Oct. 29 (Bloomberg) -- U.S. stocks rallied, sending benchmark indexes to their biggest advance since July, after the economy returned to growth following the worst contraction in seven decades. Treasuries dropped and the dollar and yen weakened, while commodities surged.

Caterpillar Inc., Alcoa Inc. and American Express Co. jumped at least 5.1 percent after the Commerce Department said gross domestic product grew at a 3.5 percent pace from July through September after shrinking for four straight quarters. Motorola Inc., Procter & Gamble Co., Newmont Mining Corp. and Kellogg Co. climbed on better-than-estimated earnings.

“The fourth quarter will be the Waterloo of the bears,” said E. William Stone, who oversees $102 billion as chief investment strategist at PNC Wealth Management in Philadelphia. “We are in economic recovery both in the U.S. and globally, so you will eventually see revenue growth because you are seeing the recovery hold.”

The Standard & Poor’s 500 Index increased 2.3 percent to 1,066.11 at 4:05 p.m. in New York. The Dow Jones Industrial Average added 199.89 points, or 2.1 percent, to 9,962.58. Both gauges jumped the most since July 23. The MSCI AC World Index, a measure of developed and emerging markets, rose 1.6 percent after seven straight losses.

‘Not Over Yet’

The growth in GDP topped the median estimate of 3.2 percent in a Bloomberg survey of economists and eased concern that a seven-month rally in equities outpaced the prospects for recovery. U.S. stocks extended a global slump yesterday as an unexpected decline in new-home sales exacerbated those concerns. The S&P 500 has surged 58 percent from a 12-year low on March 9, yet slipped 2.9 percent from this year’s high on Oct. 19.

The VIX, the benchmark for U.S. stock options that is known as Wall Street’s “fear gauge,” tumbled 11 percent to 24.76 in its steepest slide since February amid reduced demand for protection against declines in equities.

“The stock rally is not over yet,” said Jeffrey Kleintop, who helps oversee about $247 billion as chief market strategist at LPL Financial in Boston. “The stock market can celebrate. This news is an important confidence boost, in particular to individual investors.”

The return to growth also fueled speculation that the Federal Reserve will begin to discuss lifting its benchmark interest rate from a record low range near 0 percent and further unwind other programs meant to stimulate the economy.

European Central Bank council member Axel Weber signaled the bank may start to withdraw its emergency stimulus measures next year. The Fed has already announced a phase-out of some of its programs and completed its $300 billion Treasury purchase program today. Norway and Australia have started to raise interest rates.

‘Tug-of-War’

Treasury Secretary Timothy Geithner told a congressional committee today that the recession remains “alive and acute” for struggling homeowners and the unemployed.

“It’s a tug-of-war,” said Michael Binger, a Minneapolis- based fund manager at Thrivent Asset Management, which oversees about $60 billion. “We’ve had a stronger-than-expected GDP number and corporations are running more efficiently. But I don’t see the government reversing the stimulus measures or the Fed changing language or indicating higher interest rates any time soon. The unemployment rate is still very high.”

Motorola surged 9.8 percent to $8.74. The biggest U.S. mobile-phone maker reported third-quarter profit excluding some costs of 2 cents, exceeding the average estimate for a breakeven quarter in a Bloomberg survey. Motorola cut jobs and production costs to offset slumping handset sales.

Earnings Surprises

Procter & Gamble added 4 percent to $59.54. The world’s largest consumer-products company reported first-quarter profit that topped the average analyst projection after price increases helped offset volume declines. Procter & Gamble also raised its full-year forecast for organic sales growth.

Kellogg rose 2.8 percent to $51.38. The largest U.S. maker of breakfast cereal said it had third-quarter profit of 94 cents a share. The company was forecast by analysts to earn 85 cents, based on the average estimate from a Bloomberg survey. Symantec Corp. jumped 13 percent to $17.74. The biggest maker of security software reported second-quarter profit that topped analysts’ estimates after winning back customers from competitors and adding new business users.

Genworth Financial Inc. jumped 17 percent and led insurance companies 5.4 percent higher, the biggest gain among 24 S&P 500 industries. The life insurer and mortgage guarantor was raised to “buy” from “neutral” by Bank of America Corp.

MetLife Inc. gained 7.9 percent to $36.84 ahead of its earnings report. The biggest U.S. life insurer reported third- quarter operating profit of 87 cents a share after the close, beating the average analyst estimate by 1 cent. Lincoln National Corp., the bailed-out insurer, climbed 14 percent to $25.34 after its first profit in a year topped estimates.

Financial shares surged 4.3 percent for the biggest gain in the S&P 500 among 10 industries. The group of 79 banks, insurers and investment firms had slumped 7.8 percent in the four days through yesterday, compared with a 4.6 percent drop of the U.S. equity benchmark.

Bank of America Corp., JPMorgan Chase & Co., Goldman Sachs Group Inc., Citigroup Inc. and Morgan Stanley added at least 3.7 percent each.

Profit Analysis

Earnings-per-share have exceeded the average analyst estimates at 81 percent of the companies in the S&P 500 that posted third-quarter results so far, which would be a record proportion for a full quarter, according to Bloomberg data going back to 1993. Still, profits have decreased 23 percent on average for the 296 companies that reported since Oct. 7.

U.S. stocks also gained after the number of Americans collecting unemployment insurance fell more than forecast to the lowest level in seven months. The number of people receiving jobless benefits declined by 148,000 to 5.8 million in the week ended Oct. 17, the lowest since March 21 and biggest weekly drop since July, Labor Department figures showed.

All 10 industry groups in the S&P 500 climbed at least 0.6 percent. Indexes of raw-material producers and energy companies rose at least 2.4 percent as oil, gold and industrial metals gained after the GDP data.

Commodities Gain

Crude for December delivery gained $2.41 to $79.87 a barrel. Gold rebounded from a three-week low, while copper climbed for the first time this week. Commodities prices also rose as the dollar declined 0.6 percent against an index of six major currencies, increasing demand for an alternative investment and inflation hedge.

Treasuries extended losses after the U.S. sold a record $31 billion in seven-year notes, sending the 10-year yield up eight basis points to 3.49 percent.

Newmont Mining added 3.6 percent to $43. The largest U.S. gold producer reported third-quarter profit of 79 cents a share on higher bullion prices and lower production costs. The results topped the 55-cent per-share average estimate of 17 analysts.

Exxon Mobil Corp. rose 0.2 percent to $73.96, after falling as much as 2.4 percent. The world’s biggest company by market value reported third-quarter net income of 98 cents a share, 4 cents lower than the average of 15 analyst estimates compiled by Bloomberg. Demand slumped for fuels to run cars, trucks, factories and airplanes.

First Solar Inc. tumbled 17 percent to $126.47. The world’s largest maker of thin-film solar power modules reported sales of $480.9 million in the third quarter, trailing the average analyst estimate by 9.3 percent, according to Bloomberg data.

Bullishness Subsides

The rally in global stocks has failed to convince investors and analysts that it’s time to take on more risk or dispel their concerns about U.S. economic policies and its banking system.

Only 31 percent of respondents to a poll of investors and analysts who are Bloomberg subscribers in the U.S., Europe and Asia see investment opportunities, down from 35 percent in the previous survey in July. Almost 40 percent in the latest quarterly survey, the Bloomberg Global Poll, say they are still hunkering down. U.S. investors are even more cautious, with more than 50 percent saying they are in a defensive crouch.

‘Serious Bumps’

The U.S. economy faces “serious bumps” ahead that are likely to slow the pace of growth, Nobel prize-winning economist Joseph Stiglitz said. The economy won’t be expanding quickly enough to reduce unemployment, Stiglitz told a press conference in Beijing today. The economy will enter “a very gloomy period” of high unemployment, economist David Malpass, president of Encima Global in New York, told Bloomberg Radio.

The U.S. unemployment rate reached a 26-year high of 9.8 percent in September.

“GDP numbers were good and will stimulate more investor interest in stocks,” said Randy Bateman, who oversees $13 billion as chief investment officer at Huntington Asset Advisors in Columbus, Ohio. “We can’t declare victory yet. Maybe it was more pronounced because of the success of cash-for-clunkers program. I believe we are not going to double dip, but maybe we’ll see a lesser number in the fourth quarter.”

Brazil’s Bovespa stock index rallied 5.9 percent today after yesterday’s 4.8 percent tumble extended its retreat from the high of the year to 11 percent, exceeding the 10 percent threshold that marks a so-called correction.

Morgan Stanley said the global stock market rally, which resembles the bull run between 2003 and 2007, will end as government spending slows after so-called easy money boosted asset prices.

“Such echo rallies are never as big as the original one and we will see it fading away,” Ruchir Sharma, 35, who oversees $25 billion in emerging-market stocks at Morgan Stanley, said in an interview in Mumbai. “The rally will end as the effects of the stimulus begin to fade and the credit bubble caused by easy money disappears.”

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net.

Last Updated: October 29, 2009 16:41 EDT