Dow Finds Its Footing

An early decline is mostly wiped out as bullish sentiment prevails. But postclose news is tilted to the negative.
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After Tuesday began with stocks taking a breather from a strong rally, Tobias Levkovich, chief U.S. equity strategist at Citigroup, offered some words of wisdom: "Markets don't always go up."

Indeed, since July, stocks have advanced amid a steady stream of "backing and filling," and most market participants were feeling all right about a little consolidation. A little pullback would be healthy. The proverbial pause to refresh.

But the market digested the day's bad news faster than expected, and by early afternoon, the

Dow Jones Industrial Average

was once again climbing toward the 12,000 threshold. That doesn't mean tomorrow won't be the day for indigestion in the wake of postclose earnings news that was tilted toward the negative.

"The market was able to look beyond the near-term issues today," says Art Hogan, chief market analyst at Jefferies & Co. Once the market really looked at the day's news, investors and traders realized much of it was either priced in or not very damaging, he says.

After trading as low as 11,9887.35, the Dow ended the day down 0.3% at 11,950.02. The

S&P 500

dropped 0.4% to 1364.05, and the

Nasdaq Composite

declined 0.8% to finish at 2344.95.

A high core producer price index report Tuesday doesn't necessarily correlate to Wednesday's more important consumer price index. But if core CPI comes out with an ugly increase like core PPI's 0.6% jump in September, investors may have higher rates to worry about. On Tuesday, the data, which far exceeded expectations for a 0.2% increase, didn't stick.

The inflation data didn't even stick in the bond market, which ignored the PPI report and rallied early based on the Treasury department's report of a record $116.8 billion in net purchases of U.S. securities in August. This solidly beat expectations for $53 billion, and July's $32.9 billion number. Most importantly, the $116.8 billion easily exceeds the record $69.9 billion trade deficit in August.

Treasuries, which tend to do better when economic growth is slowing, were also supported by a weaker-than-expected report on industrial production and capacity utilization.

The 10-year Treasury note gained 2/32 in price to yield 4.77%, while the 30-year bond gained 4/32 in price to yield 4.9%.

As for analyst downgrades of

Intel

(INTC) - Get Report

and

Yahoo!

(YHOO)

, the bad news is already baked into those stock prices, says Hogan. Intel is one of the worst performers in the Dow, and Yahoo! preannounced earnings. How much more can they disappoint?

After hours Tuesday, Intel did not disappoint, and neither did tech bellwether

IBM

(IBM) - Get Report

. Intel's shares were gaining back their 3.29% loss in after-hours trading. IBM was recently up 4.5% in after-hours trade. Yahoo!, conversely, reported a decline in its net profit, and its shares were falling 3.3% in postclose trading.

Also after the close,

Motorola

(MOT)

reported third-quarter revenue that fell short of expectations. Its shares were recently down about 8% in post-close trading.

Prior to the open,

Merrill Lynch

(MER)

didn't disappoint investors with its earnings report. But

Goldman Sachs

(GS) - Get Report

has set such a high bar for brokerages that competitors must beat expectations by a long shot to see much upside in their shares, says Hogan.

Merrill Lynch shares fell initially with the market but ended the day up 0.5%. Traders punished shares of

Jefferies & Co.

(JEF) - Get Report

, whose revenue fell short of analyst expectations. Its shares declined 7.67% Tuesday. The Amex Broker/Dealer Index fell 1.65%.

On the flip side, news of Food and Drug Administration approval of

Merck's

(MRK) - Get Report

diabetes drug was welcomed with much more open arms. Merck's shares gained 0.5% as the Amex Pharmaceutical Index added 0.5% on the day.

In other pharma news,

Eli Lilly

(LLY) - Get Report

said it will acquire Cialis maker

Icos

(ICOS)

for $32 per share; Icos stock jumped 16%.

Investors also embraced news that the

Chicago Mercantile Exchange

(CME) - Get Report

plans to buy the

Chicago Board of Trade

(BOT)

for $8 billion. Shares of each climbed 2.6% and 13%, respectively.

Finally, in M&A,

Level 3 Communications

(LVLT)

rose 13% on news it will acquire

Broadwing

(BWNG)

, whose shares jumped 19.7%.

The rally is still somewhat cautious, despite the three week-long upswing and the glass-half full rebound intraday Tuesday, says Levkovich. He points to outflows from U.S. equity fund flows as evidence there is still more room to gain. Money will soon begin to come back into U.S. stocks, he says. Levkovich is bullish on large-caps and predicts the S&P 500 tops out at 1400 by year end and the Dow ends at 11,900.

"Nothing in our sentiment or earnings work points to a prolonged decline," says Levkovich.

Indeed, fund managers are back on the bullish wagon, according to the Merrill Lynch survey of fund managers for October. Fund managers reduced their cash balances to 3.8% from 4.4% in August, according to the report, and they've deployed it in U.S. stocks. For the first time in five years, fund mangers report a net underweight position in emerging market equities, according to the survey.

"Although

fund managers remain highly cautious about the economic outlook, the collapse in oil prices has shaken them out of their risk aversion and prompted them to put their high cash balances to work," writes Alastair Irvine, analyst at Merrill Lynch. "Gone are the fears of rising core inflation, of excessively stimulatory monetary policy, of higher short-term interest rates."

Maybe so, though such ebullience after such a big run in front of a psychologically important 12,000 level on the Dow is one of those things that makes many investors go hmm.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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