Look! The sky isn't falling!
The market is showing tentative signs of recovery. Here's why investors should be encouraged....even though they also need to be prepared for more volatility.
NEW YORK (CNNMoney.com) -- Did you notice that the market didn't collapse yesterday?
There were scores of bearish (pun intended) headlines following news of the bailout/buyout of investment bank Bear Stearns (BSC, Fortune 500) by the Fed and JPMorgan Chase (JPM, Fortune 500). But after a rough start, the market bounced back a bit Monday.
JPMorgan Chase's 10% jump accounted for most of the Dow's gains. But AT&T (T, Fortune 500), Johnson & Johnson (JNJ, Fortune 500), Merck (MRK, Fortune 500) and Verizon (VZ, Fortune 500) all rose more than 2%.
And on Tuesday morning, there was more reason to think markets could soon calm down.
Goldman Sachs (GS, Fortune 500) and Lehman Brothers (LEH, Fortune 500) both reported steep declines in quarterly profits, but the earnings were better-than-expected and the two stocks moved sharply higher Tuesday morning.
Yahoo (YHOO, Fortune 500), in the midst of fighting off a takeover attempt by Microsoft (MSFT, Fortune 500), reaffirmed its forecast for sales, easing concerns about ad spending in an economic downturn.
In addition, housing starts in February, while down from January, were stronger than economists had forecast, suggesting a possible stabilization in the real estate market.
"Housing might be bottoming," said Brian Stine, senior portfolio manager with Allegiant Asset Management. "There are still risks, but it looks like the decline is decelerating."
Don't panic but don't go overboard either
The temptation after yesterday's Bear Stearns news was to run and hide. But instead of panicking, some investors appeared to be acting as if there was a light at the end of the tunnel. And that light may be in the form of another big rate cut from the Federal Reserve today.
Yes, I've argued repeatedly in this column that another steep cut could do more harm than good since it will further weaken the dollar and lead to more increases in the price of oil, gold and other commodities. But I'm definitely in the minority here.
There is a growing sense that more rate cuts, combined with the many moves the Fed has taken to provide more liquidity to struggling financials, are what's needed to end the credit crunch - and that doing that takes precedence over worrying about inflation.
"What the markets are now factoring in is that the Fed is using all the tools at its disposal to get the credit crisis unlocked. It's encouraging that the market is seeing this in a positive light," said Subodh Kumar, an independent market strategist.
Of course, investors still need to be careful in a market as jittery as this. Just as it doesn't make sense to panic on a day when the market is plunging, investors shouldn't get overly (or dare I say, irrationally) exuberant on a day when stocks are heading higher.
Despite the promising news from Goldman and Lehman, Phil Dow, director of equity strategy with RBC Dain Rauscher, said the worst is not over yet for most big banks.
"There are further problems with the financials. The most optimistic people think we may be only halfway through the subprime writedowns," Dow said. "For serious investors, this is a time to be cautious."
With that in mind, Stine said he's recommending investors buy more international-based companies as a way to capitalize on stronger economies and fewer financial headaches overseas.
And Kumar conceded that even though the lack of a big sell-off Monday and the rally Tuesday were positive signs, it's premature to say that the worst is over for banks or the market as a whole.
"The first step in confidence coming back has to be more interest in larger companies. We started to see that with healthcare, telecom and other defensive companies but it's too early to say the volatility is behind us. I think we will see a lot more back and forth in the market in the coming weeks," he said.
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