Wall Street faces the bears of summer

That's bad news for the broader stock market. Usually, financials and consumer discretionary stocks lead the way in a recovery, but both sectors are heading south now. The Philadelphia KBW Bank Index, which tracks banking stocks, was down 34 percent in the first half of 2008, compared with 12.8 percent for the Standard & Poor's 500-stock index. And consumer-related companies from Starbucks to Kohl's are reeling.

In fact, few sectors are showing signs of life. Technology-industry analysts are fretting about a slowdown in corporate spending, while health-care stocks are being pummeled on fears of policy changes in Washington after the 2008 election. On July 2, for example, medical insurer UnitedHealth Group cut its profit outlook for the year. The lone bright spot: energy, especially coal stocks and oil drillers.

Meanwhile, the continued weakness in the financial sector is fueling speculation that another big bank or two will suffer the same fate as Bear ­Stearns. The sharks are already circling Lehman Brothers, the smallest of the major Wall Street firms. Skeptics say the investment bank can't remain independent, since its new risk-averse posture will make it hard to earn the fat profits the Street demands. On June 30, Lehman's stock plunged to an eight-year low of 20 on talk of a "take-under," in which a larger rival would buy the firm at a price below its market value. The stock later rallied after management agreed to give employees a bigger stake in the company.

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Bargain basement
It doesn't help matters that every time a cash-starved bank seeks a handout from a deep-pocketed investor such as a sovereign wealth fund or a private equity firm, the investment is priced at a deep discount. The twin pressures of more shares at lower prices are weighing heavily on financials in particular and the rest of the market in general. Now banks are feeling motivated to dump noncore assets and businesses to raise capital without hurting shareholders any further. Some analysts think Merrill Lynch could sell off part of its 49 percent stake in money-management firm BlackRock to bolster its balance sheet. Of course, dumping profitable holdings like BlackRock in a weak environment may only extend the recovery time for companies. A Merrill spokeswoman declined to comment.

With so much uncertainty swirling, some money managers are pushing instruments designed to limit investors' exposure to volatility. Absolute return barrier notes tie up a wealthy client's money for 18 months. If a specific benchmark, such as the Dow Jones industrial average, stays within a certain range over that period the notes pay a hefty interest rate. Should the index deviate from the target range, the investor in these sophisticated products doesn't collect the yield, but the principal remains intact. "It's an opportunity to get an above-market return with protection," says Keith Styrcula, chairman of the Structured Products Assn. "You either get everything or nothing but your principal." Given the way the market has been performing, just treading water may be enough for many investors.

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