Stocks Surge, Dow Ends Up 335 on Fed Rate Cut

Stocks closed with big gains on Tuesday as investors cheered the Federal Reserve's decision to cut interest rates more deeply than expected.

"The Fed gave us a little more than most of us had expected -- they are looking at the future and the U.S. economy is weakening -- I think that's why equities are responding to the upside," said Robert Doll, global chief investment officer of equities at BlackRock.

"This is a process that will take time to unfold so I think we'll have more volatility in both directions -- thankfully today's is to the upside," Doll added.

The Dow Jones Industrial Average closed with a gain of about 335 points, or 2.5%, the best one-day point gain for the blue-chip index since October 2002 and best performance on a percentage basis since April 2003. The Dow, now up 10% year to date, now sits just 261 points below the record close of 14000.41 set on July 19.

The benchmark S&P 500 closed with broad gains of 2.9% while the Nasdaq Composite rose 2.7%. The last time all three major indexes gained more than 2% in one day was Oct. 1, 2003.

Turbulent credit markets due to ongoing problems in the home mortgage sector prompted the Fed to lower interest rates by half a percentage point to 4.75%. The last time the U.S. central bank cut rates was June 2003 when Alan Greenspan was chairman.

"The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally," the Federal Reserve's Open Market Committee said in a statement.

"Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

In a related move, the Fed said it unanimously voted to lower the discount lending rate to 5.25%.

"Today's announcement is less important than where the Fed is headed for the rest of this year," said Andrew Schwarz, founder and manager for AGS Specialist. "The direction for the rest of the year is what's going to move the market. When it's all said and done, hopefully the Fed will do the right thing."

Buying was broad-based, with all of the S&P 500 sectors trading higher. Advancing shares outpaced decliners by about two to one on the New York Stock Exchange.

The financial sector jumped more than 2.7% news of the rate cut, while consumer discretionary stocks and basic materials each gained more than 2%. Meanwhile, safe-haven sectors such as health care and telecom lagged.

Earlier, the major markets moved higher in anticipation of a rate cut in addition to solid earnings from Lehman Brothers .

Lehman reported fiscal third-quarter earnings of $1.54 a share on revenue of $4.31 billion.  Revenue declined 3% from the year-ago period due to challenges the investment bank is facing from the subprime mortgage crisis but results still beat analysts' estimates of $1.47 a share in earnings on revenue of $4.3 billion.

"Lehman came out and for the first time we had some clarity on what the subprime problems," said Schwarz. "We have some other big banks reporting this week and I think the crystal ball becomes clearer at that point and I think we'll rally big."

Consumer electronics retailer Best Buy posted higher quarterly profit on Tuesday, helped by strong international results and demand for computing, home theater and video gaming products.  Best Buy reported earnings of 55 cents a share, compared with analysts' consensus forecast of 44 cents.

Bank of America , the second-largest U.S. bank, said late Monday that recent volatility in capital and credit markets will have a "meaningful impact" on third-quarter results at its corporate and investment bank.

Online brokerage E*Trade Financial warned Monday that it expected full-year earnings per share to be sharply below its previous forecasts as it increases provisions for bad loans, and writes down the value of some mortgage-linked securities.

Treasury prices declined sharply as investors shifted money out of bonds and into equities following the Fed decision.

In economic news, the August Producer Price Index (PPI), plunged by 1.4%, with falling food and energy prices leading the decline. That was a much sharper decline than the 0.3% economists polled by Briefing.com were expecting. The core PPI, which excludes volatile food and energy prices, climbed a greater-than-expected 0.2%.  Economists were expecting core prices to rise 0.1%.

European stocks finished sharply higher, with the banking sector rebounding after the U.K. government, the Bank of England and the banking sector's regulator issued a statement last evening that the government will guarantee the savings of depositors of beleaguered mortgage lender Northern Rock.

Asian markets closed on a bearish note, with financial shares falling.

New York light sweet crude futures closed at a record of $81.51 a barrel as traders bet that the Fed's easing will boost the economy and increase energy demand. Oil has closed higher in 15 of the last 18 trading sessions and has gained 34% year to date.

The CBOE Volatility Index fell sharply.

In other corporate news, Nasdaq weighed selling a piece of itself to an overseas investor to help it fight Borse Dubai in a bidding war for Nordic exchange operator OMX, the Wall Street Journal reported on its Web site, citing people familiar with the matter.

And IBM said it would start offering free word processing and other office software, joining a growing group of companies with free applications challenging a core Microsoft product.

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