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But assessments as to how close lawmakers were to a deal varied somewhat on Sunday afternoon.

U.S. Senate Majority Leader Harry Reid said on Sunday that despite progress, there was still "a ways to go" to get a deal to raise the $14.3 trillion U.S. debt ceiling.

Earlier, Senate Minority Leader Mitch McConnell, the top Senate Republican playing a key role in the negotiations to cut the deficit and permit a vote to raise the debt ceiling, said lawmakers were "very close" to a deal.

The possibility of an agreement raised hopes that a bitter, weeks-long partisan battle over cutting the U.S. deficit might be near a close.

"If we can put this to bed, we can go back to a normalized market -- one that trades on fundamentals and not fear," said Steven Wolf, managing director of investments at Source Capital Group in Westport, Connecticut.

David Plouffe, a senior adviser to President Barack Obama, cited general agreement on a plan to cut the U.S. deficit over 10 years in two stages: $1 trillion up front and the rest based on the recommendation of joint bipartisan committee.

Anxiety over the debt crisis and the U.S. economic outlook sent the S&P 500 lower last week, resulting in the worst week and month for the benchmark index since last August.

The CBOE Volatility index, Wall Street's "fear index," rose more than 40 percent, its biggest jump since May.

U.S. Treasury prices rallied last week as investors clung to relatively safe U.S. government debt and concluded that a weak economy meant the Federal Reserve would keep monetary policy accommodative for the foreseeable future.

A stock market rally prompted by a debt ceiling deal could be limited, however, by the U.S. economy's uncertain outlook, prospects that would not be helped by a debt ceiling plan based on fiscal austerity.

"Once the euphoria of having a deal is over, we will get back to the economy and that picture is not a pretty one," said Kevin Giddis, president of fixed income capital markets in Morgan Keegan in Memphis, Tennessee.

Government data released on Friday showed the U.S. economy stumbled badly in the first half of 2011 and came close to contracting in the January-March period.

Those data offered little hope that this week's data -- including July's employment report -- could turn the tide.

"Put it this way: putting all the debt deal concerns aside, the (stock) market would probably be here anyway," said Michael Marrale, managing director and head of sales trading at RBC Capital Markets in New York.

Any relief enjoyed by the stock market would probably come at the expense of the U.S. Treasury market which benefited from its safe-haven status during the debt ceiling conflict. That would lead to higher U.S. yields.

Still, any rise in U.S. Treasury yields resulting from diminished anxiety about the debt ceiling would be limited by the troubled outlook for the U.S. economy, circumstances that appear to ensure that the Federal Reserve's monetary policy will remain accommodative for a long time.

The recent retreat in stocks has put them in a precarious position from a technical perspective as the S&P 500 index moves closer to its 200-day moving average, a level which could bring about additional selling if the index breaks below it.

The benchmark index successfully bounced off the level on Friday after the early morning decline.

"That is the line in the sand that really divides things going maybe bad -- to things really turning bad," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont.

Even if a deal is struck, a possibility remains the United States could lose its triple-A credit rating if the terms are not draconinan enough to satisfy credit rating agencies.

Investors can still find some solace in corporate earnings. According to Thomson Reuters data through Friday, of the 327 S&P 500 companies that have posted earnings, 73 percent have reported results higher than analysts' expectations.

Companies due to report earnings this week include Kraft Foods Inc, Clorox Co, Pfizer Inc and Prudential Financial Inc.

But a weak economy combined with a debt ceiling bill that involves more fiscal restraint could hurt stocks later on.

"Companies have been able to offset a lack of demand by refinancing their balance sheets, but longer term, the sledding will be much tougher for equities and corporations," Giddis said. "We have to improve job growth for businesses to do well or for the equity market to do well."

In addition to weak economic data, corporate earnings, and U.S. debt ceiling developments, investors must remain prepared for any developments from the simmering debt crisis in the euro zone, which could further heighten investor angst.

"There are two things I keep my eye on -- one on Washington and one on Brussels, because between the two of them you never know which headline risk is going to hit you over the head next," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont.

(Editing by Bernard Orr)

Anxiety over the debt crisis sent the S&P 500 lower for five straight days, resulting in the worst week and month for the benchmark index since August. The CBOE Volatility index, Wall Street's "fear index," rose more than 40 percent for the week, its biggest jump since early May.

With four days before the United States loses its ability to borrow, U.S. President Barack Obama on Friday told Republicans and Democrats to stop bickering and find a way "out of this mess.

"Right now, overall the market is being totally driven by the debt situation, whether it is in Europe or the U.S.," said Rick Bensignor, chief market strategist at Dahlman Rose in New York.

The deadline for raising the U.S. debt ceiling has investors on edge. Volatility, currently at its highest since the earthquake in Japan, can be expected to increase as time runs out.

"You've got individual stocks that can make significant moves but the market itself collectively is being pushed and pulled by every headline and how the wind is blowing out of Washington at any given moment."

The recent slide has also put stocks in a precarious position from a technical perspective as the S&P 500 index moves closer to its 200-day moving average, a level which could bring about additional selling if the index breaks below it.

The benchmark index successfully bounced off the level on Friday after the early morning decline.

"That is the line in the sand that really divides things going maybe bad -- to things really turning bad," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont.

"If we take that out next week -- man, I'm not neutral, I'm short."

Even if a deal is struck, the possibility remains the United States could lose its prized triple-A credit rating if the terms are not stringent enough to satisfy credit rating agencies.

"You are definitely going to get the downgrade by S&P," said Ken Polcari, managing director at ICAP Equities in New York.

"You are still waiting on what the ultimate deal is going to be and it's just not going to be what everybody expects, so you are going to see disappointment in the markets."

Investors can still find some solace in corporate earnings. According to Thomson Reuters data through Friday, of the 327 S&P 500 companies that have posted earnings, 73 percent have reported results higher than analysts' expectations.

Companies expected to report earnings next week include Kraft Foods Inc, Clorox Co, Pfizer Inc and Prudential Financial Inc.

"Individual stocks, especially after earnings are trading on their own accord and you are seeing moves of 5 to 10 percent sometimes after earnings come out," said Bensignor.

But added pressure is coming from economic data, with the latest revision of gross domestic product showing the U.S. economy stumbled badly in the first half of 2011 and came close to contracting in the January-March period.

The flagging data offers little hope next week's data -- including July's employment report -- can turn the tide of the pressure.

"I don't think the market is pricing in very much for the possibility we don't get a debt deal done, given how bad the economic data has been," said Michael Marrale, managing director and head of sales trading at RBC Capital Markets in New York.

"Put it this way, putting all the debt deal concerns aside, the market would probably be here anyway."

As investors asses the debt ceiling debate, slowing economic data and corporate earnings, they must remain prepared for any developments from the simmering debt crisis in the euro zone, which could further heighten investor angst.

"There are two things I keep my eye on -- one on Washington and one on Brussels, because between the two of them you never know which headline risk is going to hit you over the head next," said Mendelsohn.

(Reporting by Chuck Mikolajczak; Editing by Kenneth Barry)

Anxiety over the debt crisis sent the S&P 500 lower for five straight days, resulting in the worst week and month for the benchmark index since August. The CBOE Volatility index, Wall Street's "fear index," rose more than 40 percent for the week, its biggest jump since early May.

With four days before the United States loses its ability to borrow, U.S. President Barack Obama on Friday told Republicans and Democrats to stop bickering and find a way "out of this mess.

"Right now, overall the market is being totally driven by the debt situation, whether it is in Europe or the U.S.," said Rick Bensignor, chief market strategist at Dahlman Rose in New York.

The deadline for raising the U.S. debt ceiling has investors on edge. Volatility, currently at its highest since the earthquake in Japan, can be expected to increase as time runs out.

"You've got individual stocks that can make significant moves but the market itself collectively is being pushed and pulled by every headline and how the wind is blowing out of Washington at any given moment."

The recent slide has also put stocks in a precarious position from a technical perspective as the S&P 500 index moves closer to its 200-day moving average, a level which could bring about additional selling if the index breaks below it.

The benchmark index successfully bounced off the level on Friday after the early morning decline.

"That is the line in the sand that really divides things going maybe bad -- to things really turning bad," said Paul Mendelsohn, chief investment strategist at Windham Financial Services in Charlotte, Vermont.

"If we take that out next week -- man, I'm not neutral, I'm short."

Even if a deal is struck, the possibility remains the United States could lose its prized triple-A credit rating if the terms are not stringent enough to satisfy credit rating agencies.

"You are definitely going to get the downgrade by S&P," said Ken Polcari, managing director at ICAP Equities in New York.

"You are still waiting on what the ultimate deal is going to be and it's just not going to be what everybody expects, so you are going to see disappointment in the markets."

Investors can still find some solace in corporate earnings. According to Thomson Reuters data through Friday, of the 327 S&P 500 companies that have posted earnings, 73 percent have reported results higher than analysts' expectations.

Companies expected to report earnings next week include Kraft Foods Inc, Clorox Co, Pfizer Inc and Prudential Financial Inc.

"Individual stocks, especially after earnings are trading on their own accord and you are seeing moves of 5 to 10 percent sometimes after earnings come out," said Bensignor.

But added pressure is coming from economic data, with the latest revision of gross domestic product showing the U.S. economy stumbled badly in the first half of 2011 and came close to contracting in the January-March period.

The flagging data offers little hope next week's data -- including July's employment report -- can turn the tide of the pressure.

"I don't think the market is pricing in very much for the possibility we don't get a debt deal done, given how bad the economic data has been," said Michael Marrale, managing director and head of sales trading at RBC Capital Markets in New York.

"Put it this way, putting all the debt deal concerns aside, the market would probably be here anyway."

As investors asses the debt ceiling debate, slowing economic data and corporate earnings, they must remain prepared for any developments from the simmering debt crisis in the euro zone, which could further heighten investor angst.

"There are two things I keep my eye on -- one on Washington and one on Brussels, because between the two of them you never know which headline risk is going to hit you over the head next," said Mendelsohn.

(Reporting by Chuck Mikolajczak; Editing by Kenneth Barry)

Growth in gross domestic product -- a measure of all goods and services produced within U.S. borders - rose at a 1.3 percent annual rate, the Commerce Department said. First-quarter output was sharply revised down to a 0.4 percent pace from 1.9 percent.

Economists had expected the economy to expand at a 1.8 percent rate in the second quarter.

In addition, fourth-quarter growth was revised down to a 2.3 percent pace from 3.1 percent, indicating that the economy had already started slowing before the high gasoline prices and supply chain disruptions from Japan hit.

Economists had expected the economy would show signs of perking up by now with Japan supply constraints easing and gasoline prices off their high, but data has disappointed. This and the sharp downward revisions to the prior quarters suggest a more troubling and fundamental slowdown might be underway.

There is also heightened uncertainty over the outlook because of the impasse in talks to raise the nation's borrowing limit and avoid a damaging government debt default.

The Treasury says the government will soon run out of money to pay all its bills.

Economists have warned that a debt default could push the fragile economy over the edge.

"The implications of more rancorous foot dragging would be bad for an economy already in a precarious state," said Julia Coronado, chief North America economist at BNP Paribas in New York. "Uncertainty continues to tax an already fragile recovery."

Data released on Friday showed the 2007-2009 recession was much more severe than prior measures had found, with economic output declining a cumulative of 5.1 percent instead of 4.1 percent.

The annual revisions of U.S. GDP data from the Commerce Department showed the economy contracted at an annual average rate of 0.3 percent between 2007 and 2010. Output over that stretch had previously been estimated to have been flat.

The economy needs to grow at a rate of 2.5 percent or better on a sustained basis to chip away at the nation's 9.2 percent unemployment rate.

CONSUMER SPENDING BRAKE SHARPLY

The March earthquake in Japan severely disrupted U.S. auto production. The resulting shortage of motor vehicles weighed on retail sales as consumers were unable to find the models they wanted. That combined with high gasoline costs to curb spending.

Consumer spending, which accounts for about 70 percent of U.S. economic activity, decelerated sharply to a 0.1 percent rate -- the weakest since the recession ended two years ago.

Spending grew at a 2.1 percent pace in the first quarter.

Motor vehicle production subtracted 0.12 percentage point from gross domestic product growth in the second quarter, after adding 1.08 percentage points to first-quarter GDP growth.

The composition of growth in the April-June quarter was weak and could prompt economists to dial down their expectations for a quick and solid rebound in the third quarter.

A smaller trade deficit , as imports slowed, was one of the main contributors to the rise in second-quarter growth, with businesses spending and inventory investment also adding to output.

Government spending declined again in the second quarter as state and local authorities continued to pare their budgets, even though defense expenditures rebounded at 7.3 percent rate after contracting at a 12.6 percent rate in the first three months of the year.

Home building rose at a 3.8 percent pace, while investment in nonresidential structures increased at an 8.1 percent rate.

The easing of the auto parts disruptions and a drop in gasoline prices could be a tail wind to third-quarter growth, but economists are concerned that June data was rather weak.

"All the data we got for June thus far suggest that as we entered the third quarter, we did not gain any momentum setting up for a good third quarter," said Christopher Probyn, chief economist at State Street Global Advisors in Boston. "We are not starting the third quarter on a positive note," said Probyn, speaking before the GDP report was released.

The report also showed a moderation in inflation pressures, with the personal consumption expenditure price index rising at a 3.1 percent rate after rising 3.9 percent in the first quarter. Excluding food and energy, the core PCE index rose 2.1 percent, the fastest since the fourth quarter of 2009, after rising 1.6 percent in the first quarter. It overshot the Federal Reserve's preferred 2.0 percent level.

(Reporting by Lucia Mutikani; Editing by Neil Stempleman)

Futures for the S&P 500, for the Dow Jones and for the Nasdaq 100 were down 0.4 to 0.6 percent. Europe's FTSEurofirst 300 .FTEU3 fell 0.9 percent, while Japan's Nikkei average .N225 dropped 0.7 percent.

House of Representatives Speaker John Boehner's failure to round up enough support for his plan on Thursday exposed a rift in the Republican Party that is hampering efforts to reach a compromise to raise the U.S. debt ceiling before a Tuesday deadline.

House Republicans are due to meet at 10 a.m. (1400 GMT) on Friday to discuss a way forward.

The Commerce Department releases its advance (first) estimate of Q2 GDP at 1230 GMT. Economists in a Reuters survey forecast a 1.8 percent annualized pace of growth compared with a 1.9 percent rate in the final Q1 estimate.

The Labor Department issues at 1230 GMT the Employment Cost Index for the second quarter. Economists in a Reuters survey expect a rise of 0.5 percent versus a 0.6 percent rise in the first quarter.

Chevron ,CVX.N>, the second-largest U.S.-based oil and gas producer, will report second-quarter earnings that are expected to rise as the higher prices for oil and robust refining margins help offset slightly lower total output.

At 1230 GMT the Institute for Supply Management-New York releases July index of regional business activity. In the previous month, the index read 535.3.

The Institute of Supply Management Chicago releases at 1345 GMT July index of manufacturing activity. Economists forecast a reading of 60.0 in the month compared with 61.1 in June.

Thomson Reuters/University of Michigan Surveys of Consumers release at 1355 GMT July final consumer sentiment index. Economists in a Reuters survey expect a reading of 64.0 compared with 63.8 in the preliminary July report.

Merck & Co (MRK.N) is expected to report double-digit profit growth from higher sales of its array of pharmaceuticals and from its growing animal-health business.

Economic Cycle Research Institute (ECRI) releases at 1430 GMT its weekly index of economic activity for July 22. In the prior week the index read 127.5.

The euro zone debt crisis also continues to be a concern to markets. Rating agency Moody's put Spain on review for a possible downgrade on Friday, adding to concerns that a Greek rescue package has done little to halt the spread of Europe's debt crisis.

Amgen (AMGN.O), the world's largest biotechnology company, is expected to post lower profit and revenue as sales of its once top-selling anemia drug Aranesp continues to erode.

Shares in Telenav Inc (TNAV.O) fell 23.5 percent to $13.75 after the bell on Thursday after the company announced results.

On Thursday the Dow Jones industrial average .DJI ended down 62.44 points, or 0.51 percent, at 12,240.11. The Standard & Poor's 500 Index .SPX was down 4.22 points, or 0.32 percent, at 1,300.67. The Nasdaq Composite Index .IXIC finished up 1.46 points, or 0.05 percent, at 2,766.25.

(Reporting by Atul Prakash; Editing by Greg Mahlich)

In his strongest threat of intervention so far, Finance Minister Yoshihiko Noda said that the yen was rising "too much" and deviating from Japan's economic fundamentals.

"Our stance is clear. We will take decisive action against excessive exchange rate volatility," Noda told parliament.

"I'd like to carefully examine how long we can leave current (exchange-rate) moves unattended."

Noda said he hoped to take appropriate action, in cooperation with the Bank of Japan, to address the currency's rise that was hurting exporters and threatening Japan's recovery from damage wrought by the March 11 earthquake and tsunami.

Data released on Friday showed factory output rose further in June and manufacturers expected more gains in July and August that would bring production close to pre-quake levels, but economists said the yen's rise was clouding the outlook.

Policymakers' repeated verbal warnings have not prevented the dollar from sliding toward the record low of 76.25 yen hit in March on growing fears of a U.S. debt default or credit downgrade. It did not move much on Noda's latest warnings and hovered around 77.81.

A senior BOJ official said the central bank was focusing on how recent yen rises could affect a still fragile economic recovery, suggesting its readiness to ease monetary policy further as early as next week if yen climbs further.

SOLO ACTION

Markets rule out a repeat of the co-ordinated intervention that the Group of Seven carried out in the aftermath of the devastating earthquake in March, but some see solo action by Tokyo as a possibility.

Japanese policymakers, alarmed at the persistent nature of yen rises amid a broad-based dollar weakness, see solo action as an increasingly viable option, although markets are skeptical how long its effect would last.

"Noda's verbal warning has escalated slightly," said Michiyoshi Kato, senior vice president at forex sales at Mizuho Corporate Bank.

"It's not about dollar/yen levels alone. Authorities are probably also watching stock markets. If the U.S. debt problem triggers risk aversion and pushes the yen up suddenly, and if that increases worries about the impact on Japan's economy, Tokyo may act."

Policymakers hesitant of intervention have pointed to the resilience of the stock market as a sign the damage to the economy has been contained so far.

But the Nikkei average fell below the psychologically important 10,000 mark and business lobbies have started to complain more vocally about the government's inaction over the strong yen. Noda said he was aware of business concerns.

The BOJ feels the yen rise has yet to severely undermine business sentiment but is prepared to ease policy further if the standoff in U.S. debt talks roils global markets.

"Japan's economy is just recovering from a big shock after the quake. We need to watch out for the negative impact yen rises could have on the economy through exports, corporate revenues and a worsening of business sentiment," BOJ Executive Director Masayoshi Amamiya told parliament on Friday.

Japan's economy is expected to exit recession and grow moderately in July-September as companies make steady progress restoring supply chains hit by the quake.

(Additional reporting by Tetsushi Kajimoto, Stanley White, Rie Ishiguro and Kaori Kaneko; Editing by Tomasz Janowski)

The world's biggest coffee chain, which is coming off a years-long restructuring that involved closing poorly performing stores to rekindle growth, on Thursday reported better-than-expected fiscal third-quarter earnings.

Seattle-based Starbucks joined a raft of other premium-positioned companies -- including burrito chain Chipotle Mexican Grill (CMG.N) and Whole Foods Market Inc (WFM.O) -- in reporting out-sized same-store sales gains.

"The higher end is alive and well," said RBC Capital Markets analyst Larry Miller. Steakhouses and seafood restaurants also had strong results, he said.

"Reports of the consumer's demise were greatly exaggerated," said Miller, who added that McDonald's Corp (MCD.N) and other restaurant chains showed surprising health during the latest quarter.

Sales at Starbucks' U.S. cafes open at least 13 months, and which yield about four-fifths of its revenue, jumped 8 percent in its fiscal third-quarter ended July 3. Analysts expected a 5.3 percent increase.

Traffic in its home market climbed 6 percent, while average spending per visit rose 2 percent.

Chief Financial Officer Troy Alstead told Reuters menu price increases accounted for the bigger part of the rise in spending, but customers were also buying more food.

Starbucks targets more affluent consumers than the typical U.S. fast-food chain. Those customers have fared better than their lower-income counterparts as the U.S. economy sputters, and they have resumed spending on discretionary items like $4 lattes and organic foods.

CATERING TO THE WELL-HEELED

Starbucks shares, which have benefited from a massive restructuring that slashed costs and shut over 900 poorly performing cafes around the world, are up 60 percent from a year ago. On Thursday, it said it would be adding a net 800 stores globally in 2012.

That expansion comes despite high unemployment and the uncertain outcome of the U.S. debt ceiling debate weighing on the minds of consumers.

Upscale diners seem less wary. Chipotle, which offers naturally-raised meats and organic produce where possible, saw same-restaurant sales jump 10 percent in the most recent quarter. Whole Foods, top U.S. seller of organic food products, said its identical-store sales jumped 8.1 percent.

The gains at Starbucks, Chipotle and Whole Foods outpaced a 4.5 percent rise in U.S. same-restaurant sales at McDonald's, one of the restaurant industry's top performers and the leader among fast-food chains.

"Our results are a little bit in contrast to what I still believe to be an uncertain and fragile environment out there," Alstead said.

Wall Street also was upbeat about the coffee chain's new partnership with Green Mountain Coffee Roasters Inc (GMCR.O), whose popular Keurig machines control about 80 percent of the fast-growing North American single-serve brewing segment.

The companies plan to begin selling Starbucks coffee and Tazo tea for Keurig machines at wholesale clubs, drugstores and supermarkets in North America this autumn, in time for the important winter holiday season.

Alstead said the partnership would generate 3 cents to 5 cents in incremental earnings per share in fiscal 2012.

Green Mountain shares soared more than 16 percent on Thursday, one day after it said that deals with the likes of Starbucks and newly public Dunkin' Donuts (DNKN.O) would brew up bigger profits.

Seattle-based Starbucks boosted its earnings forecast for this fiscal year to $1.50-$1.51 per share from $1.46 to $1.48 a share, previously. Analysts, on average, were expecting a fiscal 2011 profit of $1.50 per share.

It also forecast a 15 percent to 20 percent increase in earnings per share in 2012 and a 10 percent increase in revenue. The forecast is based on mid-single digit comparable store sales growth and the opening of net 800 new stores.

The 2012 forecast includes the expected contribution from the Green Mountain deal.

Starbucks' third-quarter net income rose 34 percent to $279.1 million, or 36 cents per share, beating analysts' average estimate by 2 cents per share, according to Thomson Reuters I/B/E/S. Revenue rose 12 percent to $2.93 billion.

Shares were up 1.3 percent to $40.50 in after-hours trade. That gain came after the shares added 2.6 percent in regular Nasdaq trade on Thursday.

(Editing by Edwin Chan, Bernard Orr)

Sales at U.S. cafes open at least 13 months jumped 8 percent in the quarter, more than the 5.3 percent rise analysts expected.

The world's biggest coffee chain gets roughly 80 percent of its revenue from the United States, where traffic was up 6 percent and average spending per visit rose 2 percent.

Chief Financial Officer Troy Alstead on Thursday told Reuters that menu price increases accounted for the bigger part of the rise in spending, but also that customers were also buying more food.

Starbucks targets more affluent consumers than the typical U.S. fast-food chain.

Those customers have fared better than their lower-income counterparts as the U.S. economy sputters, and they have resumed spending on discretionary items like $4 lattes and organic foods -- as evidenced by strong same-store sales results from chains like Starbucks, Chipotle Mexican Grill (CMG.N) and Whole Foods Market Inc (WFM.O).

Same-restaurant sales rose 5 percent for Starbucks' international business during the quarter.

Starbucks shares, which also are benefiting from a massive restructuring that closed more than 900 cafes and slashed costs, are up 60 percent from a year ago.

NET INCOME JUMPS

The Seattle-based company said net income for its fiscal third-quarter ended July 3 rose 34 percent to $279.1 million, or 36 cents per share, beating analysts' average estimate by 2 cents per share, according to Thomson Reuters I/B/E/S.

Revenue rose 12 percent to $2.93 billion.

Starbucks boosted its fiscal year earnings forecast to $1.50-$1.51 per share from $1.46 to $1.48 a share, previously. Analysts, on average, were expecting a fiscal 2011 profit of $1.50 per share.

The company also forecast a 15 percent to 20 percent increase in earnings per share in 2012 and a 10 percent increase in revenue. The forecast is based on mid-single digit comparable store sales growth and the opening of net 800 new stores.

Alstead said Starbucks has locked in coffee prices for the coming fiscal year as the market for beans remains volatile.

The company still expects commodity costs, particularly coffee, to take a 22-cent per share bite out of fiscal 2011 earnings.

"Coffee prices in '12 will be higher than '11 to the tune of 21 cents a share," Alstead said.

Shares rose to $40.84 in after-hours trade from their Nasdaq close of $39.98.

(Reporting by Lisa Baertlein, editing by Bernard Orr)

Initial claims for state unemployment benefits dropped 24,000 to a seasonally adjusted 398,000, the Labor Department said on Thursday.

Economists had forecast claims falling to 415,000.

The labor market took a beating in May and June, with the increase in nonfarm payrolls totaling only 43,000.

The drop in jobless claims last week below the 400,000 mark that is normally associated with a stable labor market will be welcome news for the economy after a recent string of weak data.

U.S. stock index futures rose on the report, while prices for Treasury debt pared gains.

"We've been surprised on the upside the past several weeks, but this drop does signal that in the most recent couple of weeks, employers are not laying off large numbers of individuals," said Patrick O'Keefe, director of economic research at J.H. Cohn in New York.

"What we're seeing is that the claims levels are returning to their more normal level, which is in a positive direction."

But an uncertain economic outlook, which has been further clouded by deadlocked talks to raise the nation's borrowing limit and avoid a damaging debt default and credit rating downgrade could hamper progress in the labor market.

The government is expected to report on Friday that the economy grew at a 1.8 percent annual rate, according to a Reuters survey, after a tepid 1.9 percent pace in the first three months of the year.

On Wednesday, the Federal Reserve said growth slowed in much of the country in June and early July.

A Labor Department official said there were no special factors in last week's jobless claims data.

The four-week moving average of claims, considered a better measure of labor market trends, fell 8,500 to 413,750.

The number of people still receiving benefits under regular state programs after an initial week of aid declined 17,000 to 3.70 million in the week ended July 16.

Data for the so-called continuing claims covered the survey week for the household survey from which the unemployment rate is derived. The jobless rate rose to 9.2 percent in June from 9.1 percent in May.

The number of Americans on emergency unemployment benefits rose 18,427 to 3.17 million in the week ended July 9, the latest week for which data is available.

A total of 7.65 million people were claiming unemployment benefits during that period under all programs, up 320,152 from the prior week.

(Reporting by Lucia Mutikani, Editing by Andrea Ricci)

* The S&P 500 .SPX fell 2 percent on Wednesday, losing nearly 3 percent for the week, hit by weak earnings and lackluster economic data and as U.S. politicians struggle to come to an agreement over the debt ceiling days before the deadline to avoid default.

* A bill to cut the U.S. deficit faced a nail-bitingly close vote in Congress on Thursday as the top Republican lawmaker sought to quell an internal revolt and push his plan to avoid a ruinous default.

* Approval of a plan by U.S. House of Representatives Speaker John Boehner would break the inertia in Washington over a U.S. debt crisis that has spooked markets and raised the prospect that the government of the world's largest economy will run out of money to pay its bills in less than a week.

* Investors were also closely watching jobless claims data due at 8:30 a.m. If the number for the week ending July 23 is near Wall Street's forecast of 415,000, it will mark the 16th consecutive week that initial jobless claims hover above 400,000.

* U.S. pending home sales probably fell about 2 percent in June after two months of unusual volatility, which included an 11.3 percent drop in April followed by an 8.2 percent rebound in May. The data is due at 10:00 a.m.

* S&P 500 futures rose 1.8 points and were slightly above fair value, a formula that evaluates pricing by taking into account interest rates, dividends and time to expiration on the contract. Dow Jones industrial average futures were up 12 points, and Nasdaq 100 futures gained 5.75 points.

* Exxon Mobil Corp (XOM.N), the world's largest publicly traded oil company, is among several companies to report results. High crude oil prices are expected to have boosted second-quarter profits, but investors have been pressing the company to deliver more cash to shareholders through a higher dividend.

* Others due to report include Starbucks Corp (SBUX.O).

* Financial stocks were in focus as major European banks announced jobs cuts. Swiss bank Credit Suisse (CSGN.VX) is cutting about 2,000 jobs after a second quarter hit by weak trading activity and the strong Swiss franc.

* HSBC (HSBA.L) may cut more than 10,000 jobs as it embarks on a cost-cutting drive, Sky News reported, citing people close to Europe's biggest bank.

* Ford Motor Co (F.N) plans to build a $900 million production plant in India, doubling its investment in the country, as the No. 2 U.S. carmaker seeks to catch up with rivals in the second-fastest growing auto market in the world.

(Editing by Padraic Cassidy)

The second quarter results released on Thursday come on the heels of a management shakeout that resulted in the departure of Markets divisions chief Devin Wenig and several other high-level executives.

Thomson Reuters Chief Executive Thomas Glocer is now taking direct responsibility for the division's turnaround.

Adjusted revenue in the Markets division, which competes with Bloomberg LP, News Corp's Dow Jones and FactSet Research, rose 1 percent from a year earlier to $1.9 billion, slowing from the 2 percent gain in the first quarter.

Overall company results were within the estimated range Thomson Reuters announced last week.

Revenue excluding divestitures was $3.20 billion, up 4 percent before currency adjustments, mainly due to a strong performance in the Professional division serving legal, accounting and other professionals.

Adjusted earnings per share rose to 51 cents from 41 cents in the same quarter last year. Analysts had expected earnings of 49 cents per share and revenue of $3.16 billion, according to Thomson Reuters I/B/E/S.

Thomson Reuters reaffirmed its outlook, saying it expected revenue to grow in the mid-single digits in 2011.

Net profit fell to 768 million Swiss francs ($958.9 million), the bank said on Thursday, below average analyst forecasts for 1 billion. Net new assets in private banking were 11.5 billion, below average analyst forecasts for 14.2 billion.

Switzerland's second biggest bank said it planned to cut about 4 percent of its staff of 50,700, about the same number it added in a post-crisis hiring spree focused on fixed income, the area hit most by current sluggish markets.

"We have to recognize the likelihood that the current headwinds in the economic and market environment may be more persistent than we would have hoped," said Chief Executive Brady Dougan and Chairman Urs Rohner.

"We expect interest rates to remain low for an extended period of time and the strong Swiss franc to continue to have an impact on our results. We may also continue to see lower levels of client activity and a volatile trading environment."

Investment banks worldwide have been hit by slow trading due to the debt crises in the euro zone and United States as well as post-crisis regulations aimed at forcing banks to hold more capital to protect them from future shocks.

Rival UBS said on Tuesday it would cut costs by up to 2 billion francs and push back targets after reporting disappointing second-quarter profits due to slow trading in fixed income, currencies and commodities (FICC).

Credit Suisse shares, which had already slipped after the UBS results, fell 2.8 percent at 0709 GMT, compared to a 0.9 percent weaker European banking sector.

"Q2 results are far below market expectations. The main reason for the very disappointing Q2 result was the investment bank," said DZ Bank analyst Matthias Duerr.

COST CUTS TO TARGET INVESTMENT BANK

Credit Suisse Chief Financial Officer David Mathers told a conference call for journalists that the cost cuts would hit all divisions but particularly the investment bank, and all geographies, with 500 of the job cuts to come in Switzerland.

The job cuts are part of a cost savings program aimed at reducing 1 billion Swiss francs in the expense run-rate during 2012. Implementation costs in 2011 would be 400 to 450 million francs, of which 142 million were taken in the second quarter due to jobs already cut in investment banking.

Credit Suisse said it would cut most of the jobs in low-return areas and continue to invest in growth businesses, including serving the ultra wealthy, emerging markets and rates and foreign exchange flow sales.

UBS and Credit Suisse face the added burden of high cost bases in Switzerland as the safe-haven franc soars.

Credit Suisse said pretax profit in investment banking dropped 71 percent to 231 million, with fixed income sales and trading results significantly lower due to challenging market-making conditions and moderately weaker client flows.

"Volatility in FICC revenues (are) also likely to raise concerns," said Cormac Leech of Canaccord Genuity, adding that the earnings miss was worse than that for UBS and he expected downgrades to 2012 earnings forecasts of 5-7 percent.

The bank said it was conducting an internal investigation after it said earlier this month it was being targeted by a U.S. investigation following the indictment of several of its bankers for helping Americans dodge taxes.

"This is a very serious issue and we're working hard to try to get a resolution," CEO Dougan told Reuters Insider.

CFO Mathers said the appointment of Hans-Ulrich Meister as new chief executive of private banking in addition to his role as CEO Credit Suisse Switzerland had nothing to do with the probe but was part of succession plans.

He noted that Walter Berchtold, who moves to become chairman of private banking, remained a member of the executive board.

(Editing by David Holmes and Andrew Callus)

European stock futures fell 1 percent in early trade, echoing losses in Asia and on Wall Street overnight.

The increasing possibility of a U.S. credit rating downgrade -- with Washington still in a stalemate over government spending -- is weighing on equity markets globally, though there have been no signs of panic selling.

The S&P 500 index finished down 2 percent on Wednesday .SPX, while the futures were up a touch on Thursday.

Fears of a U.S. debt default or downgrade and Europe's own sovereign borrowing crisis have overshadowed most other risks, just as the corporate results season gets going in Asia.

Japan's Nikkei share average was down 1.5 percent .N225. Clothing chain company Fast Retailing (9983.T), whose stock hit a 13-month high on Wednesday, was off 2.3 percent and led the Nikkei lower.

Hitachi Construction Machinery (6305.T), a subsidiary of Hitachi Ltd (6501.T), Japan's largest industrial electronics company, saw its shares jump 4.6 percent after posting a 65 percent annual rise in April-June net profits.

Japan's biggest consumer electronics makers are expected to show quarterly earnings slumped due to the March earthquake, but investors will focus on whether these companies can meet their forecasts for a swift recovery, given a fragile global economy.

"Buying on dips in companies with good earnings may continue, but exporters may not fare well for the time being as long as there are concerns about the U.S. economy," said Hideyuki Okoshi, general manager at Chibagin Securities in Tokyo.

Analysts in Asia Pacific have cut their estimates for September quarter earnings across sectors by an average 0.6 percent, according to Thomson Reuters Starmine's SmartEstimates, which give a greater weighting to more accurate forecasters.

Of these estimates, average downgrades were 4.9 percent for technology firms and 1.4 percent for industrial companies.

The MSCI index of Asia Pacific stocks outside Japan .MIAPJ0000PUS was down 1 percent, with technology, commodity-related and consumer shares the biggest drags.

The index is up 1 percent so far in July compared with a 0.9 percent fall in the MSCI all-country world index .MIWD00000PUS and a 1.2 percent decline in the S&P 500.

ASIA'S GOLDEN OPPORTUNITY?

However, the outlook for Asian earnings is still brighter than elsewhere globally.

Companies in emerging Asia Pacific are expected to generate earnings growth of 18.8 percent next year, exceeding the estimate of 15.8 percent for global emerging markets and 16.8 percent for the world in aggregate, according to Starmine.

However, valuations in some Asian markets do not reflect that premium. For example, Chinese companies are expected to post earnings growth of 20 percent next year, but are trading at 11.8 times 12-month forecast earnings, in line with the global average.

"Investors are now torn between the fear and danger of a U.S. default, even though most pundits still maintain that this will be avoided, and the potential of a golden opportunity to strike and pick up some stocks at bargain prices," said Ben Le Brun, CMC Markets analyst in Sydney.

The Australian dollar has been an attraction for investors in currency markets looking for opportunities in the midst of debt crises in the United States and the euro zone.

The currency rose 0.3 percent to $1.1050, not far from a post-float high of $1.1081 on Wednesday after Australian inflation data.

Having stayed above $1.10 even after the S&P 500 fell 2 percent, the Australian dollar may be forming a base from which it will gradually head higher, analysts said.

Of course, flows into Asia Pacific have reversed quite quickly in the past.

Three years ago as the global financial crisis was coming to a boil, the Australian dollar made a post-float high at $0.9851, with the market convinced that Australia was insulated from the West's sub-prime mortgage fallout. Three months later the currency had dropped to a low of $0.6007.

REDUCING EUROPE EXPOSURE

The euro was flat on the day at $1.4370, still well off its July low around $1.3835.

The deadlock in Washington over the U.S. debt ceiling has not pulled traders' attention away completely from the euro zone, where Italian and Spanish bond yields keep rising relative to German bonds and calm after a second bailout for Greece has evaporated.

Japanese fund managers slashed their euro-zone bond weighting to a record low and cut their U.S. bond allocation, while raising their Japanese bond weighting to a fresh all-time high, a Reuters poll showed.

After falling overnight on a less-than-stellar auction of new 5-year bonds, U.S. Treasuries stabilized. The benchmark 10-year yield was at 2.97 percent, a basis point above where it finished last night in New York.

Focus in credit markets would likely be on U.S. credit default swap rates with a ratings downgrade possible at any time. The 1-year CDS blew out to a record 85 basis points overnight, pushing out the difference over the 5-year CDS to more than 20 basis points.

Gold has also been a big winner as investors seek out hard assets to hedge against risks. Gold rose 0.1 percent to $1,615.04 an ounce after hitting an all-time high of $1,628 on Wednesday.

U.S. oil futures were down 15 cents to $97.25 a barrel, down a second day after hitting a one-month high. Brent futures were up 30 cents to $117.73 a barrel.

(Additional reporting by Ayai Tomisawa in TOKYO and Michael Smith in SYDNEY; Editing by Kim Coghill)

Once viewed as a maker of cheap cars with a poor quality record, Hyundai has been a stellar performer even during the global financial crisis, steadily increasing its global market share and nearly doubling its share price to a record high last month.

Its ability to sustain strong growth, however, will be put to the test in the coming months as Hyundai faces a strengthening won, rising competition and uneven global economic recovery. Its Japanese rivals are also quickly recovering to boost their production back to pre-earthquake levels.

"Solid growth will continue in the second half but it may lose some momentum as its Japanese rivals are recovering fast and that will provide a more level playing field for Hyundai, which has benefited from its rivals' struggle in the first half," said Ko Seung-jae, a fund manager at Dream Asset in Seoul.

"It's shares are unlikely to fall from the current level but don't have much upside potential either, given the balance of risk factors," he said.

Shares in Hyundai Motor have jumped 40 percent this year, outperforming the wider market's 6 percent gain. The stock fell 1.65 percent after the results, versus a 0.85 percent drop in the KOSPI.

The stock has risen 10-fold in the past 10 years.

STRONGEST CHALLENGER

Hyundai has emerged as the strongest challenger to Japanese automakers, aided by improved product quality, a previously cheaper won, affordable prices and savvy marketing strategies.

The firm, the world's fifth-largest auto maker along with affiliate Kia Motors, on Thursday reported a 2.3 trillion won ($2.2 billion) net profit for the April to June quarter, compared with a consensus forecast of 2.1 trillion won from Thomson Reuters I/B/E/S.

That was up from a 1.7 trillion won net profit a year ago and from 1.9 trillion won in the first quarter, helped by record vehicle sales.

Hyundai said its global car sales rose 13 percent to a record 1.03 million vehicles in the second quarter from a year earlier.

Hyundai warned on Thursday a strengthening won, fiscal problems in Europe and new model launches by its rivals are major threats for its growth in the second half of this year.

"Overall, the global automaker environment will not be easy in the second half," Lee Won-hee, chief financial officer of Hyundai told analysts, after the results were announced. "We expect Japanese carmakers to adopt a strategy to aggressively expand market share in the United States and other markets."

Nissan Motor Co on Wednesday reported a smaller-than-expected 10.4 percent fall in quarterly operating profit as it recovered from a parts shortage that hammered the industry after the March 11 earthquake in Japan.

The won is among the best performing emerging-market currencies so far this year, up 8 percent against the dollar, and investors are betting the currency has more room to gain in the coming months.

From this year, Hyundai has been reporting earnings on a consolidated basis to reflect the earnings of its affiliates, including financial operations, under new accounting rules.

Hyundai's U.S. market share jumped to 5.5 percent in the second quarter from 4.7 percent a year earlier, driven by strong sales of its Sonata sedan and Elantra compact, while its Japanese rivals suffered from production disruptions.

Those steady gains led Hyundai to raise its U.S. sales target for this year by 6 percent to 624,000 vehicles.

Hyundai also gained traction in its home market, helped by brisk sales of its new Grandeur sedan.

($1 = 1,050.00 Korean Won)

(Additional reporting by Miyoung Kim, Ju-min Park and Tae-yi Kim; Editing by Matt Driskill and Jonathan Hopfner)

Visa Chief Executive Joseph Saunders, in a conference call with analysts, said the payment processor would introduce a network participation fee in the United States for all of its debit, credit and prepaid card services.

As part of the new policy, Visa also will lower the variable rate charged for transactions.

Visa's shift away from per-transaction fees is a large departure for the San Francisco-based company. It is being done in advance of new fee caps that take effect later this year as part of the 2010 Dodd-Frank financial reform law.

Saunders did not disclose what the participation fee will be, but said it will be based on a merchant's size, and the merchants' number of locations. He also said the new fees did not rule out future price changes.

Due to the overhaul and the new fee caps imposed by Dodd-Frank, Saunders said 2012 will be a "low point" for debit card processing fees.

"We won't do as well as we have," he said.

The new program comes as Visa reported better-than-expected fiscal third quarter results, and plans to buy back an additional $1 billion in shares over the next year.

For Visa, the quarterly results highlight consumers' increasing reliance on debit and credit cards rather than cash or checks to make everyday purchases.

"They're getting better results as consumers are shifting from paper to plastic," said Shannon Stemm, a financial services analyst with Edward Jones.

Analysts said the company's continued profits drove the new share buyback program, following a similar $1 billion share buyback announced in April and completed in the fiscal third quarter.

RESULTS

Visa on Wednesday reported fiscal third-quarter net income of $1 billion, or $1.43 per Class A common share, up from $716 million, or 97 cents per share, a year ago.

Excluding the one-time, noncash gain on its Visa Europe put option, Visa earned $883 million, or $1.26 per share.

Analysts estimated Visa would report net income of $1.23 per share, according to Thomson Reuters I/B/E/S.

Total operating revenue increased 14 percent to $2.3 billion from a year ago.

Total payment volumes increased 17 percent to $941 billion from $802 billion.

Visa's international business is becoming a larger portion of its quarterly results. Payments outside the U.S. -- $422 billion -- accounted for 44 percent of Visa's third quarter volume, up from 41 percent a year ago, when such payments totaled $333 billion.

Visa shares closed down 1.6 percent, or $1.45, at $87.75 on the New York Stock Exchange before results were announced.

(Reporting by Joe Rauch; Editing by Steve Orlofsky, Phil Berlowitz and Carol Bishopric)

The Commerce Department said on Wednesday durable goods orders dropped 2.1 percent, weighed down by weak receipts for transportation equipment, after a 1.9 percent increase in May.

Excluding transportation, orders edged up 0.1 percent after gaining 0.7 percent in May.

Durable goods are items ranging from toasters to aircraft that are meant to last three years or more.

Economists had expected overall orders to rise 0.3 percent.

"It is indicative of the lingering effects of this soft patch that we've had here recently where businesses remain very cautious with regard to building any kind of stocks in anticipation of increasing final sales," said Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia.

Treasuries prices pared earlier losses on the data, while the dollar extended losses against the yen.

Durable goods orders are a leading indicator of manufacturing. Though orders tend to be volatile, last month's unexpected decline could add to fears of a slowdown in factory activity.

Manufacturing has been the bright spot in the economy, whose recovery has faltered since the start of the year.

Data on Friday is expected to show the economy grow at a 1.8 percent annual rate in the second quarter, according to a Reuters survey, after expanding 1.9 percent in the January-March period.

Orders last month were pulled down by an 8.5 percent drop in orders for transportation equipment. That reflected a 28.9 percent plunge in aircraft orders.

Boeing received 48 aircraft orders, up from 27 in May, according to information posted on the plane maker's website. However, the bulk of the orders were for its less expensive models.

Motor vehicle orders dropped 1.4 percent as manufacturers continue to deal with disruptions to production following the earthquake in Japan. Motor vehicle orders rose 0.3 percent in May.

Outside of transportation, orders for machinery fell 2.3 percent, while primary metals rose 1.0 percent. Capital goods orders fell 4.1 percent, while computers and electronic products edged up.

Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, slipped 0.4 percent last month after a revised 1.7 percent rise in May.

Economists had expected a 0.8 percent gain from a previously reported 1.6 percent increase.

Shipments of non-defense capital goods orders excluding aircraft, which go into the calculation of gross domestic product, rose 1.0 percent after increasing 1.7 percent in May.

A separate report showed demand for loans to purchase houses fell for a third straight week to the lowest since late February, suggesting home sales will remain weak.

The Mortgage Bankers Association said its mortgage purchase index fell 3.8 percent last week.

(Reporting by Lucia Mutikani, Editing by Andrea Ricci)

Declining issues solidly outpaced advancing ones, even though major averages showed mostly modest declines.

A failure to raise the U.S. debt limit by an August 2 deadline could roil markets and hurt the economy if the United States puts off paying bills. Democrats and Republicans continued to joust on Tuesday over which side's plan has the better chance of passage.

"Investors believe that there's going to be a resolution at the 11th hour, but many of those investors are starting to get cold feet," said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC in Albany, New York.

Just 6.53 billion shares changed hands on the New York Stock Exchange, NYSE Amex and Nasdaq, below the daily average of 7.49 billion.

Technology stocks again outperformed after Broadcom Corp (BRCM.O) reported strong results on Monday night, the latest in a string of chip companies to delight investors. The stock jumped 9.4 percent to $38.20.

Shares of top Chinese search engine Baidu Inc (BIDU.O) rose 5 percent to $164.36, a day after it forecast revenue well ahead of Wall Street expectations.

The SPDR Technology Select Sector Index exchange-traded fund (XLK.P) up 0.3 percent.

Second-quarter earnings that have been mostly stronger than expected have offered protective armor for a market battered by the debt debate.

At the close, the Dow Jones industrial average .DJI was down 91.50 points, or 0.73 percent, at 12,501.30. The Standard & Poor's 500 Index .SPX was down 5.49 points, or 0.41 percent, at 1,331.94. The Nasdaq Composite Index .IXIC was down 2.84 points, or 0.10 percent, at 2,839.96.

The CBOE Volatility Index .VIX, Wall Street's gauge of investor anxiety, rose 4.6 percent and broke above a 20 reading. The index could be pricing in a U.S. debt downgrade, according to optionMonster analyst Chris McKhann.

Among investors, retail clients appear more anxious than institutional ones over the failure of lawmakers to reach a deal on the debt ceiling, said Charles Lieberman, chief investment officer of Advisers Capital Management, LLC in Hasbrouck Heights, New Jersey.

"Retail investors I think are more easily scared, and they expressed concern," he said. "When we discussed the various options with them, they typically come to the conclusion there isn't a whole lot we can do to deal with the circumstances. Anything we can do could backfire."

Weighing on the Dow were shares of 3M Co (MMM.N), the conglomerate whose products range from Post-It Notes to specialty films for computers and televisions. Its share dropped 5.4 percent to $89.93, hurt by softness in some divisions even though its results met estimates.

It exerted a 38-point drag on the Dow, accounting for more than half of losses of the 30-component index on the day.

Industrial stocks were among the worst performers, with the S&P industrials index .GSPI down 1.9 percent.

Also, Ford Motor Co (F.N) fell 1.8 percent to $12.93, even after the automaker's second-quarter earnings beat expectations. Ford remained cautious about consumer demand going forward.

Among other decliners, Netflix Inc (NFLX.O) slid 5.2 percent to $266.91, a day after the movie rental company warned its red-hot subscriber growth would cool in the third quarter.

On the New York Stock Exchange, decliners outweighed advancers by about 2-to-1, while Nasdaq losers beat winners also by about 2-to-1.

After the close, tech results were mixed, with shares of Amazon.com (AMZN.O) gaining more than 6 percent after it reported a surge in quarterly revenue. Shares of Juniper Networks Inc (JNPR.N), however, declined 12.9 percent to $27.15 after its preliminary results disappointed.

(Additional reporting by Doris Frankel; Editing by Leslie Adler)

The largest Internet retailer reported a jump in quarterly revenue on sales of its Kindle electronic reader and other electronics and forecast better-than-expected revenue for the current quarter, sending its shares up more than 6 percent late on Tuesday.

Amazon benefited from growth in e-commerce, though margins continued to be pressured by heavy spending on distribution, technology and digital content.

The company is investing to build warehouses and distribution to support rapidly growing e-commerce, its main business.

It's also spending heavily on servers and data centers for its cloud computing business Amazon Web Services, while buying more digital content to bolster media offerings, such as streaming video.

This spending has dented profit margins in recent quarters. Analysts and investors are mostly happy to see such investment by the company -- as long as it winds down at some point and lays the foundation for future profit increases.

"They're sacrificing near-term profitability for longer-term revenue growth," said Michael Souers, specialty retail analyst at S&P Equity Research. "As long as they are able to transform growth into profits in the future, investors will be satisfied. The chances are strong."

Amazon on Tuesday reported a 51 percent rise in second-quarter revenue to $9.91 billion, surpassing Wall Street's expectations for $9.4 billion.

The company forecast third-quarter sales of $10.3 billion to $11.1 billion, compared with the average forecast for $10.35 billion, according to Thomson Reuters I/B/E/S.

Second-quarter net income fell to $191 million, or 41 cents per share, from $207 million, or 45 cents per share, in the same period a year earlier. Analysts expected 35 cents per share for the latest second quarter, according to Thomson Reuters I/B/E/S.

The operating profit margin fell to 2.0 percent from 4.1 percent a year earlier.

Operating income is expected to be between $20 million and $170 million in the third quarter, the company estimated. The guidance includes about $180 million of stock-based compensation expense and amortization of intangible assets. It also assumes no other acquisitions or investments will close in the quarter.

That forecast suggests Amazon's third-quarter pro-forma operating margin will be 1.8 percent to 3.2 percent, according to Aaron Kessler, an analyst at ThinkEquity. That's below his previous estimate.

"Amazon's willing to give up short-term profits for long-term growth and more market share," Kessler told Reuters. "But ultimately they are managing the business for shareholders. We're expecting modest margin expansion next year. Investors would like to see some return on these investments starting next year."

The company is expected to introduce a tablet computer later this year that would compete with Apple Inc's iPad.

Souers reckons thin third-quarter margins suggest Amazon is spending heavily on this new tablet.

"Longer term this is the best move they can make. The world is shifting toward digital from physical media and a tablet will help them cement a position in streaming content like movies and music," the analyst said.

Amazon Chief Financial Officer Tom Szkutak declined to comment on whether the company was working on a new tablet computer. However, he pledged to keep spending and investing to support growth and new businesses.

Amazon said it spent $941 million on so-called "fulfillment centers" -- warehouses or logistics centers -- in the second quarter, compared to $582 million a year earlier. Technology and content costs totaled $698 million in the latest period, versus $408 million in the same period of 2010.

"We're investing in the conversion from physical to digital and we feel very good about the traction we're getting there," he said.

Szkutak also stressed that the company is focused on cash flow and high returns on investment, rather than profit margins.

Amazon's main online retail business is growing so fast that the company needs to spend on a lot of new distribution capacity, he explained during a conference call with analysts.

Amazon has announced 15 new fulfillment centers so far in 2011 and the company will unveil more before the end of this year, he noted.

Amazon Web Services -- which hosts computing for corporate clients over the Internet -- accounts for a "big piece" of Amazon's current and future spending, because it's growing so fast, the CFO added.

Amazon shares, which have risen about 18 percent since the start of 2011, gained 6.1 percent to $227.35 in after-hours trade.

The company said sales in Worldwide Electronics and Other General Merchandise, which includes the Kindle e-reader, computers, cameras and other consumer electronics, jumped 69 percent to $5.89 billion in the second quarter.

Excluding currency fluctuations, sales rose 62 percent.

"That's very strong," said Scot Wingo, chief executive of ChannelAdvisor, a software provider that helps retailers sell more online through channels including Amazon and eBay Inc.

"E-commerce in general is growing at 10 percent to 14 percent, so Amazon continues to gobble up market share." Wingo owns Amazon shares, and eBay is an investor in ChannelAdvisor.

At some point, such growth will taper off and this is when Amazon will be able to cut back on spending and increase profitability, S&P's Souers said. He's expecting margins to increase "significantly" in coming years.

(Writing by Brad Dorfman; Additional reporting by Eunju Lie in Chicago and Noel Randewich in San Francisco; Editing by Bernard Orr, Phil Berlowitz)