An oversold market gets an overdue bounce. Now what?

The stock market can’t do anything in moderation anymore.

Last week’s record 18.2% drop in the Dow Jones industrial average was followed by today’s 11.1% rebound, the fifth-largest percentage gain ever.

Is your head spinning?

And on a day like this after a week like that, the first thing you’ll hear from Wall Street analysts is that the market was overdue for a big bounce -- so be careful, they warn, about reading too much into it, or betting it has legs.

After last week, "This was the largest oversold situation we’ve seen in a generation," said Ryan Detrick, senior technical analyst at Schaeffer’s Investment Research in Cincinnati.

"Oversold" means the selling had gone on for so long that, for the moment, there were few investors left to jettison stocks.

The Dow had dropped 26% from Sept. 19 through Friday, in a slow-motion crash that speeded up last week as hedge funds and mutual funds dumped shares to meet real or expected investor redemptions.

Once a rally gets going from oversold conditions, the buyers temporarily are in total control, notes Tony Dwyer, market strategist at FTN Midwest Securities in New York. They would include, he says, "short sellers" who are buying back stock to cover bearish bets, day traders and other momentum players, and the "Oh-my-God-I-missed-it" investors who thought about buying last week but waited.

Still, the market needed a catalyst, and it got one: news of literally trillions of dollars in new government aid for banks in Europe to get them over the credit crisis.

And in Washington, the Bush administration pushed ahead with plans to directly inject capital into U.S. banks, a strategy that may be a faster route to restoring faith in the financial system than buying up bad loans.

"Governments needed this rally to happen," to bless the new, expanded bank rescue plans, said Marc Pado, U.S. market strategist at Cantor Fitzgerald.

So maybe for the first time in this crisis, investors and government bailout engineers were seeing eye-to-eye today.

But even if there’s a thaw in the credit situation, the stock market will have to face up to the damage already baked into the outlook for the economy and corporate earnings, Pado notes.

In third-quarter profit reports that will begin to roll out in earnest this week, he figures many companies will sound extremely cautious in their forecasts for the fourth quarter.

"I think they’re going to put the worst-case scenarios out there," Pado said.

And without a clear sense of how bad off the economy will be in the fourth quarter and in 2009, investors who haven’t sold stock thus far may be itching to let some go with this rebound -- putting a lid on the market's recovery potential.

Welcome as the vast new bank bailout plan may be, Dwyer says, investors ought to realize that "saving the global financial system from Armageddon is not a growth strategy."

Photo: On the NYSE floor today. Richard Drew / Associated Press

Comments

[peartree]

Ok, I know nothing, but I'll take a crack at this.

Cramer's call (way late) to sell; Time magazine cover of breadlines or soup-lines or whatever that was, etc. etc. -- all signs of a bottom. And then Monday's huge rally a sign not to sell and in fact to start buying?

Maybe, maybe not.

After years of consumers/investors being told "it's different this time"-- the tech bubble, then the housing bubble, stocks won't fall and housing prices won't fall because "it's different this time"--now we're told by the Wall Street Journal et al that "it ISN'T different this time."

In other words, it's NOT the Great Depression 2.0, it's just another severe October correction, and if you've got at least a five-year horizon, start buying now or you're going to miss out.

But what if it IS different time--actually more like the crashes of 1873 and 1929 than those of the late 20th century?

Who HAD to buy in bulk on Monday? Pension funds, for starters, which are married to equities and can't afford a divorce.

It's criminal to make Americans' secure retirements dependent on a rigged casino called Wall Street.

[Mike Barker]

Volume like that is the result of the mutual funds buying at any price to get the averages up to stem the tide of redemptions. If anyone is tempted to get back in the market I would suggest waiting a while to see if this rally lasts. I predict it will not and is just a ruse to separate investors from their money one last time.

[subgenius]

Have a look at the charts of stock price movements for 1929-1930...

[Mr.Bilko]

People need to stop bringing up the Great Depression of 1929. What turned the recession of 1929 into the Great Depression of 1929 was the Dust Bowl, which lasted from spring 1930 until about summer of 1939, which just happens to mirror the time period of the Great Depression. Revisionist historians pin the blame of the Great Depression on Wall Street but the truth is the Dust Bowl of the 1930s is what turned a recession into a depression. If it weren't for the severe draught that caused the Dust Bowl, there would have been no Great Depression.