Ghost of stagflation past spooks Wall Street

By Ellis Mnyandu

NEW YORK (Reuters) - Stocks tumbled on Monday on concerns that a persistent housing slump, combined with surging prices, posed the threat of 1970s-style stagflation.

Government reports last week showed rising price pressures in November, while concern about the housing slump intensified after news that sentiment among U.S. home builders held at a record low for a third consecutive month in December.

Shares of industrial companies especially sensitive to business cycles fell. Heavy-equipment maker Caterpillar Inc (CAT.N) dropped 3 percent and ranked as the Dow's biggest decliner after a broker downgrade on concerns about the slowing economy.

Technology shares also took a beating on fears the outlook for business spending was weakening. Apple Inc's (AAPL.O) stock suffered its biggest drop in five weeks, sliding 3.2 percent.

"The stagflation word is being thrown around," said Frederic Dickson, senior vice president and market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon.

Stagflation, which refers to when prices rise and growth stagnates, was last seen in the late 1970s.

"That's something that would cause investors to take profits in economically sensitive sectors like industrials, materials and technology," Dickson said.

The Dow Jones industrial average .DJI slid 172.65 points, or 1.29 percent, to end at 13,167.20. The Standard & Poor's 500 Index .SPX dropped 22.05 points, or 1.50 percent, to 1,445.90. The Nasdaq Composite Index .IXIC tumbled 61.28 points, or 2.32 percent, to 2,574.46.

Factoring in Monday's slide, the S&P 500 is now up only 2 percent for the year.

In an interview with ABC television on Sunday, former Federal Reserve Chairman Alan Greenspan said the U.S. economy was showing early signs of stagflation as growth threatens to stall while food and energy prices soar.

Investors worry that menacing inflation would tie the hands of Fed Chairman Ben Bernanke, keeping policy-makers from cutting rates to avoid a recession.

CAT MAULS THE DOW

Shares of Caterpillar exerted the heaviest weight on the Dow, with CAT ending down 3 percent at $71.16 on the New York Stock Exchange.

Morgan Stanley downgraded Caterpillar to "underweight" from "equal weight," with a $67 price target, citing a slowing U.S. economy and a "likely" recession.

Diversified manufacturer Illinois Tool Works (ITW.N) cut its fourth-quarter earnings estimate, sending its shares tumbling 6.1 percent to $52.49 on the NYSE.