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Stocks recover, but experts warn of volatility ahead

WASHINGTON—The U.S. and Chinese stock exchanges returned to a semblance of normalcy Wednesday, but concerns about both economies linger following the worst global sell-off of stocks in more than five years.

Wall Street's rebound Wednesday was quickly dubbed the Bernanke Rally, after Federal Reserve Chairman Ben Bernanke. His relaxed, almost professorial, testimony before the House Budget Committee calmed jittery markets.

Bernanke told lawmakers that he expects a mid-year return to solid economic growth, despite new data showing that the U.S. economy has entered slow-growth mode. The Commerce Department on Wednesday revised economic growth for the fourth quarter of 2006 to a 2.2 percent annual rate, much slower than the 3.5 percent rate initially estimated last month.

"My view is, taking all the new data into account, there is really no material change in our expectations for the U.S. economy," Bernanke said. He painted a largely positive economic picture, including an expected rebound in housing.

That sparked a morning rally on Wall Street before investors backed off later Wednesday, as the Dow Jones industrial average closed up 52.07 points, or 0.43 percent. The tech-heavy Nasdaq and S&P 500 also finished the day up, but none gained significant ground after the markets' worst single day since trading after the 9/11 terrorist attacks resumed on Sept. 17, 2001.

U.S. investor sentiment was aided by a rebound in China's Shanghai Composite Index. On Wednesday it clawed back nearly half of its 8.8 percent drop of a day earlier.

However, one day doesn't a trend make on Wall Street

"Even when the earthquake is over, you see some aftershocks. So I think we can expect some volatility for a while now," said David A. Wyss, chief economist for the rating agency Standard & Poors. "We're coming off of a period of exceptionally low volatility, so you shouldn't be shocked. It had only one way to go."

Bernanke brought a temporary reprieve, telling lawmakers that financial markets "seem to be working well." He added that the fundamentals of the U.S. economy remain strong and that he expected a pickup in growth by midyear.

The Fed chairman acknowledged but didn't fret over a rise in defaults on risky sub-prime adjustable-rate mortgages and January's nearly 8 percent drop in the purchase of business equipment by major manufacturers and industries.

"We believe that if the housing sector begins to stabilize, and if some of the inventory corrections that are still going on in manufacturing begin to be completed, that there is a reasonable possibility that we'll see some strengthening in the economy sometime during the middle of the year," Bernanke said.

That positive view stood in sharp contrast to that of his predecessor, Alan Greenspan, whose Monday comments that a recession could loom late this year or early next contributed to Tuesday's global stock-market slide.

Adding to the uncertainty, the Commerce Department reported Wednesday a 16.6 percent drop in new-home sales for January, compared with December. That was the worst single-month showing in about 13 years. But that sour news was partially offset by a National Association of Realtors report Tuesday showing an unexpectedly strong 3 percent jump in existing home sales for the same month.

Financial experts now say that with hindsight, this week's stock market correction was inevitable.

"What triggered the drop in equity prices had little to do with economic fundamentals and more to do with what happens when investors get complacent about financial risk," independent analyst Bernard Baumohl wrote in a note to investors.

By early February, he said, analysts had begun noting that the Dow hadn't seen a correction of 2 percent or greater since May 2003, the longest such streak in half a century. That made investors nervous. Many were on hair-trigger alerts to pull money out of stocks at the first sign of bad news in order to take profits.

"We'd been expecting a correction in the market. But when it happens it's obviously a surprise," added Wyss of Standard & Poors.

So what did the stock slide signal about the U.S. economy?

"Frankly, not much," insisted Baumohl. "The economy itself is sound and growing, and we still believe the chance of a recession this year is no higher than 20 percent."

But the economy clearly isn't growing as fast as first thought, and that ushers in market volatility.

Financial markets welcomed the fourth-quarter GDP revision as evidence that the slowing economy would likely reduce inflation so the Fed won't have to raise interest rates again to do so.

Bernanke also sought to ease fears of rising foreclosures on homes sold to riskier borrowers.

"We've seen the increasing rates of default, we've seen the financial distress on the part of lenders and this is a concern," he said. "Our assessment though . . . is that there is not much indication at this point that the sub-prime mortgage issues have spread into the broader mortgage market, which still seems to be healthy, and the lending side still seems to be healthy. It's a concern, but at this point we don't see it as a broad financial concern."

While U.S. and Chinese exchanges rebounded Wednesday, emerging markets didn't, particularly in Asia. Exchanges in Australia, Japan, Hong Kong and South Korea all closed down Wednesday in a range of 2 percent to 3 percent. Smaller economies such as the Philippines and Malaysia closed down nearly 8 percent and 7 percent, respectively. And India, an important emerging economy that's helped drive global growth, saw its exchange close down 4 percent.


(c) 2007, McClatchy-Tribune Information Services.

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