Stocks rallied to the finish line Tuesday, led by financials, after Lehman Brothers announced plans to raise more capital and two European banks disclosed write-downs.
The Dow Jones Industrial Average kicked off the new quarter with a gain of more than 3 percent. The S&P 500 index and Nasdaq also gained more than 3 percent, marking the third time in two weeks that all three major indexes posted gains above 3 percent in the same day. The last time this happened three times in such a short period of time was October 2002.
The CBOE Volatility Index, or VIX, tumbled more than 11 percent.
As market participants poured their new-quarter money into stocks, commodities receded. Oil fell for a third straight sesson, settling around $100.98 a barrel on the New York Mercantile Exchange. Gold fell to a two-month low below $880 an ounce. The dollar gained against both the euro and yen.
Lehman Brothers shares rocketed 18 percent Tuesday after the investment bank made its boldest move yet to stave off short sellers looking to make it another Bear Stearns, announcing that it has sold $4 billion of convertible preferred sharesin an already oversubscribed offering.
The market's response wasn't so much about another bank raising money, analysts said, it was the terms of the offering that provided an endorsment of the bank's financial situation. The shares were priced with a dividend yield of 7.25 percent and at a 33 percent premuim to the stock's closing price Monday. And, the deal is already done -- the shares are already sold.
“Unfortunately, we’re in a market where perception trumps reality,” Lehman Brothers Chief Financial Officer Erin Callan told CNBC.
This is an industrywide problem, Callan said, but last week, “we, in particular came under the white hot lights around rumors and suppositions with respect to the strength of our firm.”
“We didn’t want to wait for it to get to a point where we were in a wholly defensive mode,” Callan said. “We felt it was necessary to make a strong statement."
As for dilution for existing shareholders, Callan said she thought the stock's rally today was an endorsement of the firm's view that "the dilution concern is minor relative to confidence in the organization.”
Punk Ziegel, which has a "buy" rating on Lehman stock, cut its price target to $46 from $51 and lowered its 2008 earnings forecast for the firm to $3.87 from $4.30 a share.
Thornburg Mortgage shares soared 20 percent after the provider of large residential mortgages said it successfully raised $1.35 billion in a last-ditch effort to avoid bankruptcy, but at a large cost to existing shareholders.
Fannie Mae also jumped 20 percent, while Freddie Mac gained 15 percent.
Before the opening bell in the U.S., news emerged of more write-downs from European banks, offering some market participants hope that we're nearing a bottom.
Swiss bank UBS , the hardest hit by the credit crunch in Europe, announced it will write down another $19 billion because of exposure to risky assets, bringing its total to $33 billion in write-downs since October 2007. UBS also said it was planning to raise 15 billion Swiss francs ($15.03 billion) through a rights issue, underwritten by a syndicate of banks led by JP Morgan, Morgan Stanley, BNP Paribas and Goldman Sachs.
Deutsche Bank made an unexpected announcement for 2.5 billion euros ($3.9 billion) in write-downs, saying market conditions had deterioriated significantly in recent weeks.
A lot of people jumping into financials think "we've seen the worst and we're done with it," said John Massey, a portfolio manager at AIG SunAmerica Asset Management in New Jersey. "A lot of people felt that way in December. That was a falsehood. We think that will continue to be a head fake."
In addition to the "worst is over" mentality, there is also optimism that actions by the Federal Reserve and the Treasury "spell out very clearly that they're not going to let the [financial] system collapse," said Chris Orndorff, head of equity for Payden & Rygel in Los Angeles.
"My concerns are that, while [financial] stocks may look cheap on a P/E basis right now, the 'E' part of the equation -- earnings -- might be falling faster than people are expecting," Orndorff said, "and therefore, stocks that appear to be cheap may, in fact, turn out to be expensive."
Orndorff expects that, overall, the market rally will continue for the next few months but the problems in housing and credit markets will take some time to work through the system. "This is going to be a market where you really need to be patient," Orndorff said.
Massey agrees.
"We keep asking ourselves, do we feel better today than yesterday?" Massey asked. "I haven't found anybody yet who does," he said.
"You'll have plenty of these false rallies for the time being," Massey said. "Probably for the rest of this year, quite frankly."
Carter Worth, chief market technician at Oppenheimer and a "Fast Money" contributor, told CNBC he's not coming in an hitting the "sell" button first thing but that doesn't mean it's time to jump into the market.
"Here's the critical thing: Does one have to be early? One of the most flawed concepts in all economic theory is first-mover advantage," Worth said. "You don't want to be the first mover. That's the guy with the arrow in his chest lying dead on the side of the road. You want to wait for things to develop."
Goldman Sachs lowered its forecast for Citigroup and Merrill Lynch, saying it expects significant write-downs for both firms amid deterioration in credit and equity markets. Goldman now expects Citi to post a loss of $1.55 a share amid write-downs of $12 billion, and pegs Merrill's loss at $2.45 a share on write-downs of $2 billion.
Morgan Stanley issued a note saying that investment banks are taking their worst hit to earnings in 20 years and that long-term returns on equities will suffer amid de-leveraging and tighter regulations on banks that will require them to hold more cash reserves to guard against future problems.
A better-than-expected reading on the manufacturing sector also fueled gains.
The Institute for Supply Management reported that its purchasing managers' index unexpectedly roseto 48.6 in March from 48.3 in February. However, the sub-50 reading points to contraction for a second straight month and new orders were the lowest since October 2001.
A separate report showed that construction spending fell 0.3 percent, less than expected, in February, marking the fifth straight month of decline. Economists had expected a 1 percent decline, the same as January.
Semiconductors also gave the market a boost, with the Philadelphia Stock Exchange semiconductor index up more than 4 percent. Among the sector's biggest gainers were Sandisk and Infineon Technologies .
Microsoft shares gained 4 percent as sources told Reuters the software giant sees no reason to increase its bid for Yahoo. Speculation has been swirling that Microsoft would -- or should -- raise its $44.6 billion offer.
IBM is under investigation by the U.S. Environmental Protection Agency over an $80 million bid it made in 2006 to modernize EPA financial systems and has been suspended from seeking new contracts with all U.S. agencies.
And Dell said it will save as much as $3 billion over the next three years as it cuts costs and lays off workers.
U.S. auto makers General Motors and Ford reported double-digit percentage declines in March salesamid a sharp drop in demand for trucks and SUVs and concerns about gasoline prices.
Still to Come:
WEDNESDAY: MBA applications; factory orders; oil inventories; Bernanke testifies; Earnings from Monsanto, Best Buy, Research In Motion
THURSDAY:Jobless claims; ISM services index; Fed's Yellen speaks
FRIDAY: Jobs report
Send comments to cindy.perman@nbcuni.com.