Optimism Pushes Stocks to New Highs

Buoyed by tech and a Fed governor's comments, the major indices close at their highest levels in almost two years.
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Updated from 4:05 p.m. EST

Positive developments in the technology sector and renewed optimism that the

Federal Reserve

will keep interest rates low for the near future triggered a major rally Monday that took stocks to their highest closing levels in almost two years.

At the close, the

Dow

gained 134.22 points, or 1.3%, to 10,544.07; the

S&P 500

gained 13.74 points, or 1.2%, to 1122.22; the

Nasdaq Composite

jumped 40.68 points, or 2%, to 2047.36. It was the Nasdaq's biggest point gain since Nov. 24.

"The weekend remarks from Bernanke were helpful; they seemed to tell the market there is no need to worry about rates," said Larry Wachtel, market strategist at Prudential Securities. "Anticipation is also quite high for fourth-quarter earnings, given the lack of a confessional season."

"There continues to be a large appetite for stocks; the economy remains strong and growth is reaching global proportions," added Wachtel.

Volume on the NYSE was 1.57 billion shares. On the Nasdaq, 2.82 billion shares changed hands. In both cases, advancers beat decliners by a 2-to-1 margin.

On Sunday, Fed governor Ben Bernanke said the economy is recovering but "because inflation is so low today, monetary policy can afford to be more patient to ensure that the recovery is self-sustaining."

On Monday, the president of the Atlanta Federal Reserve Jack Guynn underscored that point, saying there is "little threat that inflation is poised to rise significantly."

But Gunn added a cautionary note: "If the economic expansion continues to build momentum and breadth, it will be appropriate at some point to bring policy back to a longer-run setting that is more consistent with noninflationary, sustainable growth."

In economic news, construction spending rose 1.2% to a record $934.5 billion in November, after October's 0.9% increase. Economists had expected a 0.5% rise.

In addition, the Semiconductor Industry Association said worldwide chip sales rose 25.7% to $16.1 billion in November. The report helped support the technology-lead rally.

Other Markets

Markets overseas closed higher. Germany's Xetra DAX added 0.4% to 4036, while London's FTSE 100 gained 0.1% to 4513. In Asia, Hong Kong's Hang Seng finished up 1.6% at 13,005 and Japan's Nikkei gained 1.4% to 10,825, following a long holiday weekend.

The 10-year Treasury note fell 1/32, yielding 4.38%. The dollar was close to its recent all-time low vs. the euro at $1.2678 and was also lower against the Japanese yen, after Bernanke said the risk of a dollar crisis was low.

The stock market gains came despite another jump in commodities prices. Crude oil futures surged 3.8% to $33.75 per barrel as meteorologists forecast extremely cold weather from Chicago to Boston later this week. In addition, gold futures jumped 2.1% to $424.80 an ounce, after setting a new 15-year high earlier in the day.

Will Higher Rates Roil Stocks?

While stocks rallied partly because of a favorable interest rate outlook Monday, some say warning signs are beginning to appear. Treasury yields backed up sharply on Friday, following an unexpected rise in the Institute for Supply Management's Purchasing Managers Index. The index surged to 66.2 in December from 62.8 in the previous month, sending the 10-year bond yield soaring to 4.38% late Friday from 4.247% late Thursday. An early stock rally quickly faltered following the news, sending the Dow and S&P 500 into the red before finishing the session.

Many market experts blamed Friday's equity market turnaround on the recent increase in interest rates; could higher interest rates, sparked by stronger-than-expected growth, threaten the longer-term trend for stocks? Most experts say yes, but they disagree on whether investors are focused on the level of bond market yields or the pace of actual rate increases.

"As the year goes on, interest rates and inflation will become more of an issue for the markets," said James Awad, chairman of Awad Asset Management. "It is currently a dark cloud hanging over the market, but in the short term, momentum is likely to drive stocks."

Byron Wien, U.S. equity strategist at Morgan Stanley, believes there is at least a 50% chance that interest rate hikes will trigger a down year for stocks. In his annual list of 10 surprises, Wien predicted: "Higher short- and long-term interest rates are too much for the equity market. After a rally early in the year, the S&P 500 runs out of fuel and closes at 1000 in December in spite of higher earnings, proving again it's best to buy when the outlook is bleak."

"If rates get up to 5% on the 10-year

Treasury bond, that could spell selloff for the equity markets," said Wachtel. "One of the biggest risks for stocks in 2004 is that growth is too good," sparking an unexpected policy response from the Fed. Awad agrees that a 5% yield on the 10-year is a key psychological level for stocks.

However, Daniel Morgan, fund manager at Noble Financial Group, is more concerned about the pace of rate hikes rather than their actual level. He believes the markets are ready for a gradual increase in rates, but warns that a sudden jump could be construed as a threat to continued expansion.

Movers

In corporate news,

Walgreen

(WAG)

said it earned 25 cents a share in its fiscal first quarter, in line with analysts' expectations and a 4-cent improvement over last year. The stock lost 68 cents, or 1.9%, to $35.03.

Siebel

(SEBL)

said Monday that it expects fourth-quarter earnings of 8 cents a share on revenue of $365 million. This compares with analysts' estimates for a profit of 6 cents a share with revenue of $349.7 million. Shares of the company were up $1.18, or 8.4%, at $15.17.

Another mover was

Repligen

(RGEN) - Get Report

, whose shares plunged $1.74, or 41.8%, at $2.42. The company said Monday that its treatment for autism failed to prove effective in a late-stage clinical trial. WR Hambrecht downgraded the stock to hold from buy following the news.

In other earnings-related news,

Eli Lilly

(LLY) - Get Report

said it sees first-quarter profit of 65 cents to 67 cents a share, below the consensus expectation of 67 cents. In addition, the firm said it expects full-year 2004 earnings of $2.80 to $2.85 a share, below the consensus of $2.92. Lilly shares slipped $1.08, or 1.5%, to $70.16.

Kmart

(KMRT)

said it will earn about $250 million in the first two months of its fourth quarter, due to strong inventory management and initiatives to control unprofitable promotions. The shares surged $5.50, or 23.9%, to $28.50.

And research action has

Pfizer

(PFE) - Get Report

upgraded to overweight from equal weight at Morgan Stanley. The stock improved 86 cents, or 2.94%, to $36.41.

SG Cowen upgraded

Dell

(DELL) - Get Report

to strong buy from outperform. The firm expects a recovery in corporate PC upgrades and expects Dell to improve market share. The company's shares advanced 91 cents, or 2.7%, to $35.20.

In addition, SG Cowen upgraded

Microsoft

(MSFT) - Get Report

to strong buy from outperform, citing strong growth prospects and a relatively modest valuation. The shares rose 63 cents, or 2.3%, to $28.08.

SG Cowen also upgraded

Agilent

(A) - Get Report

to strong buy from outperform, citing a modest valuation and the view that the company is in a strong position to benefit from a cyclical recovery. Agilent shares improved 53 cents, or 1.8%, to $29.33.

Tomorrow, the ISM Services index for December will be released, and is expected to improve slightly to 60.8 from 60.1 in November. In addition, factory orders are due out. Economists are forecasting a 1.5% decline in November after a 2.2% increase in the previous month.