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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)

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

But the market reaction focused more on sales growth than profits.

"If you look at top-line growth it was extremely strong," Dan Geiman, analyst at McAdams Wright Ragen, said. "At this point it's a question of how long the company is going to continue to invest at their current levels. Presuming these investments don't go on forever, earnings should grow going forward."

The world's largest web retailer reported a 51 percent climb in revenue to $9.91 billion, surpassing Wall Street's expectations for $9.4 billion.

Operating margin fell to 2.0 percent from 4.1 percent a year earlier.

Amazon 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.

Shares of the company, which have risen about 18 percent since the start of 2011, gained 6.3 percent to $227.57 in after-hours trade.

Second-quarter net income came in at $191 million, or 41 cents per share, versus $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.

(Writing by Brad Dorfman, editing by Bernard Orr)

A small majority of economists -- 30 out of 53 -- surveyed over the past two days said the United States will lose its AAA credit rating from one of the three big ratings agencies -- Standard & Poor's, Moody's or Fitch.

Respondents saw a 20 percent chance of a new recession over the next year, a prospect that some economists say has been compounded by the acrimonious political fight over what is normally a procedural legislative vote on the debt.

Lawmakers have one week left to hash out a deficit-cutting plan without which Republicans in Congress have said they will not raise the legal $14.3 trillion debt limit, risking a potentially devastating government debt default in August.

"We believe that Congress will act with an 11th hour deal to raise the debt ceiling. However, the risk of that deal failing increases with each passing day," said Guy LeBas, director at Janney Capital Markets.

"I would say that the chance of a U.S. ratings downgrade is now more likely than not."

Economists still see the probability of an outright default on U.S. Treasury bonds as remote -- 5 percent on median. link.reuters.com/nyc82s

Downgrade and default would have vastly different consequences. A ratings cut might raise the risk of recession by hurting confidence, but might allow financial markets to muddle through the next few months without incident. A default, however, would send shockwaves through the global financial system that could kick-start a new financial crisis, analysts say.

Even if this worst-case scenario is not borne out, a firm majority of respondents -- 38 out of 54 -- said the uncertainty brought about by the political acrimony over the debt has already hurt economic growth.

The U.S. economy had already been under stress in recent months. Gross domestic product expanded just 1.9 percent in the first three months of the year, and the second quarter is not expected to have fared much better. Industrial production has slowed and employment nearly ground to a halt in the last two months. The jobless rate climbed to 9.2 percent in June.

"This whole debt ceiling debate doesn't seem to be making anyone any more confident," said Sean Incremona, economist at 4Cast Ltd. in New York.

Goldman Sachs argued in a research note recently that the decline in consumer sentiment over the last few months has been disproportionate to the economy's slowdown, pegging the debt battle as a culprit.

The government's first reading on GDP in the second quarter will be released on Friday.

(Reporting by Andy Bruce, Polling by Bangalore Polling Unit; Editing by Ruth Pitchford, Leslie Adler, Chizu Nomiyama and Dan Grebler)

* Stocks dipped in the previous session as lawmakers remained deadlocked over a deal to raise the government's debt ceiling to avoid default. But investors were hopeful a compromise could be reached before the August 2 deadline.

* President Barack Obama took to the airwaves last night to rally public support for a package proposed by Democrats, warned that failure to make a deal would severely hurt the nation.

* Ford Motor Co (F.N) shares were up 3.1 percent at $13.50 in premarket trade after the automaker's second-quarter earnings beat expectations. Revenues were also ahead of Wall Street's forecast.

* Other major companies due to announce results include Amazon.com Inc (AMZN.O), Cummins Inc (CMI.N), 3M Co (MMM.N) and Gilead Sciences Inc (GILD.O).

* S&P 500 futures rose 2.8 points and were 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 gained 26 points, and Nasdaq 100 futures added 3.75 points.

* The May Standard & Poor's/Case-Shiller home price index will be released at 9 a.m. EDT. Economists in a Reuters survey expected the index to be unchanged versus a 0.1 percent drop in April.

* At 10:00 a.m. EDT, the Conference Board reports on July consumer confidence. Economists expect a reading of 56.0, compared with 58.5 in June.

* Also coming at 10 a.m., the Commerce Department releases new home sales for June. Economists forecast a total of 320,000 annualized units, compared with 319,000 in May.

* Resource-related stocks will be in focus as copper prices rose for the first time in five sessions on a weaker dollar. Other key base metals also advanced.

* U.S. specialty finance company Orchid Island Capital Inc postponed its initial public offering due to market conditions.

* European shares .FTEU3 were slightly down, while Japan's Nikkei average .N225 closed up 0.5 percent.

(Reporting by Angela Moon; editing by Jeffrey Benkoe)

In North America, Ford's pre-tax profit rose 0.5 percent to $1.91 billion.

North America was the only global region where the company's profit improved. In Europe, where Ford's performance has been lagging in recent quarters, its pre-tax profit was trimmed nearly in half to $176 million.

Ford shares rose 2.3 percent in early trading on Tuesday at $13.47 per share.

The company did not alter its North American production outlook or its 2011 U.S. auto sales forecast.

Excluding one-time items, Ford's quarterly profit fell to 65 cents per share from 68 cents a year ago.

Analysts, on average, had expected earnings of 60 cents per share excluding one-time items, according to Thomson Reuters I/B/E/S.

Revenue rose 13 percent to $35.5 billion.

Net income fell to $2.4 billion in the quarter, or 59 cents per share, from $2.6 billion, or 61 cents per share.

Ford has posted eight straight quarterly net profits after recording net losses totaling $30 billion from 2006 through 2008 when it cut jobs, sold unprofitable brands and reshaped a lineup laden with large SUVs and pickup trucks.

(Additional reporting by Ben Klayman; Editing by Derek Caney)

European and U.S. stocks were primed for gains, with futures on the Dow Jones Eurostoxxe 50 flat in early trade and S&P e-mini futures rising 0.2 percent.

Short-term speculators took aim at the dollar after Obama delivered a prime-time address to Americans, warning that a default on U.S. bond obligations would be a "reckless and irresponsible outcome". But he gave no indication a compromise was imminent.

So far investors have shown few signs of panic even as Republicans and Democrats have failed to bridge their differences with just a week to go to the August 2 deadline that the U.S. Treasury has set for when it may fail to pay out on Treasuries.

The market reaction to a sudden breakdown in talks over the weekend was limited given the threat of a technical default and a potential cut in the United States' top-notch AAA credit rating.

But some market players were taking no chances, shifting funds into safe-haven gold and the Swiss franc, driving both to record highs in U.S. dollar terms. Gold was steady in early trade at $1,614.60 an ounce.

Portfolio managers and traders have said they believe an agreement will be reached in Washington at the last minute, and that even a technical default or rating downgrade may only cause short-term market volatility rather than a full-fledged crisis.

"There's obviously political points to be made, who is going to blink first, but in the final analysis we're confident that there will be a compromise and that they will raise the debt ceiling," said Malcom Wood, head of Asia Pacific strategy at Morgan Stanley Smith Barney in Hong Kong.

Asian bonds, currencies and even shares have been one of the beneficiaries from all the debt trouble in Europe and the political gridlock in the United States, with investors viewing the region's stronger growth and fundamentals as a relative safe-haven.

The MSCI index of Asia-Pacific shares outside Japan .MIAPJ0000PUS was up 1 percent and has squeezed out a 1.6 percent gain on the month and year, withstanding the occasional bouts of volatility from the U.S. deficit debate and euro zone debt crisis.

Southeast Asian markets have fared the best. Indonesia's Jakarta Composite .JKSE extended its winning streak, vaulting to an all-time high and taking this year's rise to 11.3 percent. Currencies have also been on a tear, with the Singapore dollar hitting a record high.

Gains were fairly broad but on very light trade as summer holidays took a toll on trading activity. By sector, energy, financial, resource and technology shares were the main drivers.

The improved appetite for risk spread to commodities. U.S. crude oil prices were up 40 cents a barrel at $99.60.

JAPAN RECOVERS

Japanese shares also rose as its big automakers and manufacturers have recovered more quickly than expected from the March 11 earthquake and tsunami.

Japan's Nikkei average .N225 climbed 0.6 percent, thanks in part to solid earnings from blue-chip companies such as Canon (7751.T) despite the yen's persistent strength.

In currencies, the dollar erased gains scored against the euro the previous day on widening Spanish and Italian bond yield spreads and hit a six-week low against a basket of currencies.

The euro rose 0.7 percent to $1.4485, bursting through chart resistance. The dollar hit an all-time low of 0.8005 Swiss francs. The dollar hovered near 78.00 yen after briefly falling below that level.

High-yielding currencies were among the biggest winners. The New Zealand dollar jumped 0.7 percent and hit a high of $0.8708 -- the highest since being allowed to trade freely in the early 1980s.

Option markets -- where investors typically hedge themselves against potential risks -- were also showing no signs of panic across the dollar, S&P futures and Treasury futures.

While the closely watched VIX index .VIX of S&P implied volatility ticked up on Monday to 19.35, it remains well off peaks earlier this year.

Implied volatility on Treasury futures was also higher this month but historically subdued. For a chart see: r.reuters.com/paz72s

Analysts said that macro hedge funds and others were reluctant to trade, having struggled with choppy markets all years and cut back on positions heading into the European summit on Greece last week.

"It has been a tough year for macro funds, and many do not want to trade Washington headlines," said Alan Ruskin, macro strategist at Deustche Bank in New York.

U.S. Treasuries slipped for a second day, with long-term Treasuries under the most pressure from the worries about a rating downgrade.

Ten-year notes were down 6/32 in price to yield 3.017 percent, up one basis point. Thirty-year bonds fell 5/32 to yield 4.328 percent, also up a basis point.

(Editing by Kim Coghill)

President Barack Obama, in a televised address aimed at rallying public support for a package proposed by Democrats, warned that failure to increase the U.S. borrowing limit would severely hurt the nation.

"For the first time in history, our country's triple-A credit rating would be downgraded, leaving investors around the world to wonder whether the United States is still a good bet," he said in remarks in the East Room on Monday night.

Republican and Democratic lawmakers, despite weeks of intense talks, have been unable to agree on how to lift the $14.3 trillion debt limit by an August 2 deadline, when the country runs out of cash to pays its bills.

Markets have been rattled by the descent of negotiations into an acrimonious stalemate, with both sides offering competing plans that are unlikely to win bipartisan support.

Gold has been pushed to an all-time high and the dollar has softened as investors weigh the harm a default could do to U.S. and world growth if it pushed up borrowing costs as expected.

"Every day that goes by without a deal will see investors become a bit more defensive," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

Obama warned a default would inflict a tax hike on all Americans by pushing up borrowing costs on things like credit card loans and mortgages, but sought to assure markets a deal could still be reached.

"I have told leaders of both parties that they must come up with a fair compromise in the next few days that can pass both houses of Congress - a compromise I can sign. And I am confident we can reach this compromise," he said.

Rating agency S&P warns it could downgrade the United States unless lawmakers agree on steps to reduce the deficit by $4 trillion over 10 years.

A credit rating cut would be felt around the world. Investors will likely demand a higher return for holding U.S. government debt, a benchmark for almost all other financial markets, forcing up interest rates and sapping asset prices.

Republicans and Democrats both insist they will not allow the United States to default.

This commitment has not yielded a plan to lift the debt ceiling, which Republicans say must be accompanied by even larger reductions in spending.

Democrats want to shield Medicare and Medicaid and say any cuts in these cherished healthcare programs for older or poor Americans must be balanced by changes in the U.S. tax code that generate more revenue in the future.

But Republican lawmakers in the House of Representatives are adamant they will not vote for a deal that includes tax increases, reflecting the determination of Tea Party conservatives elected last year to shrink government. They control the House while Democrats hold sway in the Senate.

House Speaker John Boehner, the top Republican in Congress, must placate these demands and on Monday advanced a two-stage deficit reduction plan that would start with an initial $1.2 trillion in savings over 10 years.

It is sure to be rejected by Obama because it would raise the debt limit for only a few months, meaning the issue would have to be revisited in early 2012, making the politics even harder for lawmakers with an eye on the November election.

"A six-month extension of the debt ceiling might not be enough to avoid a credit downgrade," he warned.

Democrats formally presented their competing plan for $2.7 trillion in deficit reduction over the next decade with a debt limit increase to carry through the November 2012 election, when Obama and many lawmakers are up for re-election.

Boehner dismissed the Democratic plan as "full of gimmicks." Senate Democratic Leader Harry Reid insisted "extremists" within the Republican Party must not be allowed to dictate the outcome of the debt debate.

The Obama administration has not ruled out invoking the 14th Amendment of the U.S. Constitution to sell debt, even if Congress fails to raise the borrowing ceiling.

(Editing by John Crawley)