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Goldilocks Eats Bears' Porridge

Solid September jobs gains deal a blow to the recession thesis.

Goldilocks is back.

Friday's report that the U.S. added 110,000 jobs last month emboldened bulls. Stocks rallied, reflecting investors' belief that the

Federal Reserve's

interest rate policy "threaded the needle" and kept the economy growing without spurring inflation.

"The Fed tightened just enough through June of last year to pop a couple of bubbles and un-tighten the labor market," says T.J. Marta, fixed income strategist at RBC Capital Markets.

"We've had the evolution of the housing problems from builders to lenders to hedge funds to banks to consumers, and we're back to the original question of, 'Can the housing market take down the U.S. economy?'" adds Marta. "We're highly skeptical that it can."

Adding to the optimism was a positive revision to August's report. The initial report of a loss of 4,000 jobs spurred fears that the economy was stumbling into a recession and gave the Fed room to cut rates at its Sept. 18 meeting.

But the government said Friday that a revised look at earlier data shows the economy added 89,000 jobs in August and 93,000 in July, a gain of 25,000 from the initial July reading.

For now, the markets appear unperturbed that the good news on jobs may mean no further rate cuts. Federal Reserve Vice Chairman Donald Kohn made remarks in a speech Friday morning that were taken to mean that the 50-basis-point cut in August would be enough for now.

In explaining the Fed's reasoning behind the rate cut, Kohn said the central bank's easing was aimed at "encouraging moderate economic growth over time," not at mitigating a repricing of risk "or the gains and losses that the repricing will entail for market participants."

He went on to say that while weakness from housing and tighter credit conditions may still dampen growth, September's rate moves -- which paired a half-point cut in the fed funds rate along with a similar move in the so-called discount rate for emergency borrowing -- will take "their maximum effect only after several quarters."

Once that weakness is worked through, Kohn added, "I am looking for moderate growth with high levels of employment."

Kohn and the jobs report reflect the market's sentiment, which is putting the credit crunch in the past.

"The market is looking to the future," says Marc Pado, chief market analyst at Cantor Fitzgerald. "The story right now is: dump everything in the third quarter and move on."

Pado adds that traders are thinking about fourth-quarter earnings at this point, not third-quarter reports, which begin in earnest next week. And, the market's cheering this week's credit crunch-related writedowns by

Citigroup

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,

Merrill Lynch

(MER)

,

Washington Mutual

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and others because they believe it's washing out the bad news now.

"All corporations want to end the year on a strong note, so they throw the bad news into the third quarter," he says.

Measures of investor sentiment also show that traders are back to pre-credit-crunch levels of bullishness. According to Investor Intelligence, bulls have reached 56.5%, matching levels of market peaks in July after falling to 40.6% in August, notes Randy Diamond, a trader at Miller Tabak. Likewise, the measure of bears in the market has fallen to 25%, its lowest reading since July as well.

Bullishness brings out the

short traders, as many investors automatically hedge when sentiment nears peak levels, says Diamond, adding that more short selling also means more short-covering rallies.

In sum, the mind of the market is cleared of credit clutter, reassured the Bernanke-led Fed will ride to the rescue if there's another crisis, and hopeful that the fourth quarter will show the crunch was just a hiccup.

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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