Dow Rallies To a Record Close; Credit Fears Easing

By Tomoeh Murakami Tse
Washington Post Staff Writer
Tuesday, October 2, 2007

NEW YORK, Oct. 1 -- Stocks kicked off the fourth quarter with a strong rally Monday, with the Dow Jones industrial average closing at an all-time high despite warnings from two major investment banks that they would be hit by substantial losses from the ongoing credit crunch.

The rally came as investors bought shares of small companies and ventured back into the banking and housing sectors. These areas have been battered in recent months as investors sought safety in Treasury bonds and shares of multinational companies during the turmoil in the subprime mortgage sector.

The Dow, made up of 30 blue-chip companies, rose 191.92, or 1.4 percent, to 14,087.55. It comfortably surpassed its previous record of 14,000, reached July 19. The Standard & Poor's 500-stock index, a broader market measure, rose 20.29, or 1.3 percent, to 1547.04, just six points from its all-time high. The tech-heavy Nasdaq composite index rose 39.49, or 1.5 percent, to 2740.99.

That the stock market broke into record territory so soon after the summer's credit squeeze caught some traders and money managers by surprise, even with the Federal Reserve's move two weeks ago to cut its benchmark short-term interest rate by a half a percentage point. Some analysts warned that conditions in the credit market were still fragile and that many risks remained for the economy.

"This is something of a false rally," said Randy Bateman, chief investment officer at Huntington Advisors. "I think [the subprime mortgage turmoil] has got far-reaching tentacles. I think the Fed recognized that as well, and that's why they moved so aggressively, which set off this market recovery. But the fact that they are concerned enough to do that gives me even more pause."

News from the corporate sector was far from positive.

Citigroup said its third-quarter profit would shrink 60 percent compared with a year ago, with $2.7 billion in write-downs for assets, including loans of leveraged buyouts and securities backed by subprime mortgages. Citigroup closed at $47.72, up $1.05, or 2.3 percent. For the year, the stock has lost 14.3 percent.

UBS, the Swiss bank, said it would report its first quarterly loss in nine years. The company said it would write down $3.4 billion, largely in subprime mortgage-related securities in the United States, when it reports third-quarter results Oct. 30. UBS also said it would restructure its management and cut about 1,500 jobs. UBS closed at $54.94, up $1.69, or 3.2 percent. The stock is down 8.9 percent for the year.

Such statements from the world's biggest banks might have been enough to cause a panic in what was a jittery market just a month ago. But on Monday, they served to calm and encourage investors who believe that this is as bad as it's going to get, analysts said.

"The question really is, 'Is this the end of it or not?' " said Axel Merk, portfolio manager of the Merk Hard Currency Fund. "For whatever reason, the market wants to see the glass as half full. I just think we need to see more." An area to watch, some analysts said, is the impact of the rapidly unwinding leveraged-buyout boom. In recent years, Wall Street firms have made a handsome profit underwriting corporate buyouts led by private-equity firms. Until recently, investment firms that underwrote the buyouts were able to sell the debt to yield-hungry investors. Now, as investors start to pull back, the banks face the possibility of having to hold billions of dollars in bridge financing as permanent loans on their books.

Among home-building stocks, Lennar closed at $23.27, up 62 cents, or 2.7 percent, and Pulte Homes closed at $14.79, up $1.18, or 8.7 percent.

Some market analysts also cautioned against reading too much into the recent market rally, which was made on low trading volumes.

Shares of many large companies, such as those represented in the Dow, have recovered because of investments in strong economies overseas and a weak dollar. Investors view these companies as being better able to ride out the credit crunch, unlike many mortgage companies, banks and home builders, which are trading far below their highs.

There are questions about the larger economy as well. Most adjustable-rate mortgages are scheduled to reset over the next several years, which could lead to higher foreclosure rates, lower home prices and less consumer spending.

"One of the things that hasn't been priced into the market sufficiently is the weakness in the consumer," Merk said. "That, in my view, is going to spill over into other parts of the economy."

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