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FINANCIAL MARKETS : Stocks Mixed at Quarter's End; Dow Off 11 : Markets: Bond yields ease, but analysts say an 8% Treasury rate is possible soon. Wall Street fears stocks' reaction.


Despite soaring interest rates, stocks posted surprising gains in the third quarter that nearly offset first-half losses--and raised the tenor of the debate over what happens next.

The Dow Jones industrial average, which rocketed in late summer to within a stone's throw of its all-time high, eased 11.44 points to 3,843.19 on Friday.

Despite a selloff in the last two weeks, the Dow still finished up 218.23 points, or 6%, for the quarter and now is up 2.4% for the year to date--even as long-term bond yields hover just below 27-month highs, waiting for the economy's next move.

Some broader market indexes posted bigger gains in the quarter. The Nasdaq composite index of mostly smaller stocks jumped 8.3%, recouping most of its first-half loss and leaving it down just 1.6% for the year so far.

Indeed, analysts say the distraction of rising interest rates may have caused many investors to lose track of how powerful a recovery stocks enjoyed in the quarter.

Yet the split performances of U.S. stock and bond markets in the summer also are Wall Street's greatest source of anxiety today. Unlike in winter and spring, when stocks dove as interest rates jumped, share prices rallied in the third quarter even as rates pushed higher.

With the 30-year Treasury bond yield at 7.81% on Friday, up from 7.61% at the end of the second quarter and 6.35% at Jan. 1, many analysts believe that a few more reports of strong economic growth could be enough to push the bond yield to 8%.

That could happen in tandem with the next Federal Reserve Board move to raise short-term interest rates, which some economists believe may occur even before the November election.

Wall Street's fear is that another surge in bond yields will spark a renewed plunge in stocks, in part because institutional investors may decide to sell stocks and buy bonds should yields hit the psychologically important 8% level.

"Our guess is that the whole world is making reservations to dine on an 8% long bond yield," said William Dodge, market strategist at Dean Witter in New York.

A jump in yields could punch the Dow down as low as 3,550, Dodge said. That would be an 8% decline from Friday's close.

David Shulman, strategist at Salomon Bros. in New York, believes the market is already in the midst of a sharper pullback on the order of 10% to 12%. The fact that it's October, a month with a nasty reputation for hosting market crashes, won't help investor psychology in the short run, he said.

Yet some pros believe the fourth quarter will bring a rally rather than a dive, precisely because so many people expect trouble.

"I'm bullish," says Ron Elijah, who has steered the Robertson Stephens Value Plus stock mutual fund to a 15% rise this year. Recent reports of continued economic strength "are ancient history," he said. Investors "are missing the point--the economy is slowing down," he contends.

Once that becomes apparent in the fourth quarter, he said, "the bond market will get better" and stocks will enjoy a "relief" rally.

Other money managers believe that healthy third-quarter corporate earnings reports will have the same positive effect on stocks this fall that strong second-quarter reports had in the summer.

But some Wall Streeters warn that, given the market's flat performance so far this year, it isn't clear whether stocks are forming a base from which a new rally will spring or a top that will give way to a bona fide bear market.

In other markets, third-quarter action was mixed:

* Major European markets failed to follow Wall Street higher. Frankfurt's DAX index was off 0.7% for the quarter and remains down 11.2% for the year. London's FTSE 100 stock index, which jumped 33.8 points to 3,026.3 on Friday and gained 3.7% for the quarter, is still off 11.5% for the year.

* Many Asian and Latin American markets resurged in summer, after plummeting with U.S. shares in the first half. Mexico City's Bolsa index rose 28.6 points to 2,746.11 on Friday, bouncing back from a mid-week selloff that followed another political assassination. For the quarter, the Bolsa jumped 21.4%.

But Tokyo stocks, the first half's global leaders, were hit by profit taking in the third quarter. The Nikkei index fell 51.31 points to 19,563.81 on Friday and was off 5.2% for the quarter.

* In commodities trading, near-term gold futures closed at $394.20 on Friday, down $1 on the day. For the quarter, gold rose $8.40, or 2.2%, as the economy's resilience sparked new inflation fears.

But the CRB index of 21 key commodities closed the quarter at 229.85, down marginally from 230.03 on June 30.

* The dollar jumped compared to the Japanese yen Friday on optimism about a U.S.-Japan trade pact before the midnight deadline. The dollar rose to 99.15 yen in New York from 98.65 on Thursday, but it is only slightly above its July 1 level of 98.50.

U.S. Stocks: Good Quarter, Flat Year

Led by smaller stocks, Wall Street rallied briskly in the third quarter despite rising interest rates. But for the year to date most major U.S. stock indexes are down marginally, while foreign markets are mixed. Changes, in percent:

Nasdaq composite: 3rd quarter: +8.3% Year to date: -1.6%

S&P mid-cap: 3rd quarter: +6.2% Year to date: -2.5%

Dow industrials: 3rd quarter: +6.0% Year to date: +2.4%

NYSE composite: 3rd quarter: +4.2% Year to date: -1.4%

S&P 500: 3rd quarter: +4.1% Year to date: -0.8%

Foreign Shares

Market (index) Qtr. (% change) Y-T-D (% change) Mexico City (Bolsa) +21.4 +5.5 Hong Kong (Hang Seng) +8.7 -20.0 London (FTSE-100) +3.7 -11.5 Frankfurt (DAX 30) -0.7 -11.2 Paris (CAC 40) -0.7 -17.1 Tokyo (Nikkei 225) -5.2 +12.3

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