This Rally's Not About Fundamentals

Now that's entertainment! For the first time since Sept. 5, the Dow Jones Industrials closed above the 10,000 mark, while the Nasdaq Composite closed above 2000 for the first time since Aug. 7.

Since the postattack lows, the DJIA is up 23% and the Nazz has risen a whopping 44%. A better script could not have been written for what the global reaction would be to the tragic events of Sept. 11.

I have written a number of columns referring to the tug-of-war between liquidity and fundamental reality. The liquidity is a combination of short-covering and portfolio performance anxiety. Performance anxiety refers to money coming in from the sidelines as fund managers attempt to get invested so they don't show significant cash buildup as the market ramps. It is forgivable to lose money if the markets are going down and everyone is losing money. It is unforgivable to not make money as the market moves higher, especially after a treacherous two years.

Let me use a mock interview between a fund manager and a client as an example:

Client: Hey -- nice to see the market going higher, looks like we are going to make up for some of those losses.

Fund Manager: Yeah, win one for the good guys.

Client: So how are we doing, given the market rally off the lows?

Fund Manager: Pretty good. We remain concerned that valuations are way too high and that the economic weakness is going to continue for some time.

Client: So how is pretty good? I mean, the Nazz is up almost 50% from the lows and everyone is talking about a turn in tech.

Fund Manager: Well, we haven't recovered as much as the market, and it is too early to say there has been a turn in tech.

Client: Would you just answer the question of how we are doing?

Fund Manager: Well -- the numbers aren't in and the quarter isn't over -- but we are up about 10% from the lows.

Client: This has been an awful year for us, and I just hope things improve by the end of the year -- besides, CNBC just said that the Nazz has crossed the 200-day moving average!

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At that point, the client hangs up and the fund manager calls his trading desk:

Fund Manager: Hey bud! Just got off the phone with one of our largest clients who made it clear we need to improve performance by the end of the year.

Trading Desk: So what do you want to do? The market is overbought, valuations are high and the market is up too far, too fast.

Fund Manager: You sound like me. Problem is that how we view the market won't matter if we don't have any clients because we are underperforming this bounce so badly, as we continue to wait for a dip that doesn't come!

Trading Desk: I would bet the liquidity will dry up the closer we get to the end of the year, so if you want back into the game, we better do it soon.

Fund Manager: We can worry about the fundamentals next year. Let's get back to at least a market weighting in tech because we obviously sold too much on the way down.

This mock conversation goes to show how the buy and sell decisions out there by mutual funds may not be fundamentally driven. As a result, it is impossible to determine where the strength will end. Clearly, there is very little justification for the move given the current fundamentals. But the rally has very little to do with the fundamentals.

Let the liquidity push run its course and prepare for what happens when it is over. If you were uncomfortable owning too much tech and telecom on the way down, use this run as an opportunity to rotate out of some tech if you own too much and rotate into more stable growth and/or higher yielding companies. Two examples are soft drink and tobacco companies.

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