NEW YORK (Reuters) - Stocks took their cues from Europe's troubled debt markets on Tuesday, staging a comeback rally to end up more than 1 percent as Spanish bond yields came off euro-era record highs.
Trading has been choppy this week as investors struggle for clarity over whether the $125 billion bailout for Spanish banks agreed over the weekend will be effective and have turned to bond yields as a thermometer for risk aversion.
Economically sensitive sectors that had sold off recently were the strongest performers, suggesting investors saw value in beaten down shares, while traders looked for an oversold bounce as the S&P 500 slipped back toward 1,300.
"We are just being held hostage by all the news flow," said Frank Lesh, a futures analyst and broker at FuturePath Trading LLC in Chicago. "I don't think anyone has a handle on this."
"Right now everyone has got a pretty short-term trading mentality," he said. "You have to be ready to abandon your thoughts and change your mind at a moment's notice."
Economically sensitive shares that rise and fall as fears ebb and flow were the biggest gainers. Materials, financial and industrial shares were up over 1.5 percent.
Boeing Co (BA.N) led the Dow, climbing 3.5 percent, helped by an upgrade by Sanford C. Bernstein, which said it saw a better outlook for the company's new Dreamliner plane.
For the week so far, the S&P is close to flat, reflecting the uncertainty in the market.
For the day the Dow Jones industrial average .DJI gained 162.57 points, or 1.31 percent, to 12,573.80. The Standard & Poor's 500 Index .SPX rose 15.25 points, or 1.17 percent, to 1,324.18. The Nasdaq Composite Index .IXIC added 33.34 points, or 1.19 percent, to 2,843.07.
The S&P financial sector .GSPF gained 1.7 percent, almost reversing Monday's decline. Bank of America Corp (BAC.N) said it will reduce its long-term debt by about $40 billion in the second quarter, reducing its interest expense by $230 million per quarter. Its shares rose 2.9 percent to $7.49.
The S&P 500 index lost 6.3 percent in May on concerns about the European financial crisis and signs of an economic slowdown in the United States and China.
Despite initial enthusiasm over the EU aid package for Spain agreed over the weekend, the S&P fell more than 1 percent on Monday on questions about the terms of the bank-rescue deal and the impact it could have on Spanish debt levels.
Trading was volatile during the day. Wall Street dipped earlier as yields on Spain's 10-year bond hit 6.86 percent, the highest level since the 1999 launch of the euro, pointing to stress in the nation's debt markets shortly after the bailout deal was agreed.
With the news flow so uncertain many traders are taking their cues from market levels, with 1,300 on the S&P 500 emerging again as a focus this week.
"We held 1,300 on the S&P, so OK I'll buy against it and here's what you got," said Lesh. "But do I have any confidence to be holding the positions or feel comfortable with it short or long? This stuff reverses against you and usually overnight."
"At this point I have at least a break-even stop so if the market does reverse it takes me out with no loss or a minimal loss," he said.
Volume was low for a third day. Around 6.2 billion shares traded hands on the NYSE, the Amex and the Nasdaq, about 12 percent below the 20-day moving average.
Data late Monday showed that short interest on the NYSE jumped 6.1 percent to 14.3 billion shares in late May, the highest level since early October, indicating an increased expectation that stocks will fall.
Investors are also staring down the barrel of upcoming elections in Greece. The ballot on Sunday is viewed as a major risk that could result in the country leaving the euro zone. But it could also spark a rally if the outcome favors Greece's bailout agreement with international lenders.
"It's certainly possible that we recover all the May losses, I think that is on the table," said Peter Jankovskis, co-chief investment officer at OakBrook Investments LLC in Lisle, Illinois.
Nasdaq (NDAQ.O) halted short sales of Zynga Inc (ZNGA.O) as shares of the social gaming company plummeted 10.3 percent on increased concerns that the craze for games on Facebook (FB.O) has already peaked. The stock was the most traded on Nasdaq.
Also in company news on Tuesday, shares of Michael Kors Holdings Ltd (KORS.N) jumped 7.6 percent to $41.10 after the designer clothing company reported a stronger-than-expected fourth-quarter profit and gave a full-year outlook that exceeded Wall Street's forecast.
Editing by Leslie Adler