The dogged bull

Despite the day-to-day turmoil, the stock market damage has been limited, with the Dow and S&P 500 clinging to levels not far from record highs.

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By Alexandra Twin, CNNMoney.com senior writer

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The credit markets are on fire and central banks are racing to the scene, but the Dow and S&P 500 are not far off of record highs.

NEW YORK (CNNMoney.com) -- There's a credit market crisis so broad that the Federal Reserve has had to reach out to central banks across the pond. Yet the Dow Jones industrial average is within shouting distance of its all-time record.

Bank of America (Charts, Fortune 500) and Wachovia (Charts, Fortune 500) both said Wednesday that they will record bigger multi-billion dollar writedowns in the fourth quarter than previously estimated, reminding Wall Street that the financial sector's exposure to subprime remains unclear. Yet, with all the bad news for banks, the group as a whole is up 9 percent off its 2007 lows, which hit in late November, as measured by the Amex Securities Broker/Dealer index.

When the Federal Reserve "disappointed" stock investors by only cutting interest rates by a quarter-percentage point Tuesday, the Dow fell nearly 300 points. That's bad, but not that bad considering the level of day-to-day volatility seen in the second half of the year.

That volatility was in full effect Wednesday, when stocks first rallied and then cooled off after the Fed said it was teaming up with other central banks to pour billions into banking systems around the world.

Clearly stocks have been choppy of late - a fact of life that has been tough on investors. But a fair question to ask is: Why stocks aren't lower, considering all the negatives?

As of Wednesday's close, the Dow and S&P 500 were barely 4 percent off the record highs hit in October. The Nasdaq is 6 percent off of its 2007 high from the same period.

What's in the Kool-Aid?

"There's a lot of uncertainty about what lies ahead and an understanding that these problems won't be worked out overnight, said William Hummer, principal at Wayne Hummer Inc. "But the stock market may be hinting that longer term, the economic fundamentals are good, and if we can get through '08 without a recession, '09 could be a lot better."

Earnings and valuation

Earnings fell off this year, with the third quarter showing a 1 percent drop in growth from a year earlier among the S&P 500, according to Thomson Financial. That was the worst quarterly performance in more than five years.

As Wachovia and Bank of America made clear Wednesday, earnings forecasts for the banking sector are going to continue to be adjusted downward as time marches on. Other sectors will see adjustments too. But select sectors are shaping up for decent growth, including the ever-strong energy sector.

Compared to historical standards, stocks still aren't particularly expensive, one could argue. Earnings for 2008 are on track to grow about 7 percent versus a year ago.

Should that forecast hold up, it would suggest stocks are still reasonably priced, with a forward price-to-earnings ratio for the S&P 500 of around 15. Generally, lower is better, and 15 compares positively with the historic average since 1950 of 18.6 during previous periods of comparable inflation, according to a recent Goldman Sachs note.

The more that earnings forecasts for the year ahead drop, the more expensive stocks become. But for now, valuations could be seen as reasonable, helping to sustain gains.

Unemployment and consumer spending

The threat of a recession next year remains, but recent reports have suggested that some economic strength exists outside of the housing and credit markets. That could help the United States avoid a recession next year, said Chris Molumphy, chief investment officer at Franklin Templeton Fixed Income Group.

And stock markets may be keying off those economic readings.

"While the housing markets and subprime and commodity prices dominate the headlines, underlying that are some signs of healthier fundamentals," he said, including the labor markets.

The November jobs report released last week was pretty positive, showing that while employment growth has slowed, it still remains fairly healthy and wages are continuing to rise. Should that prove to be a trend, that's good news for consumer spending, which fuels two-thirds of the economy.

The Federal Reserve

As the central bank made clear Tuesday and Wednesday, it's willing to take actions to counter the impact of the credit crunch. On Tuesday, the Fed cut a key short-term interest rate by a quarter percentage point.

Stock investors who were looking for a bigger cut were disappointed, but that disappointment was short-lived. On Wednesday, the Fed said it was teaming up with other central banks around the world to help banks borrow money more easily.

The Federal Reserve alone can't save the economy from recession, but the more involved it seems to be, the better the stock market seems to feel. That was the case in August of this year when even the hint that the Fed would start cutting rates again helped stocks bounce back after a multi-month slide.

'Tis the season

Seasonal trends are to be taken with a healthy grain of salt. But for what it's worth, stocks tend to do well this time of year and that may be helping to offset some of the bigger worries. Between end-of-year bonuses and other seasonal factors, December tends to be the second best month of the year for the Dow and S&P 500 going back to 1950, according to the Stock Trader's Almanac.

Those who think the market loosely follows the four-year cycle of a presidential term will tell you that the year before an election, such as 2007, and the year of an election, such as 2008, tend to be positive. Why? Because the party in power does what it can to help stay in power, including stimulating the economy.

"We've got subprime and all those issues now, but we've had big challenges before and historically this is still a good month, and good year in the election cycle," said Curtis Teberg, portfolio manager at the Teberg Fund.

Consider 1999, when worries about Y2K gave way to what the Almanac calls the Millennial fever crescendo, sending stocks broadly higher by the end of the year. No one is betting on big gains through year-end, but stocks could continue to limp higher. To top of page

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.