Time to buy stocks? More thoughts on the spring rally

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This post on Friday has sparked some good (and heated) discussion about the stock market’s rally of the last few weeks and whether it has staying power.

First, the headline on the post was an attempt to be a little facetious. I’m not exhorting anyone to buy stocks. That isn’t my style, and I’m happy to leave that job to Cramer.

My goal was to provide some ideas about what’s behind the market’s turn. And I think it is pretty simple, as I said: A lot of big-money players on Wall Street were braced for the worst in mid-March -- meaning a financial-system catastrophe. The Federal Reserve managed to keep the system from melting down, and that has been enough for some investors to move back into stocks (and out of the safe-haven play of Treasury securities).

Back in 2003, the big money also was braced for the worst before the Iraq war began. Once the market realized that conquering the Iraqi army would be relatively easy, stocks zoomed. Investors weren’t going to wait to see whether the occupation would become a quagmire. Like Scarlett said, they’d worry about that tomorrow.

A number of commenters have tacked up the standard laundry list of worries: the housing crash, the falling dollar, shrinking job rolls, soaring oil prices, etc.

But you have to keep in mind how pension funds, sovereign wealth funds and many other money managers view the world. They can’t invest for Armageddon; they’ve got obligations to meet for their beneficiaries and clients two, five, 10 and 30 years down the road. They’re always looking for opportune times to increase their stock bets (here and abroad) because the market remains a prime way to cash in on economic growth in the long run. And they know they won’t meet their obligations earning 2% on Treasury notes.

What else has been driving stocks up from their lows in March, despite the struggling economy? No doubt there is ‘short covering’ going on by the bears. Short selling has been running at record levels. And once a rally gets going day traders feed the momentum as they hop aboard to try and make a few pennies 300 or so times in a session. Not to mention what happens as antsy hedge fund managers feel like they’re missing the boat.

Could this rally be the proverbial dead-cat bounce? Of course it could. The stock market mostly looks ahead, but its vision isn’t perfect. The bulls figure the economy will get worse, but stocks clearly aren’t priced for a devastating recession. If consumer spending really does collapse, and the recession’s effect on corporate earnings is far worse than most investors are betting, a lot of stocks will be going lower this year even if they go higher first.

But to get back to the original post: If investors no longer have to worry about an immediate cataclysm in the financial system, they’ve got time to think rationally about what to do with their money. So far, that has been good for a 9.4% rebound in the Dow index from its March low. Let’s see how much more juice this turnaround has.

BTW, my column on Saturday also looks at the rebound in investors’ appetite for risk, touching on some of the same points here as well as some others.

Posted April 20, 2008