It’s Been One Week

Over the last five trading days the S&P 500 has risen just about 10%. Recall that just last Friday, the market had to absorb the bad news of the worst employment report (651,000 jobs lost and an unemployment rate of 8.1%) since 1983. Remember how bad that felt? So what’s the reason for this mini rally?

We’ve been taught to think that the market is always up or down for some good reason. Usually, someone in the media (or the poor fellow who writes the headlines for Yahoo Finance) can link the day’s action in the market to some news story, economic data point or world event. Sometimes there’s just more buyers than sellers.

So what good news could have contributed to the market’s action over the last five trading days? The employment report? No, that was clearly bad news. How about the news that US households lost 18% of their wealth last year? No, that sounds negative too. General Electric’s credit rating was downgraded? Well, the Wall Street Journal did acknowledge this move as a positive because it wasn’t as bad as expected. Ah, there’s something to focus on – the market tends to respond to events, not whether they are positive or negative, but how they are versus expectations. This is the perverse calculus of the equity market that often befuddles the casual observer. This is why bad news (GE’s credit downgrade) can be interpreted by the market as good news (not as bad as expected).

What is clear to me is that the stock market’s recent actions have little to do with the economy. The economy is like the proverbial oil tanker that moves slowly and makes it big, broad turns even more slowly. There was no positive economic news that could account for the market’s recent movement. This is the disconnect many individual investors struggle with – “If the economy is so bad, why did the market go up?”

To be fair over the last week, we did see a sprinkling of good news – Citigroup’s statement about being profitable through January and February; the big pharma mergers are a clear sign that the stocks are cheap and informed decision makers are acting as they should; retail sales for February were not bad, and so forth. Yet, the tone of the news flow remains very negative. Mr. Roubini was featured yet again in the media circus this week, saying now that the recession could now last three (do I hear four?) years! And then they ask him for his stock picks!?

Two items that I think could be helping the market here are 1) a serious discussion at the SEC to reinstate the “uptick” rule and 2) possible changes in mark-to-market accounting. The first item could lead to less downward pressure on stocks from short sellers. The second could ease some of the pain of toxic assets held by banks and insurance companies. Both are technical (not fundamental) in nature, but many have argued that these two factors have contributed both to the credit crunch and bear market. Might be a good idea to keep a keen ear to ground listening for action on either of these issues.

Has the market made its “big turn?” No idea. But I do know that the “big turn” will be marked with just as much uncertainty as we feel right now. Historically, bear market rallies occur frequently and will often take the market up quite a bit (remember the two-week 20%+ rally that started last November?). This could be just another one of those. However, it could be the “big turn.” That’s just the nature of investing in the stock market – it is an exercise in uncertainty. I suppose we cannot know if this is the big turn until the market penetrates some important levels – perhaps 800, 900 or 1,000 on the S&P 500. When the S&P 500 reaches 1,000 level, can we say with certainty that all is well, that it’s safe to jump back into the pool? I suppose so, but I feel sorry for all those investors sitting in cash waiting for some kind of mystical “all clear” signal that will likely emerge (if it does) only after missing 30% appreciation potential (more if they’d been in better stocks). We hold these truths to be self-evident: bear markets and recessions eventually end and the fundamental principles of equity investing are not dead.