What a Week: Bad News, What Bad News? Market Psychology Shifts

SAN FRANCISCO -- With astounding speed, abject misery turned to abject joy this week.

The reversal of investors' fortunes occurred almost precisely at midweek as stocks mounted a remarkable recovery from harrowing declines Wednesday morning. That session emboldened the long-suffering bottom pickers, whose optimism was rewarded with a blockbuster rally Thursday. A satisfying follow-through concluded the week, which saw the Dow Jones Industrial Average rise 0.3%, the S&P 500 climb 1.7% and the Nasdaq Composite jump 5%.

The weekly advance was the first for major averages since the five days ended Sept. 1.

Cynical observers, like yours truly, suggested the euphoria evident at week's end was not justified by fundamental macroeconomic developments. But naysayers were left in the untenable position of trying to fight a tape suddenly reinvigorated after six-and-a-half weeks of struggle.

"There are ongoing worries about softness in the euro, which translates into worries about earnings, and oil prices -- the fundamentals didn't change much" this week, said Hugh Johnson, chief investment officer at First Albany. "But even though [those] worries don't go away, the market has been driven down to levels where it's oversold and undervalued -- levels to which the slightest bit of good news can start the recovery."

Separate and Lift

The week began with the Nasdaq unable to extend the whopping gains registered Oct. 13, but resistant to any significant decline. Major proxies were restrained by steep losses at Microsoft (MSFT Quote) and Intel (INTC Quote), both saddled by concerns about earnings reports due later in the week. Meanwhile, tech favorites such as Juniper (JNPR Quote) and Redback (RBAK Quote) continued to rally.

Elsewhere, news of a merger between Texaco (TX Quote) and Chevron (CHV Quote) couldn't revive energy stocks, whose recent advance stalled as oil prices declined amid hopes for a peace settlement between Israel and Palestine.

From start to finish (and beyond) Tuesday was a tough session for those betting the selling had run its course. Major proxies fell in unison -- the Dow losing 1.5%, the S&P down 1.8%, and the Comp off 2.3% -- as fears mounted about earning reports due after the close.

Such concerns were confirmed Tuesday evening when IBM (IBM Quote) reported earnings that met expectations, but revenue growth that disappointed investors. Similarly, Intel posted earnings that bested lowered expectations, but the chip giant issued some cautious comments about its fourth-quarter sales. A host of smaller tech names also posted disappointing results, including Copper Mountain (CMTN Quote), RealNetworks (RNWK Quote) and RF Micro Devices (RFMD Quote).

The sum of those disappointments hit hard Wednesday morning as stock averages cratered from the opening bell -- as big declines in the futures markets indicated would occur. But the steep early drop would prove to be the nadir of the market's recent woes.

Buoyed by a sense big-cap tech and financial names had reached irresistible bargains -- and with Dow 10,000 and Nasdaq 3000 proving to be key psychological levels -- investors stepped into the breach Wednesday morning, giving market averages a huge boost.

The Dow closed off just 1.1% to 9975.02 after having traded as low as 9654.64. Similarly, the Nasdaq shed just 1.3% to 3171.56 after trading as low as 3026.11. The S&P finished off 0.6% to 1342.13 after trading as low as 1305.79.

The turnaround session was quickly and immediately declared a "final bottom" by hordes of market watchers. Although many had made similar pronouncements in recent weeks, the follow-through to come would finally support their bullishness.

Nasdaq Reverses With a Vengeance From Wednesday morning's lows, the Comp recovered, and enjoyed a huge gain Thursday

After the close Wednesday came more good news, in the form of better-than-expected results from Microsoft, whose executives gave a glowing outlook about the fourth-quarter. The news from Mr. Softee, plus stellar results released during Wednesday's session by Sun Microsystems (SUNW Quote), emboldened investors' outlook for tech sector profits.

That sentiment, plus a fairly benign speech by Federal Reserve Chairman Alan Greenspan, led to huge gains on Thursday -- 7.8% for the Comp, 3.5% for the S&P and 1.7% for the Dow, along with tremendous advances for sector indices such as semiconductors and brokerages.

A quiet, but solidly positive session on Friday -- the Dow rose 0.8%, the S&P by 0.6%, and the Comp by 1.9% -- had observers convinced the lows visited Wednesday morning would remain in the market's rearview mirror. In fact, the end of the week had market watchers recalling past instances when equities bottomed in October.

Since 1945, "there is virtually no downside in [major] averages from the final low in October through the end of the year," according to a report released Friday by Bianco Research in Barrington, Ill.

In years when the averages fell more than 10% from a September closing high (as was the case this year), the Dow posted an average advance of 12.1% from its October lows to its highs reached in November or December, Bianco Research reported. Under similar circumstances, the S&P rose an average of 14.2% and the Nasdaq by nearly 21%.

Many investors are no doubt anticipating similar returns this year, but First Albany's Johnson cautioned against complacency.

"There's still a tradable rally left," he said, suggesting fair-value targets of 10,600 for the Dow, 1450 for the S&P 500 and 3600 for the Comp. "Be a buyer but keep an eye on the Middle East and the euro. This week did not reduce those risks."

Indeed, oil futures rose more than 3.3% Friday as the peace talks between Israel and Palestine appeared on the verge of collapsing.

But that development was all but an afterthought amid the ebullience over what had transpired Wednesday and Thursday -- the ability to overlook "bad" news being another indicator of the extent to which market psychology shifted this week.