Bulls Circle the Wagons

An intraday rally fails, but some take solace in the U.S. market's strength relative to losses overseas.
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Clearly if someone yells "fire" in Asia, a rush for the exits happens around the world. Monday wasn't different, but once the cry hit American shores, investors seemed to respond as though it was just a fire drill.

A fresh round of gut-wrenching declines in Asian stock markets jerked U.S. stock market futures downward Monday morning. The Japanese yen strengthened further as the carry trade, in which investors borrow money in yen and invest it in higher-yielding assets, continued to unwind, raising questions about a liquidity crisis.

Europe's markets also had an ugly day, but registered only half of Asia's declines. The U.S. looked ready to swoon Monday morning, but the major indices staged a quick rally back into the green, and spent the day flip-flopping around the flat line before sliding into the close.

The bulls' stubborn resolve suggests the war is far from over but, in the end, the bears won Monday's battle.

The

Dow Jones Industrial Average

ended the day down 0.5% to close at 12,050.41 after trading as high as 12,189 intraday. The Dow is down 4.6% from last Monday's close. The

S&P 500

fell 0.9% Monday, to close at 1374.12, while the

Nasdaq Composite

ended Monday down 1.2% to close at 2340.68. The S&P is down 5.2% since last Monday and the Nasdaq has fallen 6.5%.

Blame bargain-hunters or program-traders working to capture returns on the volatility, but the market has resisted a repeat of last week's dramatic drop despite a deepening of the same bad news that sparked it.

"The market is trying to claw its way back into neutral territory on a day that had every right to be a huge down day," says John Bollinger, president of Bollinger Capital. "I'm impressed by the market's resistance to going down here."

Then again, one could just as easily say about Monday that the market just can't sustain a bounce, no matter hard investors try. It's partly a question of perspective. Indeed, some say the complacent mood in the market is part of why the market sold off to begin with. Investors were

anxiously seeking a reason to sell off and many are calling the recent decline "healthy."

On the other hand, bulls would argue the market had a right to tank Monday because the Nikkei, the Hang Seng and the Shanghai Composite fell 3.3%, 4% and 1.6%, respectively. Europe's markets also ertr falling. The FTSE 100 fell 1.9% and Germany's DAX declined 2.2%. Likewise, investors awakened to perhaps the worst news yet from the subprime mortgage-lending front.

Subprime mortgage lender

New Century Financial

(NEW) - Get Report

fell 68.9% on the company's report that the U.S. Justice Department is investigating its accounting and stock trading. Questions about its solvency started to swirl. Likewise,

Fremont General

(FMT)

sent many of its employees home on paid leave and said it will not originate any new subprime mortgages. Its stock fell 32.4%.

Other subprime participants fell in concert.

Countrywide Financial's

(CFC)

fell 4.9% as Lehman Brothers downgraded the stock.

Accredited Home Lenders

(LEND) - Get Report

fell 26%.

Not All Change Is Good

The subprime lenders' collapse is not new news, says Margie Patel, portfolio strategist at Pioneer Investments.

"Absent fundamental data, you can't move the ball down the field," says Patel, on a day the market had a decent, though less-than-expected, ISM report of activity in the services sector to turn to for relative strength.

Indeed, the still-prevailing sentiment about this market correction is that nothing "fundamental" has changed.

That's not exactly true. Lending standards have tightened as the subprime mortgage boom continues to go bust. That's fundamental, but not necessarily economically back-breaking. According to the

Federal Reserve's

January senior loan officer survey, lending standards for mortgage credit has gotten to the tightest levels since the early 1990s.

But the credit retrenchment can't be a full-blown crunch until it bleeds into credit cards or other consumer-oriented credit products. This hasn't happened yet, but the direction of the trend is not promising.

Thus far, delinquencies in both subprime and prime mortgages are still close to recent cyclical lows, according to Torsten Slok, economist at Deutsche Bank. Foreclosures are within their recent range, and credit card and consumer loans are still not feeling the pinch of tighter lending standards, he writes. In sum, Slok says the subprime sector alone can't hurt the economy too much as these borrowers represent less than 0.1% of consumer spending.

But what's unsettling is that the direction of each of these measures is up -- delinquencies, foreclosures and tighter standards for consumer credit.

Whether or not subprime drags down the rest of the economy is still up for debate.

Certainly, fear runs high when the market has dramatic declines like last Tuesday's, but sometimes the correction is an overreaction. Hindsight shows that 1987's 20% stock market drop on Oct. 19, 1987 was a situation in which the market "had overreacted to a modest negative shift in fundamentals," writes Bank of America's chief equities strategist Tom McManus.

In the 12 months following the October 1987 crash, the S&P 500 gained 28.1%, he notes. On average, the one-year return on the S&P 500 after a "significant one-day decline" is 12.7%, only slightly better than the 10% average total return for the index since January 1928, he writes. McManus says there were 16 significant one-day declines since 1928.

The other most recent one-day decline prior to last Tuesday's was a 6.7% drop on Oct. 27, 1997, after which the S&P 500 added 24.2% in the following 12 months. It followed an Asian currency crisis at a time at which global markets were similarly correlated, as they are today. Depending on your perspective, a comparison to 1997 is a point for the bulls or for the bears.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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