Why the Dow Headed Down and Then Bounced

The lesson for today is: Don't count your chickens before they hatch.

Early this morning, it looked as if traders had made up their minds to send equities tumbling downward. Following disappointing news from the manufacturing sector, the Dow Jones Industrial Average (INDEX: ^DJI  ) had fallen more than 100 points an hour into the trading day, leading commentators to lament about "global jitters" and a massive "stock sell-off."

Yet, with only an hour left to trade, the Dow has defied the skeptics by fighting its way back to within 45 points of its opening price. As I write, the index is down a reasonable 0.35%.

Explaining the market's moves
The impetus for the Dow's early fall was a disappointing report from the manufacturing sector. According to the widely followed Chicago Business Barometer, U.S. manufacturers suffered a decrease in new orders in September. The index fell to 49.7 from 53 in August. Anything below 50 indicates contraction.

Adding fuel to the fire was the U.S. Department of Commerce's announcement that consumer spending outpaced wage gains in August. While the former increased by 0.5% last month compared to July -- largely the result of higher gas prices -- income grew by only 0.1%. Economists view this as a bad omen, because it potentially portends future cutbacks in spending.

The drive behind the index's subsequent and ongoing resurgence was news out of Spain that its banks are not as undercapitalized as the markets feared. An independent audit of the sector showed that Spain's banks need roughly $70 billion in new capital. While this is not insignificant, it's nevertheless 13% less than figures previously bandied about.

On top of this, Spain's government recently announced an additional round of austerity measures designed to bring the country's economy into compliance with its continental treaty obligations. Under the revised plan -- notably, the fifth such round of budget cuts in nine months -- government spending will decrease by 8.9%, next year's tax receipts will rise on the back of increased taxes, and a purported 43 new laws will be passed over the next six months to establish a new independent budgetary authority to monitor government expenditures.

Today's biggest winners and losers
As I write, only five of the Dow's 30 component stocks are up in midday trading. The remaining 25 are down by varying degrees.

Among the stocks that are up today are Cisco Systems (Nasdaq: CSCO  ) and International Business Machines (NYSE: IBM  ) . Early this morning, investment bank Morgan Stanley raised its earnings estimates for Cisco through 2014 due to anticipated increases in domestic demand. According to the report:

A full 50% of Cisco partners report business has been above plan the last 3 months, 44% were on plan and just 7% were below plan. Furthermore, resellers report growth expectations in '12 and '13 are higher today than they were 3 months ago. Therefore, we believe improving demand Cisco reported in 2H FQ4 is continuing.

With respect to IBM, as my colleague Dan Caplinger noted earlier, the tech blog AllThingsD reported today that the company is close to announcing a new product aimed at helping companies analyze and manage massive amounts of data.

Alternatively, leading the Dow lower are McDonald's (NYSE: MCD  ) and Intel (Nasdaq: INTC  ) . The fast-food giant is suffering from the effects of Janney Capital's downgrade of its stock. Janney argues that the company's stock got ahead of itself over the last year and will accordingly struggle to maintain its momentum. And Intel continues to suffer from a self-inflicted wound following its downwardly revised future earnings guidance from earlier this month.

Foolish bottom line
Given the increasing bad news out of the domestic manufacturing sector and the disaster that is Europe, investors would be wise to play it safe with stable companies that pay decent dividends and are widely diversified. Three companies fitting this description are identified in our popular free report: "3 American Companies Set to Dominate the World." To download this free report instantly, simply click here now.

Fool contributor John Maxfield does not have a financial interest in any of the companies mentioned above. The Motley Fool owns shares of Intel, Cisco Systems, McDonald's, and International Business Machines. Motley Fool newsletter services have recommended buying shares of McDonald's and Intel. Motley Fool newsletter services have recommended creating a synthetic long position in International Business Machines. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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