A summer merger Monday gave way to mellowness despite a flurry of deals and talk of more.

The stock market hovered around the flat line through most of Monday's session, ending down slightly. The

Dow Jones Industrial Average

finished down 0.2% at 13,612.98, while the

S&P 500

slipped 0.1% to close at 1531.05. The

Nasdaq Composite

ended the day flat at 2626.60.

Major averages dithered despite a dip in Treasury yields and buyout news, including a possible $40 billion bid for

Alcoa

(AA) - Get Report

by

BHP Billiton

(BHP) - Get Report

. Alcoa added 0.7% on the day.

News also emerged that

Dow Jones

(DJ)

may soon receive a counter-bid from

General Electric

(GE) - Get Report

and

Financial Times

publisher

Pearson

(PSO) - Get Report

, but its shares inched ahead by only a fraction. Lastly, burger chain

Wendy's

(WEN) - Get Report

put itself up for sale, though also cut its earnings forecast, sending shares down 3.7%.

After the closing bell,

Yahoo!

(YHOO)

announced that CEO Terry Semel is resigning. Co-founder Jerry Yang will take his place. Yahoo! was up 3% in the trading session amid rumors of Semel's move. After hours, the stock was recently up another 4.3%.

The main spoiler to a rally Monday was the National Association of Home Builders' report that its index of builder confidence fell to 28 in June, from 30 in May. The reading is the lowest in 16 years and weighed on shares of homebuilders such as

Centex

(CTX)

and

Toll Brothers

(TOL) - Get Report

. Any reading under 50 suggests builders believe single-family home sales conditions are poor.

With housing starts and housing-permits data for May out Tuesday morning, investors are on watch for the potential collateral damage of the recent rise in interest rates.

Indeed, investors continued to watch the bond market as the yield on the 10-year Treasury note fell to 5.14% by day's end, from 5.17% on Friday.

With bond yields stabilizing in a new range, strategists have started to assess what the new levels mean for stocks going forward. Many have ratcheted up their level of caution, reiterating or emphasizing new recommendations for large caps and defensive sectors.

Wachovia's chief investment strategist Rod Smyth cut his equity overweight position, to make room to add commodities, which he notes are good protection against inflation. Smyth writes the reward for owning stocks is not as attractive for the risk in the short run, given that bond yields are in a rising trend and stock market sentiment is excessively optimistic. Smyth says he's reduced his weighting of emerging market stocks, developed international equities, Japan, and the consumer discretionary sector, while he upgraded his weighting of the energy sector.

Indeed, energy stocks outperformed Monday as oil prices rose 1.6% to $69.09 per barrel. The Energy Select SPDR exchange traded fund gained 0.1% Monday while the Oil Services HOLDRs Trust ETF added 0.4% despite

Halliburton's

(HAL) - Get Report

1.2% decline following a Goldman Sachs downgrade.

Meanwhile, Standard & Poor's strategist Sam Stovall compares the recent move higher in rates to the start of a

Fed

rate hike campaign, which spells weakness in many sectors six to 12 months out. Since 1970, only the information technology sector has logged a positive return six and 12 months after a first interest rate hike, he writes.

Health care is positive 12 months out, on average, but not after six months. Indeed, eight of the 10 sectors he analyzes posted declines between 1% and 13% on average, six months after a rise in rates.

"We clearly see that higher rates are not appreciated by investors," writes Stovall, noting that the hardest-hit sectors are cyclical and interest rate-sensitive, such as financials, industrials, consumer discretionary and utilities. As a result, he recommends overweighting consumer staples due to its countercyclical nature, and health care because investors will seek out defensive stocks in the "aging economic expansion."

Citigroup's Tobias Levkovich takes a different approach to the rise in rates, noting that higher rates and a steeper yield curve will likely to contribute to a higher level of volatility in the markets over the next 18 to 24 months. The CBOE Market Volatility Index fell 3.7% to 13.4 Monday, but remains relatively elevated compared with readings between 10 and 12 through much of last year and early 2007.

When volatility rises, large-cap leadership becomes more pronounced, writes Levkovich. Indeed, the large-cap S&P 500 surpassed the small-cap Russell 2000 at the end of May on a year-to-date basis.

Levkovich notes that higher volatility does not mean that the stock market can't log gains. Rising volatility in the late 1990s, he notes, did not stall the stock market. But, investors could have an edge by taking a new approach to some sectors, he writes.

Sectors like information technology, pharmaceuticals and biotech sectors consistently fare better in periods of higher volatility, writes Levkovich. He adds that sectors like utilities, metals and mining, industrials, consumer services and consumer durables and apparel typically suffer. Financials reflect no consistent pattern in his research.

Alas, the summer doldrums have arrived.

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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