By Haitham Haddadin

NEW YORK (Reuters) - Stocks rose in heavy trading on Friday, giving the S&P 500 and Dow their third up month in a row for the first time since late 2001, after a report showing surprisingly strong manufacturing growth in the U.S. Midwest led investors to bet that the economy will strengthen.

Nasdaq went a step further. The tech-laden index has now strung together its first four-month streak of gains since the second half of 1999, at the height of the tech bubble.

"The market continues to forecast better economic conditions again, and the feeling is that you have to be long stocks," said Peter Cardillo, chief strategist and director of research at Global Partners Securities.

Traders said sentiment was also boosted after news the government lowered its terror threat level back to yellow, or "elevated," just 10 days after raising it to the second-highest level of orange, or "high."

Business expanded in Midwestern states in May for the first time since February, according to the National Association of Purchasing Management-Chicago index, suggesting improvement in the manufacturing sector as well as for the broader economy.

The report, regarded as a precursor to a national manufacturing report due on Monday, added fuel to the rally which has lifted the Nasdaq, S&P 500 and Dow about 25 percent, 20 percent and 17 percent, respectively, since mid-March.

"The Chicago Purchasing Managers number is very encouraging because it confirms the postwar economic bounce (after the Iraq (news - web sites) war) that the market is counting on to sustain this rally," said Milton Ezrati, senior economic strategist at Lord Abbett & Co.

NASDAQ CLOSE HIGHEST IN A YEAR

The tech-loaded Nasdaq composite (^IXIC - news) rose 20.96 points, or 1.33 percent, to 1,595.91, ending at its highest level in a year. The Standard & Poor's 500 (^SPX - news) climbed 13.95 points, or 1.47 percent, to 963.59, its highest close since early July. The blue-chip Dow Jones industrial average (^DJI - news) jumped 139.08 points, or 1.60 percent, to 8,850.26, its highest close this year.

For May, the Dow rose 4.4 percent, the S&P 5.10 percent and the Nasdaq 8.99 percent.

The last time the Nasdaq notched four straight months of gains was in 1999, when it rose for five months from August to December, according to Markethistory.com. For the Dow and S&P, the last time each index posted three straight months of gains was from October-December 2001.

Thirteen shares rose for every 4 that fell on the New York Stock Exchange (news - web sites) and the ratio was about 11 to 5 on Nasdaq. Some 1.68 billion shares changed hands on the NYSE and 2.26 billion on Nasdaq. It was the Nasdaq's heaviest trading session of the year.

A settlement in a long-running dispute between AOL Time Warner Inc. (NYSE:AOL - news) and Microsoft Corp. (Nasdaq:MSFT - news) also boosted the market. AOL rose 37 cents, or 2.5 percent, to $15.22. Microsoft headed 21 cents higher to $24.61.

ImClone Systems Inc. (Nasdaq:IMCLE - news) surged $5.04, or 21.5 percent, to $28.50. Shares rallied as investors looked ahead to a meeting where scientists will present data expected to be very positive about Erbitux, its experimental cancer drug.

McData Corp. (Nasdaq:MCDT - news) jumped $2.39, or 21.6 percent, to $13.47. The company, which makes switches and software for storage networks, reported a quarterly profit versus a year-earlier loss. Among rivals, Brocade Communications Systems Inc. (Nasdaq:BRCD - news) surged 5.7 percent, or 33 cents, to $6.11.

Helping other semiconductor stocks, Nvidia Corp. (Nasdaq:NVDA - news) surged $1.96, or 8 percent, to $26.17 after UBS Warburg upgraded the chip designer to "buy" from "reduce." The Philadelphia semiconductor index (^SOXX - news) rose 1.86 percent.