No election honeymoon as economy worries percolate

Small-cap stocks took a dive Wednesday as the market closed the door on a long and historic political campaign and refocused back on a gloomy economic picture. The Russell 2000 (NYSE:IWM) closed down 31.31, or 5.74%, at 514.64, snapping a string of six consecutive higher sessions in the process. The Russell is now down 33% for the 2008, while the Dow is off 31% and the S&P 500 down 35%.

Small-cap stocks were able to grind out modest gains Monday and Tuesday despite sloppy economic reports on manufacturing, car sales and factory orders, but were unable to sidestep awful data again today on the jobs front and on the sprawling services sector. The marquee economic release today was probably the ISM Non-Manufacturing Survey, but it also shared top billing with the ADP Employment release ahead of Friday’s big Labor Department report on payrolls. The ISM report tumbled to 44.4, which marked the lowest reading for the service sector in the 10 years that the report has been issued. Meanwhile, the ADP data showed a larger-than-expected decline in jobs, which sent shivers up investor spines ahead of Friday’s release. And while the focus now shifts to Friday’s big jobs report, there will still be a hurdle to cross Thursday morning when the weekly unemployment claims come out.

In a research letter this morning, analysts at Goldman Sachs cautioned that downside risks in the economy could lead an even larger slide in GDP figures. “Economic reports continue to imply that the U.S. economy is in decline, with real GDP perhaps contracting by more than the 2% annual rate that we are currently estimating for fourth-quarter real GDP. In just the last day, we’ve seen a sharp drop in auto sales, another significant decline in the ISM manufacturing index, and further evidence of tightening in bank lending standards. Although energy prices are also falling rapidly, this is mainly a reaction to the sharp weakening in economic activity, both here and abroad, and therefore apt to cushion the decline rather than reverse it.”

Commodities were a big part of the advance Tuesday in stocks, but reversed course today. Crude oil prices tumbled 7% today in a violent turnabout from Tuesday’s 10% rally. A weekly inventory report showed growing stocks of energy products and soft demand, which helped fuel today’s decline. Even though the dollar gave back overnight gains, commodity markets struggled today, which is a sign that . . .

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