Stocks closed lower as last week's bank rally ran out of steam ahead of Wachovia's report. A resurgence in oil prices and disappointing cholesterol-drug study from Merck also dragged on the market.
The Dow industrials and S&P 500 index held above the bear mark but the Nasdaq fell back into the clutches of the bear, more than 20 percent below its recent high.
Light, sweet crude rose more than $2 a barrelto settle at $131.04 a barrel .
A handful of financials held gains through to the closing bell, including Bank of America, Wachovia and AIG.
Bank of America, the second largest U.S. bank, posted its fourth straight quarterly revenue decline but the results surpassed forecasts. The earnings of 72 cents a share were 40 percent higher than the consensus estimate of 53 cents a share.
Bank of America is the latest in a string of banks to top forecasts, buoying hope for the financial sector.
Citigroup , Wells Fargo and JPMorgan topped expectations when they reported last week.
"Four of the five leading banks have come out with less negative-than-expected earnings, including Wells Fargo, which raised its dividend 10 percent last week," Al Goldman, chief market strategist at Wachovia Securities, told Reuters. "The financials are acting as if most of the bad news is more than fully discounted."
"We are in a bear market and counter-trend rallies are sharp and steep, but, all too often, brief," cautioned Vince Farrell of Scotsman Capital Management.
If Bank of America and Wachovia "can mildly surprise as Citi did last week with results that beat very negative expectations we will probably move higher," Farrell wrote in a guest-blog post. But Bank of America had the likelier chance of delivering a surprise and it "[c]an't be good news coming from WB," Farrell wrote.
Offering an indication of just how jittery this market is: BankAtlantic Bancorp is suing a prominent bank analyst, Ladenburg Thalmann's Richard Bove, for a report titled, "Who Is Next?" in the wake of the federal takeover of IndyMac bank.
Alan Levan, BankAtlantic's chairman, said in a statement that BankAtlantic's financial condition shows that the bank does not belong on any list of which lenders might be "next" to fail.
AIG was the biggest gainer on the Dow, climbing 5.8 percent, after Bank of America raised its rating on the insurer's stock to "buy" from "neutral," citing a "very attractive" risk-to-reward ratio.
AIG stock should rebound as the insurer's new chief starts pruning the company's sprawling businesses, BofA analyst Alain Karaoglan said in a note to clients.
Meanwhile, a large union has urged Citigroup to break itself up, saying the bank had become "too big and unwieldy to properly oversee." But a Citigroup spokesman said CEO Vikram Pandit had improved the bank's balance and governance since his appointment in December.
Overall, the banking system remains sound despite a home mortgage crisis that could cause more problems, Treasury Secretary Henry Paulson said, adding that the economy needs months to recover from its slowdown.
In economic news, leading indicators fell 0.1 percentin June after a downwardly revised 0.2-percent drop in May, the Conference Board reported. That month was initially reported as a small increase.
Adding to the dreary implications, Ken Goldstein, a labor economist at the Conference Board said, it "wouldn't take much to push the economy so that it's even weaker in the second half of 2008."
A separate report showed U.S. economic activity picked up last month but remained at a historically low level. The Chicago Federal Reserve said its national-activity index was minus 0.60 in June compared with a downwardly-revised minus 1.06 in May. The index has been negative since August 2007 but the June reading was the highest since January and marked the second straight month of improvement.
Merck was the biggest decliner on the Dow, falling 6.2 percent, after the drug maker said a study showed Vytorin, its cholesterol-busting franchise with Schering-Plough, missed the mark on its primary and one of its secondary goals. Patients given Vytorin showed "no significant difference" than those given the placebo, Merck said. Also there were more cancer deaths in the Vytorin group than in the placebo, 39 compared with 23, but the study group was small, leaving open the possibility that it was due to statistical chance. The drug did, however, lower patient cholesterol by an average of 61 percent.
Schering-Plough shares took a bigger hit, falling 12 percent.
The companies delayed reporting earnings until after the closing bell, pending this Vytorin news.
Genentech hit a two-year high as Swiss drug maker Roche Holding offered to acquire all shares in the biotech company it does not currently own for $43.7 billion, or $89 a share, representing a 9 percent premium to Genentech's closing price on Friday.
Finally, a development in the Micro-hoo story: Yahoo investor Carl Icahn has been placed on the Internet search giant's board of directors in a move to settle a proxy fight between the two sides.
Icahn had led a protest over Yahoo's negotiating stance on a buyout offer from Microsoft.
Apple shares declined ahead of the company's earnings, due out after the closing bell. A New York Post article put the focus back on Apple chief Steve Jobs, saying concerns about his health have not abated more than a month after the company's developers' conference, when his appearance spurred speculation about a possible relapse of pancreatic cancer or other illness.
Shares of hand-held rival Research In Motion advanced.
Asian stocks rallied and European shares traded slightly higher while the price of oil hovered around $130.
TUESDAY: Earnings from Caterpillar, UPS, Wachovia, Lockheed Martin, SunTrust Bank, UAL, UnitedHealth, Yahoo and WaMu
WEDNESDAY: Weekly mortgage applications; weekly oil inventories; Earnings from AT&T, Boeing, ConocoPhillips, Pfizer, Philip Morris, Anheuser-Busch, Amazon and Pulte Home
THURSDAY: Weekly jobless claims; existing-home sales; earnings from Eli Lilly, MMM, Bristol-Myers, Dow Chemical and Xerox
FRIDAY:Durable-goods orders; consumer sentiment; new-home sales; earnings from Netflix
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