How much of a bounce?

Finally two scoops of apparent good news propelled the stock market averages upward this past week. First, the second quarter reports of financial companies including Citigroup and Wells Fargo showed that sub-prime mortgage-related losses would not be sinking these behemoth banks after all. Second, the price pendulum of energy had reached its peak and began swinging back down as it inevitably must. Perhaps the world will adjust and recover as it has over time from every other shockwave in history.

At last Tuesday’s close, the KBW Bank Index was more than 45 percent lower than it closed out 2007. Either many investors were thinking banks are headed for extinction like dinosaurs or perhaps they no longer trust the FDIC (read US govamint ‘r us) to bail out the industry if conditions worsen. Fortunately, that same index leaped 29 percent over the next three trading days. Are you feeling the whiplash yet?

Crude oil dropped over 9 percent last week. In the near term its price will probably drop down to the $120 a barrel range but another step would take it back down to support at $110 or so. In response, investors sold off energy stocks as though oil companies would be losing money again any month now! Yeah, right.

Remember the primary principle that prices in the real world do not travel up or down in straight lines. Even during major trends, they most often peak far too high to be supported for long and corrections occur regularly. The fact giving me heartburn was that the Dow Jones 30 and S&P 500 plummeted 13 percent from the end of May to last Tuesday without taking more than any one day to catch its breath.

The big question: Is the worst decline past or does the beast still require a monster-sized sell-off to shake out any remaining sellers? Historically, market bottoms frequently come during September or October. But to my personal pain and suffering, I learned in 2006 that June and July will suffice in a pinch for low-point pits for bargain hunting. 

The 2007 cooling plunge came in mid-August, but even that failed to match the depth reached in March of last year. 

Despite remaining distrust of rotten financial assets and the always dangerous pre-presidential election fears, I believe the odds are 60 percent that the major indices will not again this year see the lows reached last week. Positive earnings surprises are likely to outnumber negatives once again. Also there are sufficient high profit margin companies with nicely growing revenues whose stock has been beaten down to bargain prices when you consider either price-to-sales or price-to-earnings ratios. And while consumers and our government have been borrowing like no repayment will ever be required, most businesses have little outstanding debt, GM and Ford notwithstanding. 

Are there still problems justifying concern? You bet. There always are. In the best of times, economic heart attacks and cancers are being ignored. In the worst of times, shining sectors of strength look tarnished when viewed through dirty lenses of seemingly justified permanent pessimism. 

By the grace of God, however, we muddle through. Oh look at the time - I am ready to shop for bargains again. You coming?