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Dow Gains 3.5% in Financial-Led Rally

So much has happened in the last week it's enough to make your head spin, and yet, the headline today is the same as it was last Tuesday: Stocks have their best day in five years.

Today's rally was, like last Tuesday, led by financials. This time the cause was better-than-expected earnings from investment banks and the Federal Reserve's larger-than-usual rate cut.

The Dow Jones Industrial Average closed up more than 400 points, or 3.5 percent, with all 30 components higher. It was the Dow's biggest one-day point gain since July 2002, though it was only the biggest percentage gain since last Tuesday, when the Fed announced plans to expand its securities-lending program, spurring stocks to their best performance in five years. The blue-chip average is now down only 6.6 percent from the beginning of the year.

Advancers outpaced decliners, 7 to 1, on the New York Stock Exchange.

The S&P 500 index gained 4.2 percent, marking its best percentage gain since October 2002. The Nasdaq gained 4.2 percent, its biggest percent gain since March 2003.

The Fed lowered its target for the federal-funds rate, the rate banks charge each other, by three-quarters of a percentage pointto 2 1/4 points, its lowest level since February 2005. It also lowered the discount rate, the rate the Fed charges banks, by three-quarters of a percent point to 2 1/2 percent.

In a statement accompanying its decision, the Fed said that financial markets "remain under considerable stress," though it "expects inflation to moderate" in the coming quarters.

Most importantly to the market, policy makers left the door open to further rate cuts, saying that the committee "will act in a timely manner as needed to promote sustainable economic growth and price stability." (Read the Fed statement.)

The market, which had expected a more aggressive rate cut of a full percentage point, had been staging a highly unusual rally for a rate-decision day, following better-than-expected earnings from Goldman Sachs and Lehman Brothers. Typically, stocks idle until the decision is announced.

But investors slammed the brakes on the rally right after the Fed's decision, in what felt like a sort of teen-age pout over not getting their way. Sure, it was a larger-than-usual rate cut, but it wasn't the full percentage point they'd asked for.

"There may have been some initial concerns that the Fed had changed its objective ... but then the market reconsidered," said Brian Gendreau, investment strategist at ING Investments Management. The realization set in that, "Gee, things aren't as bad as we thought in the financial sector ... plus the Fed rate cuts ... it's like a mini-Christmas!" Gendreau said.

"I think what's really happening today is that people are really pleased and relieved with Lehman Brothers and Goldman Sachs earnings," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati.

If the CEO of Lehman had said "we're not having liquidity problems," the market wouldn't have been comforted. Instead, it delivered "good, hard facts that the company is indeed solvent and liquidity isn't an issue the way it was with Bear Stearns," Detrick explained.

Financials were the biggest gainers among 10 key S&P sector indexes, jumping more than 7 percent, after falling 33 percent since the start of the year.

Shares of Goldman Sachs gained more than 16 percent to finish at $175.59 after the largest U.S. investment bank by profits reported its earnings were cut in half, but topped estimates. Net income fell to $1.51 billion, or $3.23 a share, from $3.2 billion, or $6.67 a share, a year earlier, as the investment bank logged steep losses on corporate loans and other assets.

Shares of Lehman Brothers shot up 46 percent to $46.49, delivering the stock's best day on record. Lehman, which has been the center of speculation that it might be the next domino to fall in the credit crunch, reported its earnings plunged, but beat expectations. Net income fell to $489 million, or 81 cents a share, from $1.15 billion, or $1.96 a share, a year earlier. Lehman, which was long seen as a bond house but is now more diversified, cited lower bond-trading revenue for the sharp drop. Its shares rebounded, recovering the 19 percent it lost in the previous session and then some.

Lehman CFO Erin Callan batted down speculation that Lehman is the next to fallin an interview with CNBC. Lehman is unlikely to face the kind of liquidity crisis that Bear Stearns did since the Fed's weekend action to open its so-called discount window and allow brokerage firms to borrow directly from the central bank, Callan said.

"It certainly takes the question of liquidity off the table," Callan said. The discount window is "going to be actively used" by many brokerages, she said, adding: “We’ll be a participant. It’s a great opportunity."

Bear Stearns shares rocketed 23 percent to close at nearly $6 after a sell-off Monday triggered by JP Morgan's Fed-backed offer to buy the No. 5 investment bank for the fire-sale price of $2 a share.

"Options action in Bear Stearns is retaining all the nerve-racking swagger of its pre-crash levels today," Rebecca Engmann Darst, an equity-options analyst for Interactive Brokers, wrote in a research note. Early on in the session, speculation pointed to traders betting against the "derisory" nature of the $2-a-share offer but there was also talk that senior debt holders were buying up the stock, Darst wrote.

Looking at the whole sector, Morgan Stanley says it's time for the bears to ease up on financials and for shorts to cut their positions on large-cap banks. In a research report titled "Looking for a Bottom," the analysts said the yield curve is now steep enough that points to economic recovery, the Fed is acting aggressively, as evident by its offer of financing to primary dealers, and failure of an investment bank like Bear Stearns is simply part of the bottoming process.

It's yet to be seen if investors will heed the advice, but for today, rebounds were abundant in the financial sector. Among other notable names that recovered following Monday's pounding are: National City , MF Global and Swiss bank UBS . UBS, like Lehman Brothers, has also been rumored as potential casualty of the credit crunch.

The top 25 gainers on the New York Stock Exchange included some of the biggest losers in the subprime mortgage meltdown. Mortgage companies Fannie Mae and Freddie Mac, homebuilder Hovnanian Enterprises and the home lender most associated with the credit crunch, Countrywide Financial, all ranked near the top of the NYSE's leading gainers list.

Fannie Mae and Freddie Mac also bounced back, with both stocks gaining more than 25 percent, amid expectations that restrictions on the government-backed mortgage-finance companies will be loosened, helping them pump more money into the housing market.

Homebuilders also posted strong gains after Hovnanian Enterprises CEO Ara Hovnanian expressed optimism that the industry was ready to recover on CNBC's "Squawk Box." Hovnanian called on the Fed and Congress for aggressive action.

"They need to bring stability, whether it's through getting more availability of mortgages or whether it's bringing a tax credit into play so consumers can afford to buy a home or feel good about buying a home," Hovnanian said.

Shares of Countrywide Financial soared 25 percent.

After the closing bell, Visapriced its highly anticipated IPO at $44 a share, $2 more than the high end of its range. Visa raised $17.9 billion in the offering, making it the largest U.S. IPO ever. Shares of the world's largest credit-card company will begin trading Thursday on the New York Stock Exchange under the symbol, "V."

Tech stocks advanced after some optimistic outlooks from a few big tech names.

Yahoo rose after the Internet giant said it's positioned for "accelerated growth" in the next three years and expects to stay ahead of analysts' forecasts. The company reiterated that Microsoft's roughly $44 billion bid, which works out to $31 a share, undervalues the company.

Dell gained after founder Michael Dell said he expects the company's growth rate to exceed the rest of the industry, helped by strong growth in Asia.

"We expect to continue to grow faster than the industry, particularly in Asia," Michael Dell told a news conference during a visit to South Korea to meet clients and suppliers.

Among the few decliners in today's market, Amgen skidded after the government cut the rate it pays for the biotech firm's flagship anemia drug.

In economic news, wholesale prices rose 0.3 percent, as expected. Excluding volatile food and energy costs, core producer prices increased 0.5 percent. U.S. homebuilding projects started in February fell by 0.6 percent to a higher-than-expected annual rate of 1.065 million units. Building permits, an indicator of future building activity, dropped 7.8 percent.

Elsewhere in the market today:

Crude oil finished just shy of $109 a barrel after the rate decision, while gold pulled back about $25 to $978.50 an ounce in New York futures trading.

The dollar gained against both the euro and the yen .

-- Reuters contributed to this article.

This Week:

WEDNESDAY: Morgan Stanley earnings; Visa starts trading; Starbucks shareholder meeting; Crude inventories; New York Auto Show preview
THURSDAY: Weekly jobless claims; Philly Fed report; FedEx earnings; Bond market closes early
FRIDAY: Financial markets closed for Good Friday holiday

Send comments to cindy.perman@nbcuni.com.