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Signs of life on Wall Street, amid plenty to fret

Investors have seen this before.
Image: Specialist Neil Gallagher smiles as he works on the floor of the New York Stock Exchange Tuesday
Traders and investors will have reason to smile — if — the markets' rally can hold this time.AP file
/ Source: The Associated Press

Investors have seen this before.

Since the bear market began in late 2007, the Dow Jones industrial average has fallen into a pattern of huge declines, big gains, and then even larger declines. Four times, the market has rallied only to dissipate.

This past week, the market made a fifth stab at recovery, logging its best performance in months after remarks from bank CEOs and economic data led investors to believe they'd gotten too pessimistic.

The Dow Jones industrial average rallied for four straight days from nearly 12-year lows, and gained 597 points, or 9 percent — its best week since November. That followed a two-and-a-half month drop in the Dow of nearly 25 percent.

"People have been worried that we're heading into this abyss," said Tobias Levkovich, Citigroup's chief U.S. equity strategist. "There are signs that that's not the case, and there is some floor somewhere — that we may have overreacted."

But is the worst really over?

There's no formula to figure out if this latest rally will stick. But market analysts are watching closely for signs that the worst might be behind us, and they say some good signs are starting to pop up.

"There are little subtle things that have happened that are good — good enough to see that market is trying to establish a near-term bottom," said John Kosar, market technician and president of Asbury Research in Chicago. "But it's way, way, way too premature to try to make an argument that this is 'The Bottom.' "

Here are five reasons the market may have bottomed, and five reasons to still fear the bear.

Five signs it may have bottomed:

Pumped-up volume: Market analysts say two signs of a bottom are the entrance of big institutional investors, because they hold stocks for the long-term, and high trading volumes during rallies. Check and check.

Pension funds, mutual funds, and insurance funds began snapping up bargain stocks last week after sitting things out for a while, said Stuart Frankel & Co. president Jeffrey Frankel, who works on the floor of the New York Stock Exchange. And volumes on the New York Stock Exchange on Tuesday, Wednesday and Thursday of last week were about 7 to 8 billion shares — similar to those when stocks plummeted the week before.

Economy's bad, but could be worse: The U.S. economy might be horrible, but it's not the Great Depression. Unemployment is at 8.1 percent, and expected to rise above 10 percent, but that's nowhere near the 25 percent level experienced in the 1930s. And today, when people are fired, they can collect unemployment. Conditions are a far cry from shanty towns and bread lines.

Plus, the economy's slide appears to be slowing. U.S. retail sales, after stripping out autos, actually rose 1.6 percent in January and 0.7 percent in February.

Zombie banks? Not quite: Before last week, investors were throwing around the term "zombie banks" to describe the big U.S. banks: Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co. The moniker comes from the insolvent, federally propped-up Japanese banks of the 1990s.

But last week, these three U.S. banks said they've actually been profitable so far this year. They're also borrowing less from the Federal Reserve now. Bank borrowing from the Fed fell to $19.6 billion last week — the lowest level since Lehman Brothers collapsed in September, pointed out Miller Tabak & Co. analyst Tony Crescenzi.

The commodities bounce: It's counterintuitive, but Americans should be happy oil prices aren't falling anymore. After massive price drops alongside stocks over the past several months, crude oil has jumped 16 percent in the past three weeks.

Crude oil and copper — which has risen 17 percent in three weeks — tend to be economic barometers, Kosar said. That's because if the cost of industrial metals and crude oil are rising, it means traders see demand trickling back. Growing demand means increasing industrial production.

Main Street capitulation: Everyone at cocktail parties is talking about how they've moved into cash. Certainly, the financial crisis proved that Wall Street bigwigs aren't all smarter than the rest of us. But it's usually a good time to buy when regular folks are saying they've cashed out.

"A year ago, everybody was at the dinner table talking about returns," Frankel said. "Right now, it's probably a good time to buy, because usually the masses are wrong."

And, not to be undone, here are five signs the market might not have bottomed:

Chronic credit woes: The banks may not be dead, but they're still sick. So are those giant, complicated credit markets. JPMorgan analyst Thomas J. Lee noted that the markets for securities backed by residential and commercial mortgages have recently deteriorated to their worst levels since Lehman Brothers' bankruptcy.

The market needs a plan for these "toxic assets" — either by selling them to private investors, or allowing banks to mark them differently. A failure by the government to deliver such a plan sparked a selloff last month, and if investors don't get one soon, the market could be in for another tumble. Analysts aren't ruling out a Dow drop to 5,000, or an S&P decline to 500.

"We don't believe that the bear market's over yet," said Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York. Toxic assets "either need to come off the banks' balance sheets, or they need to improve on the banks' balance sheets."

Economic drops are jagged: Economies, like stock markets, don't decline in a straight line. The recent spate of better-than-expected retail sales data could be merely a short-term blip.

Sandeep Dahiya, a finance professor at Georgetown University's McDonough School of Business, said he wants to see three months of sustained increases in the Conference Board's consumer confidence index. It is currently at the lowest levels since the gauge started in the 1960s.

"Until that happens, I'm not willing to say this thing is behind us," he said.

Shorts aren't so sweet: A big chunk of last week's rally was driven by what's known as "short-covering" — when investors buy stocks simply to offset short trades, in which an investor borrows a stock then sells it right away, hoping to buy the same shares back later at a lower price, thus profiting from the decline.

It's difficult to differentiate between short-covering and regular buying, but floor traders last week estimated that between 50 percent and 60 percent of Tuesday's 379-point jump in the Dow was due to short-covering. And a rally driven by short-covering can disappear quickly when a scary headline hits the wires.

Fear of the unknown: The market fears something wildly unexpected could happen. The Sept. 11, 2001 terrorist attacks threw a wrench in the market's recovery following the bursting of the technology bubble. And an unintended consequence of addressing the Great Depression with protectionism in the 1930s was global trade war, which hampered the U.S. market's recovery.

The Bernie Madoff factor: Even if you didn't invest in Bernard Madoff's fund, you might still be an indirect victim. Trust in the markets took a major hit after his $65 billion Ponzi scheme was revealed last December. It took another blow when R. Allen Stanford's $8 billion scheme came out in February. Without trust, the stock market can't rise for long.

"A lot of people have been beaten and wounded, and it's going to take time to recover from that. It's more than wealth — confidence has been rattled," Frankel said.

Before jumping in, "everyone is looking twice," Frankel said.