Sanity returns to Wall Street - for now
The market's six-week winning streak may be at risk. But sell-offs on bad news are a healthy sign that investor expectations are reasonable again.
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| Before Monday's big market sell-off, the Dow, S&P 500 and Nasdaq had enjoyed a six-week surge -- despite more concerns about banks and the possibility of a GM bankruptcy. |
NEW YORK (CNNMoney.com) -- The stock market has enjoyed six straight weeks of gains but it's a toss-up as to whether it will hit a lucky seventh. The streak could be in jeopardy following Monday's big market plunge -- despite an impressive rebound on Tuesday.
And to that I say, "Hip hip hooray."
Stocks surged for all the wrong reasons during the past month and a half.
Shares of many banks rallied on the hopes that the worst was over for the beleaguered sector -- even though the stress tests regulators are currently conducting are likely to show a banking system that is still very fragile.
Investors also seemed to be dismissing the potential broad damage of a bankruptcy at General Motors (GM, Fortune 500) and/or Chrysler.
And many seemed too quick to pronounce that consumers were ready to start spending freely again just because retail sales improved modestly from December's awful levels.
Now don't get me wrong. I'm not rooting for stocks to plunge sharply again and I am not going to start wearing an "End is Nigh" sign and proclaim that this recession is going to mushroom into another depression.
But a sell-off after weeks of investors blissfully ignoring reality is actually healthy.
"After six good weeks, traders may have gotten a little ahead of themselves," said Bill Knapp, investment strategist for MainStay Investments in New York. "You don't want to see the market stay in a parabolic up move. Then everyone would be worried about when the tire's going to deflate. It's encouraging to have a little pullback."
It may be true that the U.S. economy may finally be getting close to stabilizing. After all, the recession will soon enter its 18th month, which makes this an abnormally long downturn by historical standards.
But stabilization is not the same thing as a recovery. The economy may wind up just flat-lining for awhile.
That's a better scenario than the precipitous plunge in investor confidence and economic activity that followed the collapse of Lehman Brothers last September.
But it sure as heck doesn't justify a 27% pop in the S&P 500 in such a short time.
Even though most big banks have posted better-than-expected profits for the first quarter, investors finally seemed to realize that banks aren't out of the woods just yet after Bank of America (BAC, Fortune 500) hinted Monday that credit quality will probably deteriorate further.
Considering that the KBW Bank Index, which includes most major banks, doubled in the past six weeks, the sharp drop Monday was long overdue.
"It was probably unrealistic to think that banks could continue to rally without a pullback or more thought about the reasons behind the rally," said David Joy, chief market strategist with RiverSource Investments, a money management firm based in Minneapolis. "There is still a lot of nervousness, a lot of skepticism about this rally."
In addition, corporate results for the first quarter outside of banking, by and large, have been fairly anemic.
On Tuesday, construction equipment giant Caterpillar (CAT, Fortune 500) reported its first quarterly loss since 1992 and drug firm Merck (MRK, Fortune 500) reported a worse-than-expected profit. Chemicals maker DuPont (DD, Fortune 500) did wind up reporting earnings that topped analysts' estimates -- but the company slashed its full-year earnings outlook, citing "the expectation of difficult market conditions."
"We came into earnings season with expectations of numbers being lousy and we're not being disappointed," Knapp said.
With all that in mind, investors should still be jittery.
The only way to lay the groundwork for a long-term sustainable market recovery is if investors don't delude themselves into thinking that it's nothing but good news ahead.
"In order for stocks to really stabilize, you're going to have to see more economic data justify it," Joy said. "We need more convincing evidence that the hints of recovery are for real. The signs of improvement so far are tentative."
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