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Interest fears drive markets down

Investors are troubled that additional rate increases may be ahead. Tech shares lead the decline.

U.S. stock markets suffered another down trading session Friday as investors became increasingly afraid that the Federal Reserve plans to raise short-term interest rates through the summer.

Technology stocks led the way down, with the Nasdaq Composite Index falling 148.31 points, or 4.2 percent, to 3,390.40. But other indexes were not spared, with the S&P 500-stock index down 30.26 points, or 2.1 percent, at 1,406.95. The Dow Jones Industrial Average finished at 10,626.85, down 150.43 points, or 1.4 percent.

As has been the case for most of May, trading volume Friday was light, with investors in no hurry to buy the new economy companies they craved so ardently earlier this year.

Investors had shaken off their pessimism earlier with rallies Monday and Tuesday in advance of the Federal Reserve's decision to raise short-term interest rates by half a percentage point. Bulls had hoped that Tuesday's increase might mark the Fed's last, because rate increases slow the economy and can hurt corporate profits.

But now investors think that the Fed is not done. "After the rate hike, there was temporary euphoria. "People said, "They did 50 basis points. Phew, that's going to be it,'

" said Michelle Clayman, chief investment officer at New Amsterdam Partners, which manages more than $1-billion. "Now people are saying that there's going to be more."

Barton Biggs, the global strategist for Morgan Stanley Dean Witter and a longtime bear, said he expects more rate increases.

"The cyclical news on inflation is not good. Wage costs are increasing, and wage costs are sticky, so once they get embedded in the system, it's not so easy to get them out," he said. With energy prices also increasing, the Fed has no choice but to raise rates to slow the economy, Biggs said.

In addition, many money managers believe that the biggest technology companies will have to drop further before they are reasonably valued compared with both non-technology companies and smaller Internet-focused technology names.

Both Cisco and Oracle trade at more than 100 times trailing earnings, almost four times the valuation of the average S&P 500 company and a level rarely seen before the last two years. Now, many professionals think the rout in the technology sector will not end until even the megacaps feel significant pain.

"The bear market is incomplete in technology stocks and the Nasdaq," Biggs said. "In this next stage, the big-cap tech companies that are wonderful companies but very overpriced stocks are going to get hit." He expects the Nasdaq to fall below 3,000, a drop of more than 10 percent.

Michael Murphy, editor of the California Technology Stock Letter and a longtime technology bull, expects the Nasdaq to remain at its current levels until the fourth quarter of this year, when earnings at leading technology companies finally begin to catch up with their stocks.

Still, Murphy does not think the Nasdaq will fall below 3,321.29, its April 14 low, and he advised investors to remain patient. Demand for technology stocks is stronger than ever, he said.

"What's supporting the market is earnings. Earnings are just great," Murphy said.