A sharper-than-expected drop in factory activity had markets and exchange traded funds (ETFs) sinking lower this morning.

The Philadelphia Federal Reserve Bank said business activity unexpectedly fell to -37.5 in October, from 3.8 in September, reports Ellis Mnyandu for Reuters. The numbers are just the latest kick to the stomach Wall Street has been reeling from for several weeks now.

The Federal Reserve also released numbers showing the big industry production plunged last month my the largest amount since late 1974. Activity at the nation’s factories, mines and utilities fell by 2.8%, adding to a 1% drop in August, reports Jeannine Aversa for the Associated Press. Blame the hurricanes: the Fed estimates that disruptions because of them accounted for about 2.25% of the drop. Analysts were expecting just a 0.8% decline.

The threat of stagflation, which had weighed on economists for months, seems to have receded slightly. The Consumer Price Index stayed flat in September, given an assist by cheaper gas, heating oil and clothing, reports Michael M. Grynbaum for the New York Times.

Another area where prices are continuing to decline is real estate, where many economists feel that the industry is far from any bottom. Home prices around the United States are expected to continue a decline well into 2009, if not longer, reports Vikas Bajaj for the New York Times. A double whammy of declining incomes and tighter lending make prospects for the market grim for the time being.

• Industrial Select Sector SPDR (XLI), down 38.8% year-to-date
• iShares Dow Jones US Industrial (IYJ), down 39.2% year-to-date

Tags: IYJ, Real Estate, Retail, Sector ETFs, XLI