April 22 (Bloomberg) -- U.S. stocks retreated for the second time this week as concern that government stress tests will reveal weakness in banks snuffed out an early rally spurred by an unexpected improvement in housing prices.
Morgan Stanley, the fifth-biggest bank by assets, tumbled 9 percent after posting a wider-than-estimated loss, while KeyCorp tumbled 13 percent after BMO Capital Markets said credit problems are spreading. Wells Fargo & Co. fell 3.4 percent, erasing an earlier rally of 9.3 percent, after Chief Financial Officer Howard Atkins said "credit may not have turned yet."
The Standard & Poor's 500 Index lost 0.8 percent to 843.55, erasing a rally of 1.4 percent in the final 45 minutes of trading. The Dow Jones Industrial Average declined 82.99 points, or 1 percent, to 7,886.57, reversing an earlier 75-point gain.
"It was just a roller coaster," said Frank Ingarra, the Stamford, Connecticut-based manager of the $160 million Hennessy Focus 30 Fund that beat 98 percent of its peers in the past five years. "People are uncomfortable holding the financials for the whole day. The financials just fell out of bed."
The market's earlier advance came after AT&T Inc. posted better-than-estimated earnings, General Electric Co. reiterated its projection that its finance unit will be profitable and a gauge of home prices unexpectedly increased 0.7 percent in February from January, the first consecutive monthly gain in two years.
Gains Erased
The rally was reversed as concern grew that government stress tests will undermine confidence in banks. The Obama administration may direct banks that are judged to be short of capital to disclose how they are going to get additional funds when the government reveals the results on May 4, according to a person familiar with the matter.
Should the U.S. unemployment rate rise to 12 percent from its current 25-year high of 8.5 percent, then most banks will need to raise more capital, Paul Miller, an analyst at Friedman Billings Ramsey Group Inc., said in a Bloomberg Television interview.
"The higher we go the worse off these banks are going to be," Miller said during a Bloomberg Television interview today.
Morgan Stanley fell $2.21 to $22.44. The bank reported a loss of 57 cents a share, wider than the 8-cent deficit estimated by analysts as real-estate and debt-related writedowns overwhelmed trading gains. The company also cut its dividend to 5 cents a share from 27 cents.
KeyCorp, Wells Fargo
KeyCorp fell 90 cents to $6.15, the biggest decline in the S&P 500, after BMO Capital Markets downgraded Ohio's second- largest bank to "market perform" from "outperform," saying the company's "problem assets are spreading to other loan portfolios."
Wells Fargo & Co. dropped 63 cents to $18.18. Atkins said in an interview on CNBC that he doesn't know what the U.S. may say in their stress tests and told Bloomberg Television that "I don't want to say we're out of the woods yet." The second- biggest U.S. bank by market value rallied earlier after saying first-quarter profit rose 53 percent as borrowers rushed to refinance mortgages.
The S&P 500 Financials Index of 80 banks, insurers and investment firms closed down 3.8 percent after rising as much as 2.2 percent. The gauge is still up 68 percent from a 17-year low reached March 6.
Earnings per share decreased 25 percent on average at the 113 companies in the index that reported results since April 7. Analysts estimate that profits dropped for the seventh straight quarter, the longest stretch of declines since at least the Great Depression.
Prudential, Merck Drop
Prudential Financial Inc., the second-biggest U.S. life insurer, fell 5.7 percent to $24.32 after deteriorating results prompted Barclays Plc to downgrade the company to "underperform."
Merck & Co., the drugmaker buying rival Schering-Plough Corp., fell 2.4 percent to $22.97. GlaxoSmithKline Plc plans to release the first study to compare its cervical cancer vaccine with Merck's blockbuster Gardasil, more than a year after completing the research.
General Electric added 10 cents to $11.80. Chief Financial Officer Keith Sherin reiterated that GE's finance unit will be profitable this year, easing concern that the credit crisis would trigger a loss in the company's biggest business segment. The shares rallied as much as 6.7 percent earlier before paring gains as the market turned lower.
Caterpillar Inc. jumped 3.4 percent to $32.45 for the biggest rally in the Dow average. The world's largest maker of bulldozers and earth-moving equipment was upgraded to "overweight" from "neutral" at JPMorgan.
'Flooded With Earnings'
AT&T Inc. climbed 1.8 percent to $25.74 after reporting first quarter profit of 53 cents a share, topping the average analyst estimate of 48 cents. The company trimmed payrolls and encouraged customers to spend more on services such as text messaging.
"We've been flooded with earnings reports and most of them were either in-line or a little better than expected," said James Paulsen, who helps oversee $375 billion as chief investment strategist at Wells Capital Management in Minneapolis.
Of the S&P 500 companies that reported earnings from the close of trading yesterday through today's open, 22 beat the average analyst estimate and 10 missed, according to Bloomberg data.
Treasury 10-year yields touched 2.96 percent, the highest level since the day the Federal Reserve announced it would buy U.S. debt, after the home-price report added to signs the economy may be improving.
'Tail Risk'
The benchmark index has rebounded 25 percent from a 12-year low on March 9 as government efforts to fix the financial system and revive economic growth fueled speculation the first global recession since World War II will end.
The risk of "sizable moves" in global stock markets has abated over the last five months amid a decline in economic uncertainty even as the world faces its worst recession since World War II, according to Morgan Stanley.
Options markets suggest that the probability of so-called tail risks are "thinning" as investors sell contracts protecting against large swings in equities into the market, the brokerage said. By selling options, investors are betting they won't be exercised, allowing them to keep as profit the price paid.
The probability of a decline of more than 50 percent over the next 12 months in the S&P 500 is now 9 percent compared with 17 percent in November, it said. The brokerage based its prediction on S&P 500 skew, which measures the cost of options to bet on or protect against large swings.
To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net
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