The big question on investors’ minds this week is whether the market has reached a major bottom following the Federal Reserve’s sensational attempt to rescue troubled brokerage Bear Stearns and slash short-term interest rates. It sure looked that way to many Tuesday after the big stock indexes soared by 4%. But Wednesday not so much, as stocks forfeited three-quarters of their gains.
So here’s the plain facts: You can only get a major bottom in stocks if the impulse to sell has been exhausted and if investors respond to lower prices with a powerful, sustained wave of buying. And the actions this week suggest that neither has occurred. Selling was clearly not exhausted Tuesday because sellers came roaring back Wednesday.
(Update: The market's gain on Thursday shows investors are hope the worst is over. But it hardly proves that stocks are cheap enough.)
The verdict is therefore clear: A major bottom in the market hasn't yet arrived. To understand why, consider what got folks excited Tuesday. The bailout of Bear Stearns might seem positive on the surface but it loses its allure when you stop and ponder the implications of the fact that the fifth-largest brokerage in the nation lost 95% of its value in a few weeks' time. And the three-quarter point cut in interest rates means the Fed believes the economy is in terrible shape. As if to put an exclamation point on this issue, on Wednesday Merrill Lynch, UBS and Lehman Brothers, all of whom had business models with similarities to Bear Stearns, were on the hot seat -- sinking in value by up to 11.5% and closing at lows. Investors thus collectively decided more shoes will drop, and the Fed cannot bail them all out at once.
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