Services data set to hit US stocks

Wall Street stocks were set to slump on Tuesday after the US services industry contracted last month for the first time in almost five years, raising new fears for the health of the US economy.

The ISM non-manufacturing index plunged to 41.9 in January, from a reading of 54.4 in December, the first contraction since March 2003, as new orders collapsed.

"This data release corroborates the notion that the US economy is in recession," said TJ Marta, fixed income strategist at RBC Capital Markets said.

Economists were expecting only a small pull back to 53.5 with a reading above 50 still indicating expansion.

The non-manufacturing employment index fell to 43.9 last month from 51.8 in December, following on from last week's disappointing jobs report, which also showed a slowdown in service sector employment.

The ISM data were released ahead of schedule after a possible breach of information, ISM said. Bond prices had risen sharply ahead of the report's release.

The gloomy outlook for the US economy came as millions of Americans prepared to vote in electoral primaries on Super Tuesday.

"An absolutely stunning ISM non-manufacturing number leaves the chart of the index looking like it has fallen off the edge of a cliff, and is heartwarming only for those who think the economy is already in a recession," Alan Ruskin, strategist at RBS Global Banking & Market, said.

Less than an hour before the opening bell, S&P 500 futures were down 16.3 points at 1,362.50 and below a fair value of 1381.76.

Nasdaq futures were down 17.5 points at 1809.25, below a fair value reading of 1834.64 while futures for the Dow Jones Industrial Average were down 132 points at 13,100.

Bond prices rose sharply as risk aversion increased after the ISM services index. The yield on the two-year Treasury note dipped below 2 per cent, falling 9 basis points lower to 1.96 per cent while the 10-year Treasury note was yielding 3.56 per cent, a decline of 9bp. A spread of 160bp marked the steepest yield curve since September 2004.

Yields on short-dated treasuries have fallen more rapidly amid expectations that the Federal Reserve will keep slashing interest rates to head off a severe economic downturn.

The dollar pared earlier gains against other major currencies. The US currency was trading only 0.1 per cent higher against the yen to Y106.81 having earlier risen 0.6 per cent.

Gold retreated back below the $900 mark, falling $15.80 to $893.60 while crude oil prices slipped 0.9 per cent to $89.19.

In spite of the gloomy outlook for stocks the homebuilder sector may avoid the worst of the selling pressure on Tuesday after Banc of America upgraded shares of four companies because of expectations that lower house prices will increase demand.

Analyst Michael Wood told investors to buy shares in KB Home, Pulte Homes and MDC Holdings and set a neutral rating on Toll Brothers, predicting an average share price rise of 20 per cent over the coming year. ""While we do not expect a spike in demand immediately, we expect that it will gradually improve over 2008," Wood said in a research note," he said.

Homebuilders were one of the worst performing sectors last year as the subprime mortgage crisis caused house prices to fall and led builders to post massive losses.

But, together with fellow laggards like financial companies and retailers, homebuilders have enjoyed a rally in recent weeks. After hitting a low on January 9, the sector index has soared more than 50 per cent, though it remains more than 60 per cent below a high set in July 2005.

Financial companies may come under pressure today after Oppenheimer & Co analyst Meredith Whitney cut her rating on Goldman Sachs from "outperform" to "perform" on valuation concerns. Ms Whitney said Goldman would "suffer from its own success" as it faces tough earnings comparisons this year after successfully avoiding the worst of the subprime mortgage crisis in 2007. Goldman shares fell 1.4 per cent to $198 in pre-market trading and have fallen 6.6 per cent this year.

Earnings news was led by News Corp which said after the closing bell on Monday that fourth quarter profit increased 1.2 per cent from $822 to $832m as higher advertising sales offset weakness in its film business. The stock rose 5.2 per cent in pre-market trade.

Also reporting after the close on Monday, Yum! Brands, owner of the KFC, Taco Bell and Pizza Hut chains, said fourth quarter profit dipped from $234m to $232m causing the shares to drop 2.3 per cent in the pre-market.

NYSE Euronext, the exchange operator, more than tripled quarterly net income to $156m on record equity trading and new listings but the shares slipped 2.1 per cent in pre-market trading. Also reporting quarterly results was CME Group, parent of the world's largest derivatives exchange, which said earnings almost doubled to $201m from $103m the previous year.

Boston Scientific, the medical device maker, swung to a $458m loss as costs from an acquisition weighed on its fourth quarter results.

European stocks were fell ahead of the open on Wall Street. The FTSE Eurofirst 300 index was down 1.1 per cent, with the FTSE 100 down 1 per cent and the Ibex 35 down 2.5 per cent in Madrid. Asian equity markets closed mainly lower led by a 0.9 per cent fall on the Hang Seng and a 1.6 per cent drop in Shanghai.

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