Stocks: Is the Worst Over?

Nobody is dancing in the street, but Wall Street is a considerably cheerier place lately. Moods have been lifted by a strong stock market rally, sparked when stocks in early March hit their lowest prices since the mid-1990s. Stifel Nicolaus (SF) market strategist Barry Bannister went so far as to declare: "Mar. 6, 2009 was probably the equity bottom for 2009."

By Mar. 6, when the broad Standard & Poor's 500 index hit an intraday low of 666, stocks had finally deflated a decade-old bubble, he believes. "We appear to have unwound the entire U.S. equity bubble phase that commenced in 1995," he wrote Mar. 18.

The actions of Washington policymakers have helped raise investors' hopes. On Monday, Mar. 23, stocks jumped more than 4% in morning trading on the Treasury Department's rollout of its bank-rescue plan. Stocks also shot up Mar. 18 when the Federal Reserve said it would spend more than $1 trillion extra to buy up debt, an aggressive effort to unclog credit markets and revive lending to students, buyers of homes and autos and others in need of financing. To end the financial crisis and revive the economy, "you've got the federal government pulling every trick out of their book bag," says Mark Travis, chief executive of Intrepid Capital Management.

The Turning Point?

Professional investors know that calling a stock market bottom is very difficult and can be a fool's game. "You never really know you hit bottom until way after the fact," says Wasif Latif, an equity manager at USAA.

But that doesn't mean market participants don't try to identify and profit from the big market turning points. The S&P 500 is up 14% since the Mar. 6 low. So if investors can hold onto those gains, a lot of money will have been made.

Bear Losing His Grip

Peter Cardillo, chief market economist at Avalon Partners is reasonably optimistic. The market may re-test March's lows, or even dip a little lower, but not by a wide margin. "The tight bear grip on the market has weakened considerably," Cardillo says. One sign of "a better frame of mind" on Wall Street is investors seem to be reacting favorably to good news, which has included some positive talk from bank CEOs and some better-than-expected economic data.

Market pros often cite the conventional widsom that stocks move higher six months before the economy does. Fed Chairman Ben Bernanke has predicted that the recession will end this year and a recovery will begin next year. Yes, the job market continues to worsen, but, Cardillo says of the economy, "the fear of a total collapse has all but dissipated."

Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN), looks at leading economic indicators and also sees some faint signs of hope. "It has stopped getting worse," he says.

Data Revisions Possible

Some retail sales numbers and consumer confidence measures haven't been as bad as expected. However, Gambera admits these data points can be revised in the future, and plenty of other economic measures look terrible. Those include the unemployment rate and new jobless claims, though labor figures are often a lagging indicator, one of the last to show improvement.

Others aren't buying into the optimistic mood. "It's premature to definitively call the bottom," says Doug Peta, an independent market strategist. "I don't think we can see a sign yet that the economy is out of the woods."

The "incredible" and "really unprecedented" loss of jobs in the U.S. is a big problem for an economy still so reliant on consumer spending, Peta says. "If Americans are losing their jobs, they have to spend less," he says. Because of tightening credit conditions, Americans can't borrow to finance purchases. "You can't spend above your income anymore," he says.

"Too Many Unknowns"

John Merrill, chief investment officer at Tanglewood Wealth Management in Houston, thinks there is less than a 50% chance that stocks have hit bottom. However, he bought stocks this month. For a long-term investors, prices were so low that "you'd really taken a lot of risk off the table," he says. As stocks continued to rally, however, he stopped buying.

The stock market's ultimate low depends on how much the U.S. economy contracts, and that's very hard to predict. "There's too many unknowns," Merrill says. "Nobody can know."

Several fundamental measures on the horizon could help investors decide whether the stock market rally can continue. Kalivas of MF Global Research is watching three factors that could weigh on stocks: increasing unemployment, problems for commercial real estate, and higher commodity prices that could hurt corporate profits.

Waiting for First-Quarter Numbers

A key test of the economy comes on Mar. 25, when data on durable goods orders is released. Economists are expecting a 2% decline. If orders stopped their slide with a flat reading, Gambera says, "there would be people dancing in the streets."

First-quarter earnings figures will begin arriving in April, and could be a "good litmus test," Latif says. Many are wondering if the upbeat tone from some bank CEOs will be matched by reality.

Investors will also keep an eye on Washington's actions, which can sometimes put a damper on the markets. Stocks plunged after a key Geithner speech on Feb. 10 that investors criticized as short on details.

Plenty of Thrills and Chills

One thing is certain: the debate about whether stocks have really hit bottom this month will continue. If the past year has demonstrated anything, it is that this is a stock market prone to unexpected twists and turns.

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