down 4 percent from its peak, and August is on track to be the Dow's worst month since May 2012.

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On Tuesday, the Dow posted in its fifth straight day of losses, the first time that's happened this year. While the S&P 500 and Nasdaq composite index did rise modestly, it was first time in four days those indices have seen green.

The stock market slide in the last couple of weeks reflects a shift in investor strategy that began in the bond market and spilled into stocks. The spillover then mixed with lingering concerns about the U.S. economy, leading to the last several weeks of volatility, market observers say.

"The bond market is the catalyst for this selloff," says Quincy Krosby, market strategist with Prudential Financial.

While most of the selloff occurred in the last couple weeks, it had its origins months ago.

Up until early June, bond funds had been one of Wall Street's more popular investments -- particularly among average investors. More than $1.2 trillion was socked away into bond mutual funds and bond exchange-traded funds between 2009 and 2012, according to TrimTabs.

"People were just throwing money at bonds, even at low rates," says Julius Ridgway, an investment advisor with Mississippi-based firm Medley & Brown.

That was before Federal Reserve Chairman Ben Bernanke said the central bank could pull back on its $85 billion-a-month bond-purchase program, which was designed to keep bond yields low.

Bernanke made bond investors nervous in mid-June by saying that the Fed, one of the bond market's biggest customers in the last several years, may scale back its buying. Investors pulled more than $65.8 billion out of bond funds in June, according to mutual fund research firm Lipper, the largest amount ever on a cash basis and the second largest outflow in percentage terms since the financial crisis in 2008. Investors pulled an additional $22.5 out of bond funds in July, according to Lipper.

With so many investors exiting bonds -- particularly Treasuries -- at the same time, bond prices declined sharply. The yield on the benchmark 10-year U.S. Treasury note has climbed from 1.63 percent in early May to as high as 2.88 percent this week. Yields climb as prices fall.

"As the 10-year yield has inched higher, the selling has led to more selling," Krosby said.

This exodus out of bond funds has touched the stock market in two different ways, investors say, starting with dividend-paying stocks.

Shares in industries such as utilities, pharmaceuticals and telecommunications are often purchased because they provide a higher-than-normal dividend. As Treasury yields rise, it makes all dividend-paying stocks less attractive to investors. That's because Treasuries can provide a similar return with significantly less risk.

Dividend-paying stocks have been hurt the past month. The S&P Utilities index is down nearly 5 percent while the S&P Telecommunications index is down 4 percent. Another type of investment that got hit in recent weeks was real estate investment trusts -- investment companies that focus on buying and managing real estate. An index that tracks REITs, as real estate investment trusts are commonly known, is down nearly 8 percent.

Investors also have broader economic concerns. It is unclear how the possible ending of the Fed's bond-buying program will affect growth.

"Bernanke is going to try to make this transition as smooth as possible, but we just don't know how much (the bond buying) is going to be scaled back," Krosby says. "And the biggest enemy to the market is uncertainty."

Investor worries have also been heightened by bad news from retailers. Wal-Mart, Kohl's, Macy's and Saks all cut their investment outlooks for the year last week -- raising concerns that the American consumer, who makes up roughly 70 percent of the U.S. economy, might be pulling back.

While stocks have declined noticeably in the last few weeks, it's important to keep things in perspective, says Greg Sarian, managing director of the Sarian Group at HighTower Advisors and a certified financial planner. The S&P 500 is up 16 percent this year while the Dow is up 15 percent. In any normal year, such returns would be considered respectable for a retirement portfolio.

On Tuesday, the S&P 500 index rose 6.29 points, or 0.4 percent, to close at 1,652.35. The Nasdaq composite rose 24.50 points, or 0.7 percent, to 3,613.59. The Dow fell 7.75 points, or 0.05 percent, to 15,002.99.

Sarian says more turbulence will come until investors get clarity from the Fed about its bond-buying program.

"Expect to see more volatility or see a short-term pull back," Sarian says Better results from Best Buy and other retailers helped the stock market close mostly higher Tuesday.

Bond yields, which had been rising sharply for the last several days, pulled back, bringing relief to investors worried about higher interest rates.

The Standard & Poor's 500 index ended a four-day losing streak. the Dow Jones industrial average, however, ended with a small loss after being up for most of the day. That extended the Dow's string of losses to five, the longest of the year. The Dow was held back by weakness in Home Depot and Johnson & Johnson.

The mostly higher finish failed to shake the market out of a slump it's been in since early August, when investors became discouraged by poor corporate earnings and a sharp increase in interest rates. The Dow has lost 4 percent since hitting an all-time high on Aug. 2 and is headed for its worst month since May 2012.

The S&P 500 index rose 6.29 points, or 0.4 percent, to 1,652.35 points and the Nasdaq composite rose 24.50 points, or 0.7 percent, to 3,613.59.

The Dow fell 7.75 points, or 0.05 percent, to 15,002.99.

Small-company stocks rose far more than the rest of the market, a sign that investors are more comfortable taking on risk. The Russell 2000 index jumped 15.32 points, or 1.5 percent, to 1,028.57.

Best Buy and Urban Outfitters rose sharply, leading the retail sector higher.

Best Buy jumped $4.07, or 13.2 percent, to $34.80, the biggest gain in the S&P 500. The electronics retailer said it earned 32 cents per share in the last three months, much better than the 12 cents per share financial analysts expected. Most of the growth came from cutting costs and focusing on online sales.

Urban Outfitters jumped $3.27, or 8.2 percent, to $43.19. The Philadelphia-based teen retailer reported a 25 percent surge in second-quarter income as sales rose across nearly all its brands.

The better news from retailers was a respite for investors, who have spent the last week and a half getting disappointing earnings and sales outlooks from some of the nation's largest store chains. Wal-Mart, Macy's, Kohl's and Saks all cut their sales forecasts, raising worries that the American consumer might be cutting back.

"The fact that some of these retailers were giving mixed signals was somewhat disconcerting," said Phil Orlando, chief equity market strategist with Federated Investors.

It wasn't all good news in the retail sector, however. Barnes & Noble plunged 12.4 percent after the bookseller's first-quarter loss more than doubled and the company's chairman called off his offer to buy the company's stores. Excluding one-time items, Barnes & Noble lost 86 cents per share, more than the 81 cents Wall Street analysts had expected. The stock fell $2.06 to $14.61.

In the bond market, the source of a lot of investor worries recently, yields declined modestly after nearly two weeks of increases. The yield on the benchmark U.S. 10-year Treasury note fell to 2.82 percent from 2.88 percent late Monday. It's still up sharply from its low of the year, 1.63 percent, reached in early May.

Bond yields are important because they are used to set interest rates on many kinds of loans, including mortgages. Investors have worried that a sharp rise in borrowing costs could disrupt the recovery in the U.S. economy.

The Federal Reserve has been buying $85 billion worth of bonds every month to keep interest rates low and encourage borrowing and hiring. Now that the economy appears to be on the mend, investors expect the Fed to cut back on its purchases as soon as its September policy meeting.

"We're not talking about the Fed pulling the plug on the economy here," Orlando said. "We're talking about the Fed looking to normalize bond yields because the economy is improving."

In commodities trading, the price of crude oil fell $2.14, or 2 percent, to $104.96 a barrel. Gold rose $6.90, or 0.5 percent, to $1,372.60 an ounce.

The dollar fell slightly against the euro and the Japanese yen.

Among other stocks making big moves:

-- TiVo rose 51 cents, or 5 percent, to $10.99 after the company announced a new line of digital video recorders to give television viewers more control over what they watch.

-- LightInTheBox plunged $7.69, or 40 percent, to $11.58. The newly public, China-based online retailer's sales forecast for the current quarter fell short of Wall Street's expectations. The company's initial public offering of stock in June priced shares at $9.50 each.

-- Medtronic fell $1.27, or 2.3 percent, to $52.83 after the medical device maker's revenue fell shy of what Wall Street analysts were expecting. The stock has surged 29 percent this year and is trading at a five-year high.

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