Small caps turn lower, ravaged by inflation fears

After breaching bear market territory to start the second half of 2008, small caps recovered ground 30 minutes into the session on rosier-than-expected manufacturing data, but took a sharp turn down midday remaining entrenched in the red on inflation fears.

At 12:53 p.m. ET, the Russell 2000 skidded 11.13, or 1.61%, to 678.53, while the Dow slumped 139.63, or 1.23% to 11,210.38.

Riding in as the market’s knight in shining armor for the morning, the ISM Manufacturing Survey released at 10:00 a.m. clocked in at 50.2. The figure was above the forecasted 48.6, causing the market to pull back from sharper lows of the day. A read above 50 signifies economic expansion, while anything below represents economic contraction. The upside surprise on the ISM data sparked a sizable recovery bounce in equities, with the Russell 2000 shooting some eight handles off the morning lows.

But the better-than-expected catalyst couldn’t keep the bears from scouring the Street. The uptick in manufacturing activity was welcome news for Wall Street, but investors soon focused on the index of prices paid, which climbed to 91.5, marking the highest reading since 1979. That spike in prices coupled with continued lofty crude oil prices seen all session sparked inflation fears. 

Although it’s a new quarter today, the economic picture that has clouded small-cap equities’ performance year-to-date continues to loom. Climbing crude oil prices coupled with slumping financial stocks caused investors to pass up stocks for bonds this morning.

Just ahead of the opening, crude oil prices climbed back above $143 dollars a barrel, jumping some $3 dollars from Monday’s U.S. close. Oil spiked on heightened geopolitical tension in the Middle East, as rumors of a potential attack on Iran’s nuclear facilities by Israel remain on the front burner. Iran has threatened to take action on shipping through the Straight of Hormuz if attacked, and approximately 40% of the world’s fuel supply moves through that waterway. In addition, the International Energy Agency projected this morning that although demand for energy products would soften from the higher prices, the supply side would remain tight.

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