Stocks Find Their Footing

Major indexes posted solid gains Monday after last week's rout. Upcoming economic data may hold the key to further recovery

Stocks finished impressively higher Monday, overcoming initial skittishness following last week's sell-off. Investors were cheered by some positive earnings reports and ongoing evidence of sustained M&A momentum with a $4.9 billion sale of businesses by Ingersoll-Rand (IR).

The market also took strength from a retreat in the VIX index, a volatility gauge sometimes called the "fear index", which shot to a 5-year high last week on concerns that subprime loan problems would spread to other sectors, Standard & Poor's said.

Starting Tuesday, a new wave of economic data, led by personal income and consumer spending, and construction spending, could give the markets an added boost, according to Standard & Poor's. The beginning of a new month and anticipation of a positive July employment report due out on Friday were also seen as supportive.

With no new economic numbers to devour, investors found other morsels of information to chew on. Among them was an unexpected Standard & Poor's upgrade of its credit rating on Morgan Stanley (MS), which helped spur a rally in the financial stocks around the middle of the session. The ratings agency, like BusinessWeek a unit of The McGraw-Hill Companies, cited Morgan Stanley’s successful implementation of growth strategies across its core investment banking and trading businesses and said it is better positioned to withstand continuing credit market turmoil than some of its peers.

A report from GMAC Financial Services, General Motors' (GM) part-owned financing arm, which said losses in its home-lending unit that weighed on second-quarter results weren't as bad as in the first quarter, also encouraged investors seeking relief from a spate of negative housing and subprime-mortgage news.

On Monday, the Dow Jones industrial average ended up 92.84 points, or 0.70%, at 13,358.31. The broader S&P 500 index rose 14.96 points, or 1.03%, to 1,473.91. The tech-heavy Nasdaq Composite index finished 21.04 points, or 0.82%, higher at 2,583.28.

In addition to financials, industrial and energy stocks also flexed their muscles, allaying some of the jitters and buoying confidence in the overall market. Meanwhile, the debate continues about whether a full-blown credit crunch will materialize.

Helping to fuel optimism Monday was news that Chicago hedge fund Citadel Investment Group is buying the credit positions of Sowood Capital, the Boston-based hedge fund hit by losses recently on bond-related positions. The deal is probably worth hundreds of millions of dollars, and shows that for all the recent market troubles, there is still ample money on the sidelines waiting to step in to buy cheap assets, according to The Wall Street Journal.

At the same time, however, there's been a change in tone in the markets since the sell-off in February. What was widespread bullish sentiment across all industry sectors then has narrowed considerably to where positive expectations are now concentrated in specific industries or are favoring large-cap names at the expense of small-caps, according to Barry Ritholtz, chief market strategist at Ritholtz Research & Analytics in New York. In contrast to five months ago, only healthcare, technology and consumer staples companies have shown ongoing strength, while retailers and financial stocks have been doing poorly.

Ritholtz cited a 9% pullback in the Russell 2000 index from a peak reading of 855 recently back to 780, below where it was in the last week of 2006. In a normal, expanding economy, when cash is a little more available, small-caps tend to take the lead in growth. But lately, notes Ritholtz, fund managers have been growing more defensive and rotating out of small-caps to be closer in more in line with what the current weighings of their benchmark indexes.

James McGlynn, managing director of equities at Summit Investment Partners in Cincinnati, says that small-caps, whose valuations have enjoyed a premium over those of large-cap value stocks, are being re-evaluated in light of the fact that most of the economic growth is coming from overseas. Large-cap stocks, which tend to be more globally oriented, will probably benefit more from the overseas growth and are also getting some credit for being sturdier and having longer track records than small-caps, he says.

While the fear of subprime contagion was only strong enough to stop financial stocks in their tracks, the postponing of four major corporate debt offerings last week was enough to cast a pall on the broader equities market until investors are more certain about how much corporate paper is going to get stuck on investment banks' balance sheets, McGlynn says. Rather than canceling them, the lead underwriters will probably try to split up the debt offerings among a range of different banks in order to reduce their vulnerability, he added.

But whether stocks reached a near-term bottom after last week's losses or will head still lower in the weeks ahead won't be known until the market sees how enthusiastic a bounce there is this week, said Ritholtz.

"The bulls need to see a broad-based snapback on big volume to be able to know if last week was an aberration and there's more upside or whether it was the start of something more ominous," he added.

In the energy markets Monday, the WTI September crude contract was down 19 cents per barrel to $76.83 on profit-taking following the rally on Friday that some see as overdone by hedge funds. Funds apparently believe the 3.4% GDP increase for the second quarter will keep demand moving up, while others are less certain about economic growth in the months ahead, according to Standard & Poor's.

Among stocks on the move Monday, Verizon Communications (VZ) reported a second-quarter profit of 58 cents a share, vs. 43 cents a share in the year-ago period, on 6.3% increase in revenue. Separately, Verizon and Vodafone Group plc (VOD) agreed to buy Rural Cellular (RCCC) in a deal valued at about $2.67 billion in cash, including debt. Rural Cellular shares leaped 34.4% while Verizon fell 1.2% and Vodafone was off 0.7%.

Archer-Daniels Midland (ADM) dipped 0.8% Monday despite posting more than a doubling of earnings to $1.47 a share for its fourth quarter from 62 cents a share a year ago, on a 28% rise in sales. Investors preferred to focus on the fact that ADM's processing businesses were hurt by lower ethanol sales volume and declining margins in some lines, while the latest results benefited from $600 million in after-tax gains on asset sales.

RadioShack Corp. (RSH) fell 11.3% after posting better-than-expected earnings of 34 cents a share for the second quarter, reversing a net loss of two cents a share last year. The swing to profitability came from cost cuts, while revenue dropped 15% to $934.8 million, missed estimates. Same-store sales fell 8.9%, hurt by the electronics retailer’s post-paid wireless business and the closing of 481 stores in 2006.

American Home Mortgage Investment Corp. (AHM) plunged 42% in pre-market trading but didn't open for trading Monday after saying it would delay paying its second-quarter dividend to preserve liquidity. Citing significant contraction in the value of its residual interests in securitizations on deteriorating global credit markets, the company said it sees a $4 to $5 per share hit to its book value over the next two quarters. Late Friday, AHM said its banks are demanding it put up more cash after it wrote down the value of its loan and security portfolios.

The company said it believes it has sufficient liquidity to endure margin calls on repo debt being used to fund these assets. RBC Capital cut its rating on the shares to sector perform from outperform.

Industrial equipment manufacturer Ingersoll-Rand (IR) said it will sell its Bobcat earth-moving division and two other businesses to the South Korean company Doosan Infracore for $4.9 billion, with the sale expected to close in the fourth quarter. The businesses it's shedding generated $2.6 billion in revenues in 2006. Shares were up 5.8%.

Mannatech Inc. (MTEX) dropped 11.1% after saying Friday it expects second-quarter earnings to drop to between four and six cents a share, compared with 31 cents a share a year ago, despite a 6% increase in sales. The manufacturer of nutritional and weight-loss products cited higher operating expenses from the implementation of its new global enterprise resource planning system.

Gehl Co. (GEHL) was off 2.2% after reporting that profits from continuing operations dropped to 71 cents a share from 75 cents a share on 3.0% lower revenue. The maker of compact excavators and other construction-related equipment pointed to continued softness in the North American housing market and projected lower-than-expected earnings of $2.05 to $2.25 for the full year.

Dow Jones & Co. (DJ) was down 5.3% after a spokesman for News Corp. (NWS) said it was highly unlikely that News Corp. Chairman Rupert Murdoch would continue his quest to buy the publisher of the Wall Street Journal and other publications if it's true that Bancroft family members, who control 64% of Dow Jones stock, have voted just 28% of the company's voting stake in favor of the deal. Murdoch was looking for at least 30% of the Bancroft voting stake to back the deal.

European stock markets were trading mostly higher on Monday. In London, the FTSE 100 index was down 0.15% to 6,206.10. Germany's DAX index edged 0.06% higher to 7,456.31. In Paris, the CAC 40 index was up a slight 0.04% to 5,646.36.

Asian markets traded higher on Monday. In Japan, the Nikkei index edged up 0.03% to 17,289.30. In Hong Kong, the Hang Seng index rose 0.75% to 22,739.90. In China, the Shanghai Composite index climbed 2.20% to 4,440.77.

Treasury Market

Treasury yields moved higher Monday as bond prices pulled back amid some reversing of last week's flight to safety. The 10-year note fell 10/32 in price to 97-20/32 for a yield of 4.80%. The 30-year bond was off 11/32 to 96-26/32 for a yield of 4.96%.

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