Stocks’ Wild Ride Isn’t Over

Even if the markets have touched bottom, there’s still plenty that could go wrong. So don’t unfasten your seat belt just yet. 

By Jon Markman 

Big investors and government officials have pulled out all the stops in recent weeks to make it look like equity markets, and possibly the U.S. economy, hit rock bottom in early March in sync with the crash and sale of Bear Stearns. Yet new evidence suggests that credit markets, where most of the world’s businesses are financed, have hardly improved a bit in the past month and threaten to drag corporate earnings and stocks back into the hole from which they appear to be emerging.

If that’s confusing, considering Tuesday’s 391-point pop in the market, imagine the climactic scene in a horror movie in which the hero fights to wriggle out of quicksand, yet every time he makes a few inches of progress he’s yanked back in by hidden forces. What makes a happy getaway for stocks so plausible is that it has come at an ideal time in the market cycle.

Investor sentiment readings by mid-March had fallen to extreme lows, prices and valuations of favorite stocks were at multiyear nadirs, short sellers had become fearless, and, by every account, a mountain of cash had accumulated on the sidelines. Moreover, the Bush administration had shockingly stepped away from its long-standing effort to keep its mitts off Wall Street by announcing a plan to rein in bank and brokerage meanies with sweeping new rules.

In other words, everything looked perfect for a massive rebound, as savvy hedge fund traders — flush with money from their successful efforts to push the market down over the past few months — could take advantage of an obviously sour mood. You could smell a short squeeze coming a mile away, and that’s why I recommended a bullish stance amid the pall last week. Give traders credit: Their effort to prey on late-coming, mom-and-pop short sellers and force them to cover their bearish bets at higher prices in the past few days has proved effective so far.

R.I.P. Pollyanna  

But don’t let all the drama fool you into thinking the bear market is over and real-money value buyers are grabbing cheap stocks.There are still plenty of things that can and will go wrong. And unlike earlier this week, when bad news from financial goliaths UBS AG, Deutsche Bank and Lehman Bros., was treated as good news, next time the reaction to bad news won’t be naively positive.