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October 14, 2008

Bear Market Rallies Economy

Yesterday's stock market rally was impressive. The Dow rose almost a thousand points. That took it to levels it hadn't seen since, since — well, since Wednesday. Market breadth was impressive, too, with almost 20 stocks going up for every stock that went down.

But that's the thing about bear market rallies. They're explosive. Partly because so many people are desperate to recoup some of their losses, and partly because so many people have sold short. Short sellers need to buy stock to close their positions. When the market starts to rally and the short sellers start scrambling to get out, they add significantly to the frenzy of buying. Market breadth (advancers leading decliners) is typical, too, of bear market rallies. Some of the rallies with the greatest breadth in history occurred during the period from 1929 to 1932 when the Dow lost fully 89% of its value.

And what about today? If all you read were the closing averages, it seemed like a pretty tame day. Dow down 76 points. No biggee. But it was actually pretty wild. The Dow shot up 400 points at the open, extending yesterday's rally, and then proceeded to drop 700 points. In the final hour, it managed to regain about 225 points; hence, the tame number at the close. But if you weren't paying attention, you missed the 700 point drop. During normal times, a 700 point drop would be big news. Now it's just another day.

But even that doesn't tell the whole story. The Dow and S&P declines were pretty slight, but the Nasdaq declined more than 3.5%. The difference was that the Dow and S&P include a lot of banks and other financial stocks, which rallied huge after Paulson announced plans to "inject" them with $250 billion in capital. The rally in financials masked the weakness elsewhere. The Nasdaq is light on financials, so it gives a truer picture of what's going on. The financial house may be slowly getting in order, but the real economy is tanking. Recession is here and it's getting worse.

If I owned stocks — which I don't, not since about a year ago — I think I might have taken yesterday's rally and the surge at this morning's open as an opportunity to get out. But that's easy to say from the sidelines. I do think there's not going to be much upside to staying in, and there's potentially a whole lot of downside to not getting out. But that's just my opinion. I'm not giving investment advice. I'm not qualified. I'm just trying to put yesterday's rally and the rallies to come in some perspective. People see a rally and they get their hopes up. But every bear market has rallies.

Posted by Jonathan at October 14, 2008 09:53 PM  del.icio.us digg NewsVine Reddit YahooMyWeb