Stocks Reverse Course Amid Conflicting Fed Signals

NEW YORK (MarketWatch) -- U.S. stocks turned higher after the Federal Reserve cancelled overnight repurchase operations, a move which the market first took to mean it was comfortable with liquidity levels in the system.

But the Fed later said it would again try to conduct the repurchase operation which it had to cancel earlier.

"If anything, it just goes to show how sensitive investors are to liquidity conditions," said Mike Malone.

The Dow Jones Industrial Average was up 36 points at 13,063, off an earlier low of 12,957. Of the Dow's 30 components, 17 advanced, led by financial stocks, including CitiCorp , which was up 1.8%, and J.P. Morgan up 1%.

Dow component Home Depot gained 0.8%.

The S&P 500 gained 7.5 points to 1,434, while the Nasdaq Composite climbed 12 points to 2,511.

At the New York Stock Exchange, volume hit 649 million shares, while declining issues slightly outpaced advancers 8 to 7. At the Nasdaq, 768 million shares were traded, and advancers beat decliners 5 to 4.

More credit woes

Stocks slid on Tuesday, with the Dow falling more than 200 points, amid further signs that trouble in the subprime mortgage market is prompting a tightening of credit.

Wednesday marks a key deadline for some investors because of a 45-day redemption notice period at several hedge funds.

Those, including some run by Goldman Sachs , are nursing heavy losses, and investors would have to make withdrawal requests by mid-week to get cash by the end of the third quarter. Other hedge funds have lock-up periods running as long as three years.

Japanese banks including Mitsubishi UFJ reported losses from subprime exposure on Wednesday, while the Financial Times reported Bank of America and Countrywide Financial have refused to lend money when hedge funds use mortgages, collateralized debt obligations and subprime securities as collateral.

Countrywide also was cut to sell from buy at Merrill Lynch, with the broker citing concerns about liquidity in the mortgage sector. Countrywide dropped nearly 3%.

"The best case scenario is we don't get any headlines regarding the subprime mess, and maybe we can weather the storm," said Peter Cardillo, chief market economist at Avalon Partners.

"But the [consumer prices] numbers are not serving as the cushion we had expected, at least in the early going."

KKR Financial Holdings announced the sale of $5.1 billion of residential mortgage loans, saying it will no longer invest in such assets, and may need to record a charge of up to $200 million. The company also got a downgrade from Lehman to equal-weight. Its stock fell 18%.

Tame inflation

The Labor Department reported a 0.1% July rise in the Consumer Price Index - a measure of price inflation on food energy and consumer products.

The Federal Reserve monitors the data for signs of rising inflation, the Fed's largest worry. The core consumer price, which excludes volatile food and energy prices, increased 0.2% for the second straight month.

Both the headline and the core reading were in line with economists expectations.

Manufacturing activity in the New York area continued at a healthy pace in August, the New York Federal Reserve Bank said.

The bank's Empire State Manufacturing index inched lower to 25.1 in August from 26.5 in July. Economists were expecting the index to fall to 19.0.

Movers

Goldman cut drinks and snacks giant PepsiCo to neutral from buy, citing valuation. The broker told clients it sees stronger potential upside for Molson Coors Brewing , which it separately upgraded to buy.

H.J. Heinz Co. said it expects to report fiscal first-quarter sales growth of about 9% and earnings per share of 62 cents to 63 cents. Analysts, on average, expect the food company to earn 55 cents a share for the quarter.

Deer & Co.'s fiscal third-quarter earnings rose 23%, with te agricultural equipment maker reporting earnings for the quarter of $537.2 million, or $2.37 a share, compared with $436 million, or $1.85 a share, a year earlier.

Other markets

On the New York Mercantile Exchange, gold futures fell, with the contract for December delivery falling $4.90 at $674.80 on ounce.

Crude oil and gasoline prices rallied after the Energy Department reported large drops in weekly supplies. Crude oil futures advanced $1.11, or 1.5%, at $73.49, while gasoline futures added 3 cents, or 1.7%, at $1.007 a gallon.

Treasury prices were mostly flat, as investors shrugged off U.S. economic data to fixate on credit-market problems. The benchmark Treasury note was up 2/32 at 100 7/32, with its yield falling to 4.721%.

The dollar gained against its European rivals, but continued to lose ground against the yen, with the greenback down 0.1% against the yen at 117.3 yen. The euro was down 0.3% at $1.3493.

By Kate Gibson