Skittish Bulls Push Ahead

Traders weighed Bear Stearns' troubles vs. Blackstone's IPO pricing in a wild day for the market.
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The stock market bounced back Thursday, but with much trepidation.

Investors weighed strong economic reports, which sent bond yields slightly higher Thursday, against a storm of news from the private equity and hedge fund fronts.

The story of

Bear Stearns'

(BSC)

two troubled hedge funds that were heavily invested in the subprime mortgage market remains a thorn in traders' sides as the tumult over private-equity firm Blackstone Group's initial public offering crescendos ahead of its Thursday night debut.

"I'm a little nervous," says Todd Leone, head of listed trading at Cowen & Co. "The market acts too well."

The

Dow Jones Industrial Average

fell as much as 90 points Thursday, but turned around in the afternoon to end the day up 0.4%, or 56 points, to close at 13,545.84, just off of its best levels of the day. The

S&P 500

finished the day up 0.6% to close at 1522.19, and the

Nasdaq Composite

finished up 0.7% to close at 2616.96.

The yield on the 10-year Treasury notes rose to 5.16%, up from 5.12% Wednesday, on stronger economic data. In keeping with recent bond market leadership, stock traders watched bond yields for several minutes to assess their stability before rallying, says Marc Pado, chief market analyst at Cantor Fitzgerald.

The Philadelphia Fed report of manufacturing activity in the region jumped to a reading of 18 in June, from 4.2 in May. The report was the strongest since April 2005, and well above analysts' expectations for a reading of 7. The Conference Board reported that its index of leading economic indicators rose 0.3% in May, beating expectations for a 0.2% gain.

But even as indicators pointed to a stronger economy, traders couldn't shake their anxiety about the Bear Stearns hedge funds.

"There are potentially broad implications," writes Louise Purtle, senior analyst at CreditSights.

Bear Stearns' wrong bets on the subprime mortgage market, which led their lenders to make margin calls, could lead to a repricing of assets in the subprime and related derivatives markets. That could generate solvency issues for other hedge funds, writes Purtle.

And by extension, if lenders become more strict about risk and leverage when it comes to the hedge funds they've supported in the subprime and related markets, "this could spark an unwind of leveraged positions in other markets and a general repricing of risk," she writes.

A repricing of risk would mean a flight to high-quality assets like Treasury bonds as investors unwind borrowing positions and flee higher-risk asset classes, such as emerging-markets equity and debt, high-yield bonds and stocks.

For Thursday, most traders shrugged off the apocalyptic hypotheticals. As Purtle notes, banks were well able to contain the repercussions of the disastrous natural gas bet by Amaranth in September 2006.

Even so, in the post-Internet boom world, investors seem to feel they can never be too wary, and the nervous caution surely held the major indices back from a sharper rebound.

"People haven't believed the entire rally, four years long now," say Tobias Levkovich, chief U.S. equities strategist at Citigroup. He's observed investors constantly worried about the next problem, often at the expense of missing the next opportunity.

The nervousness about potential contagion rippled through the brokerage sector. The group fared poorly through most of Thursday, though some in the sector rebounded in the second half of the trading session.

After falling 2.4% Wednesday, Bear Stearns rebounded 1.8% Thursday as traders observed its situation resolving itself as the day progressed.

Merrill Lynch

(MER)

, one of the counterparties involved in the Bear Stearns saga, slid 0.4% on the day, while

Deutsche Bank

(DB) - Get Report

,

UBS

(UBS) - Get Report

and

Bank of America

(BAC) - Get Report

all fell 0.5% or less on the day.

Goldman Sachs

(GS) - Get Report

and

Citigroup

(C) - Get Report

gained a hair Thursday.

Lastly, the markets couldn't avoid the excitement over Blackstone's IPO, expected to price Thursday night. Between lawmakers calling for higher tax rates for private-equity firms to protectionist concern about China's plans to take a $3 billion stake in the deal, it's nothing but uphill until the evening pricing.

That said, it's only Capitol Hill making a stink about the offering. The rest of the investment community seems quite bullish on the affair. Reports surfaced amid all the headwinds that Kohlberg Kravis Roberts is planning a similar offering. Blackstone's deal for about $4.14 billion, or 10% of the company, is expected to price between $29 to $31 per share, and it is rumored to be as much as 12 times oversubscribed, according to various reports.

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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