Here’s Why Bulls Shouldn’t Get Too Comfortable

By Brendan Conway and Steven Russolillo

Bloomberg

Today’s stock-market rally, driven by a confluence of three substantial economic events, is the most extreme bullishness the market has seen in months.

The surge has been driven by an aggressive funding-market intervention by world central banks, China’s monetary easing and a strong U.S. private-sector hiring report.

But after the dust settles, the first two of those drivers may actually underscore the reasons stock-market investors are so worried in the first place.

Central-bank interventions like Wednesday’s move, which gives European banks easier access to U.S. currency, have a record of jolting stocks higher. Traders must react to an immediate influx of new liquidity and they typically do so by driving markets sharply higher. But the underlying, and usually troubling, reasons for the banks’ actions tend to trump the action itself in the long run.

For example, the Federal Reserve triggered a series of sharp, brief stock-market rallies with its newly aggressive posture in late 2007 and most of 2008. The central bank cut the fed funds rate from 5.25% to a range of zero to 0.25% over the span of Sept. 18, 2007 to Dec. 16, 2008, with stocks chopping higher before reversing with even bigger drops.

However, over the same time frame, the unemployment rate rose to 7.3% from 4.7%, and the storm clouds of the financial crisis darkened. The Dow Jones Industrial Average fell 35% during the time span of those aggressive moves. The reasons the Fed took the actions were what mattered more for stocks.

In the present case, most investors are keenly aware the sovereign-debt crisis that has put markets on edge the last several months won’t be solved by any single central-bank action, even a dramatic one like Wednesday’s.

“It is troubling to think that we were possibly at a Lehman moment over the last couple of days,” said Channing Smith, co-portfolio manager at Capital Advisors Growth Fund. “This is by no means over in Europe.”

China’s own separate easing efforts were what originally turned U.S. markets positive in early-morning trading Wednesday. Before China cut bank-reserve requirements for the first time in nearly three years, stock futures were pointing lower, reflecting investors’ somber mood after Standard & Poor’s downgraded more than a dozen major world banks. The move also cheered European markets.

But China’s rate action followed a 3.3% tumble in the benchmark Shanghai Composite that left the measure flirting with fresh 2 1/2-year lows. The events were also seen as underscoring worries about China’s slowing growth and central bankers’ view that aggressive action needed to be taken.

About the only unalloyed positive Wednesday came from strong U.S. economic data that was highlighted by a blowout private-sector hiring report from ADP. The November payroll increase reported by ADP was the largest monthly gain since December 2010 and nearly twice the average monthly gain since May.

“We could finish the week looking at the U.S. even more positively than we have been. Some of the people [who are] still negative may be pulled into a neutral camp,” said Michael Shaoul, chief executive at brokerage firm Oscar Gruss.

However, the positive signs in U.S. economic data have taken a back seat to Europe’s drama for months, a situation viewed as unlikely to change if European bond yields can’t ease and the sovereign-debt crisis continues to worsen.

“The argument could be made that equities should be much, much higher,” said Capital Advisors Growth Fund’s Smith. “[But] the ou