FINANCIAL MARKETS : Inflation Fear Takes Toll on Stocks, Bonds

U.S. stocks fell for a third day after a report showing the economy is rebounding raised concern that interest rates will move higher and hurt corporate profits. Takeover activity helped temper the losses in stocks, but bond yields rose sharply.

“Too many people have been in the camp that rates and inflation are going lower,” said John Rogers, chief investment officer at Ariel Capital Management, which manages $1.6 billion. “We’ve become a believer that ultimately rates are going to go higher.”

Gains in Walt Disney Co. and Westinghouse Electric Corp.--each involved in the acquisition of a television network--helped the Dow Jones Industrial Average reverse most of its losses, adding about 11 points. The 30-stock index was down as much as 41.56 to 4666.91 before it pared its loss to 4700.37, down 8.1.

Acquisitions countered the lower prices in Dow stocks Caterpillar Inc., Exxon Corp. and DuPont Co. Disney benefited the most; its shares rose 2 7/8 to 61 1/2, one day after it offered $19 billion for Capital Cities/ABC Inc. And Westinghouse Electric Corp. advanced 1 1/8 to 14 3/4 after announcing a bid late today for CBS Inc. of $81 a share, or about $5 billion. CBS rose 1/4 to 78.

“The Disney-Cap Cities deal is a merger with a premium,” said Alan Ackerman, executive vice president at Reich & Co. “That’s going to bring a premium to other media mergers,” boosting shares of CBS Inc., among others.

But the broader market fell. The Standard & Poor’s 500 index, which was down as much as 5.39 to 556.67, took back some of its losses, reaching 559.64, down 2.42. Falling prices in semiconductor, telephone and oil shares led the index lower.

Declines in technology leaders Intel Corp. and Microsoft Corp. helped pushed down the Nasdaq Composite Index, which closed at 991.11, down 10.1.

About 13 stocks fell for every nine shares that gained on the New York Stock Exchange.

Signs that an economic rebound may jump-start inflation hurt shares of companies sensitive to swings in the economy--the so-called cyclical stocks.

Bond yields jumped to their highest level in more than a week after the National Assn. of Purchasing Management reported its purchasing managers’ index rose to a larger-than-expected 50.5 in July from 45.7 the month before. The 30-year Treasury bond ended at 6.90%, up from 6.84% Monday.

The news also hurt the dollar. In late New York trading, the dollar was quoted at 1.3762 marks, down from 1.3866 late Monday. The dollar also was changing hands in New York at 88.05 yen, down from 88.35.

Among market highlights:

* Shares of educational software companies, such as Minnesota Educational Computing Co., Sierra On-Line Inc. and Spectrum Holobyte Inc., also gained thanks to a takeover. Broderbund Software Co.’s acquisition of The Learning Co. for about $440 million in stock sent Learning’s shares soaring by as much as 44.8%. Learning Co. shot up 14 1/2 to close at 53 1/2. Shares of Broderbund lost 3-15/32 at 68-1/32.

The gains didn’t extend to other technology companies, though. Semiconductor and computer shares fell for a third day amid speculation expectations for the group’s growth have gotten too high. Intel shares dropped for a third day, falling 1 3/4 to 63 1/4, while shares of Microsoft gave up 1 point to reach 89 1/2.

Digital Equipment Corp., meanwhile, gained 1 7/8 to 40 1/4, even though it reported earnings that fell below analysts’ forecasts.

* Among individual shares, bellwether International Business Machines Corp. rose 3/4 to 109 5/8. Ralph Acampora, director of technical research at Prudential Securities, said IBM has broken through a key level and has the potential to rise in the long term to 160 or 200.

* Among initial public offerings, the stock of On Technology soared 3 3/8 to 18 3/8 and Jayhawk Acceptance was up 4 3/8 to 14 3/8 on the Nasdaq market.

* Caterpillar’s shares slid 2 1/4 to 68 1/8 and DuPont stock lost 1 point to 66. Aluminum Co. of America was down 1 point to 56.

Most foreign markets were quiet except in Tokyo, where the key Nikkei index ended sharply lower as arbitrage-linked selling and profit-taking by dealers on incentive-backed issues emerged in late trading. The Nikkei ended down 318.96 points to 16,358.57.

Hurricane Erin churned commodity markets, sending lumber prices jumping as lumberyards in the South bought supplies to rebuild after the storm passes.

Meanwhile, natural gas prices plunged following forecasts the winds will bypass offshore rigs in the Gulf of Mexico.