Stocks rally for third straight day on European optimism

Traders work on the floor of the New York Stock Exchange (NYSE) September 19, 2011.

NEW YORK (Reuters) - Stocks rose for a third straight day on Tuesday, pushing the S&P above 1,400 for the first time since early May, on growing optimism the European Central Bank would act soon to contain the euro zone's debt crisis.

Trading was light, which could distort the level of optimism investors truly have that Europe will follow through with adequate measures. ECB President Mario Draghi boosted hopes last week when he spoke of restoring calm to the euro zone's troubled bond markets.

Since then, good news from Greece and declines in borrowing costs for Spain and Italy from peaks above 7 percent have kept sentiment positive. The relative calm allowed the S&P to break through the psychologically important 1,400 level after trying unsuccessfully the past couple of sessions.

"If the ECB expands its balance sheet, it will keep pushing these bond yields lower, which can help these countries finance their debt, giving markets a bit of reprieve," said Joseph Tanious, global market strategist at J.P. Morgan Funds in New York. "It's likely we won't get anything official for a few weeks, and until then investors are likely to be skittish."

Summer holidays have added to light trading volume, which has contributed to volatility. Equities cut their gains just before the close on Tuesday, mirroring Monday's late-day action.

About 6.39 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, below last year's daily average of 7.84 billion.

The real tests for markets may come in September. The ECB is expected to face decisions about controlling the euro zone debt crisis and the Federal Reserve could take stimulus actions to aid the flagging U.S. economic recovery.

The Dow Jones industrial average .DJI rose 51.09 points, or 0.39 percent, at 13,168.60. The Standard & Poor's 500 Index .SPX was up 7.12 points, or 0.51 percent, at 1,401.35. The Nasdaq Composite Index .IXIC was up 25.95 points, or 0.87 percent, at 3,015.86.

Despite worries over the economies of Europe and the United States, investors have pushed the S&P 500 up more than 11 percent so far this year. Yield-hungry investors have kept buying stocks as U.S. and German government bond prices soar and yields hit historic lows.

Tuesday's advance was led by stocks in cyclical sectors like energy, materials and consumer discretionary, while defensive sectors like telecoms and utilities edged lower.

Energy stocks .GSPE rose 1.3 percent, helped by Chesapeake Energy (CHK.N), which jumped after it said it would sell some assets and spend less on new properties. The stock surged 9.4 percent to $19.37 and was one of the top percentage gainers in the S&P 500.

Banking shares .GSPF rose 0.5 percent, lifted by Morgan Stanley (MS.N), which was up 2.5 percent at $14.50.

"Despite what seems like a weekly scandal of some sort, the banks have posted incredibly large profits. The Fed has made it very easy for them to take on very little risk and make very large profits," said Randy Frederick, managing director of active trading and derivatives for Charles Schwab in Austin, Texas.

Watch and fashion accessory maker Fossil Inc (FOSL.O) soared 32 percent to $91.77 after it forecast growth in Asia and Europe.

With 82 percent of S&P companies having reported quarterly results, 68 percent have beaten profit expectations, according to Thomson Reuters data.

Pfizer (PFE.N) and Johnson & Johnson (JNJ.N) scrapped further studies of an experimental drug for Alzheimer's disease after the drug failed in a second trial. U.S.-traded shares of their partner, Elan Corp (ELN.N), dropped 0.9 percent to $11.15. Pfizer fell 2.1 percent to $23.74 and J&J edged 0.8 percent lower to $68.29.

A group of investors rescued Knight Capital Group (KCG.N) in a $400 million deal that kept the market maker in business, but existing shareholders were nearly wiped out. Knight closed 0.3 percent lower at $3.06, erasing gains of more than 3 percent from earlier in the session.

About 62 percent of stocks on the New York Stock Exchange closed higher while 61 percent of Nasdaq-listed stocks finished up.

(Additional reporting by Anna Louise Sussman; Editing by Kenneth Barry)