Market's fourth-quarter welcome rally fades

• Major stock indexes building on double-digit gains so far this year
• Investors welcome better-than-expected results of stress tests on Spain's banks
• Federal Reserve Chairman Ben Bernanke strongly defends monetary policy

NEW YORK -- Stocks mostly rose Monday after a widely followed index of manufacturing activity showed a gain in September and a report said spending on residential construction jumped 0.9% in August.

"The September ISM shows U.S.manufacturing is back in expansionary territory," says Cooper Howes, an analyst at Barclays.

The positive economic reports sent the Dow Jones industrial average 78 points higher or 0.6% by the close. The S&P 500 ended up 3 or 0.2%, while the Nasdaq composite was slightly negative, losing two points or nearly 0.1%.

But some of the rally's earlier momentum faded after Federal Reserve Chairman Ben Bernanke, in a speech to the Indiana Economic Club, Monday strongly defended the central bank's monetary policy, saying lower rates are necessary to reduce the unemployment rate.

The market's upswing was welcomed on the first trading day of the fourth quarter, boosted by the economic reports and a sigh of relief from investors following Friday's release of stress tests for Spanish banks which came in with a passing rather than failing grade.

Wall Street, which is bracing for the start of third-quarter earnings season and a key employment report due Friday, cheered the solid start to the week.

On Friday, the government reports how many jobs the economy created in September. Analysts are expecting roughly 100,000 new jobs, compared to 96,000 created in August, numbers that are too low to add to economic growth.

Investors, of course, have been worried about a weakening economy following the government's downward revision last week of second-quarter growth to 1.3% from 1.7%. Heading into today's trading session, the Nasdaq composite was up 19.6% for the year, the Standard & Poor's 500 index was up 14.6% and the Dow as up 10%.

Stocks could also be influenced by the first presidential debate Wednesday night, with President Obama facing off against Republican nominee Mitt Romney. The debate could shed more light on tax and other policies related to the economy and markets.

The better news out of Europe the past few days has also been a plus,creating a relief rally of sorts in the stock market. On Friday a independent auditor estimated that Spanish banks would require 59 billion euros ($77.6 billion) to recapitalize its banks under a negative economic scenario this year or next.

That was less than analysts had expected, according to Barclays, and allowed investors to refocus their attention on the state of global growth and other business fundamentals.

Earnings will also come into sharper focus as companies start reporting third-quarter earnings this week, although there are only a trickle of reports scheduled. Six companies in the S&P 500 report results this week.

"We now will head in to earnings season this week, which should heavily impact market direction in October," says Andrew Fitzpatrick,director of investments at Hinsdale Associates.

Wall Street, he says, has been bracing for lower earnings for a while now and that has yet to really materialize. Still, for every company in the S&P 500 that has issued a positive earnings pre-announcement for the third quarter, there have been 4.3 negative warnings, the weakest showing since the third quarter of 2001,according to Thomson Reuters.

Analysts expect profit growth to contract in the third quarter for the first time since the financial crisis. Analysts see S&P 500 companies posting negative profit growth of -2.1%

"There have been warnings from some companies that profits might be soft, due to exposure in Europe and China," Fitpatrick told clients in a research note. "But until we see that trend hold,earnings may continue to be a positive catalyst as the overall health of the corporate sector, measured by strong balance sheets, cost controls, high cash levels and low debt, helps to overcome margin pressure," says Fitzpatrick.

Markets around Europe ended higher Monday. An audit of 14 Spanish banks showed the lenders need an extra $77.6 billion in capital. That's roughly what was expected, and well within the amount Madrid can get from fellow European countries.

A slight improvement in a survey of the euro zone's manufacturing sector also helped. However, credit rating agency Moody's Investors Service might downgrade Spain's debt to junk status this week. That's likely to limit enthusiasm in Europe until the Moody's decision is known.

Germany's DAX stock index rose 1.5%, France's CAC-40 was up 2.4% and Britain's FTSE 100 rose 1.4%. Spain's Ibex 35 was up 1%.

Markets in China, Hong Kong and South Korea were closed for holidays. Japan's benchmark Nikkei 225 index fell after a closely watched survey showed confidence in the economy weakening.

The euro rose to $1.290. The yield on the 10-year Treasury note fell slightly to 1.624%.

Crude oil prices rose 23 cents, or 0.2%, to $92.42 per barrel in trading on the New York Mercantile Exchange.

Contributing: The Associated Press