Updated from 2:35 p.m. EDT

When stock proxies rally in the face of bad news, market watchers say it can be a sign that the worst is over, at least for the short-term.

The

Dow

,

Nasdaq

and

S&P 500

each jumped over 5% Monday despite news that

Qwest

(Q)

withdrew its financial forecasts for 2002 and said it improperly booked $1.16 billion in sales and other items from 1999 to 2001.

The news wasn't too surprising, of course; the company was already under investigation for its accounting procedures and has seen its stock fall 91% this year. Still, analysts were pleased that initial weakness in Qwest's share price had next to no impact on the major averages. The stock was actually flat in late trade, having erased an earlier 26% decline.

Investors also brushed off news that Standard & Poor's lowered its outlook on

America Online

(AOL)

. Indeed, AOL actually rose 5% after tumbling in after hours trade Friday.

Meanwhile, shares of

Williams Cos.

(WMB) - Get Report

surged 62% to $1.72 despite the company reporting a large second quarter loss amid significant declines in its energy, trading and marketing business.

Bullish Signs

David Skarica, publisher of the newsletter

Addicted to Profits,

was encouraged by the rally Monday because he noted that up volume on the NYSE exceeded down volume by more than 9-to-1.

This is the second time in the last month that advancing volume has outpaced declining volume by such a wide margin, making it a very bullish indicator. Since 1960, the market has always been higher six months after two 9-to-1 days, he said.

"My guess is we've seen the bottom," added Tony Cecin, head of equity trading at U.S. Bancorp Piper Jaffray. "We were exceptionally oversold."

Heavy selling over the last two months pushed stocks down to multiyear lows and wiped out trillions of dollars in market wealth. But signs that the government is serious about cracking down on corporate fraud have helped to restore confidence.

Last week, several former

Adelphia

executives were arrested on charges of securities fraud, and Congress agreed on legislation that would give much stiffer penalties, including jail time, to white-collar criminals.

With the Dow now up 1220 points, or more than 16%, since the low on Wednesday, some analysts are convinced that the trend has reversed.

Sideways Volatility

"The bad news has been discounted," said Ed Peters, chief investment strategist at PanAgora Asset Management. "We could easily see a 10% to 15% bounce from here."

Peters said the market is "chronically undervalued" but he added that as stocks become more fairly valued, the rally will likely falter. "I expect some sideways volatility for a while," he said. "It won't be until the fourth quarter that we get enough news to actually start a decent rally."

UBS Warburg strategist Ed Kerschner believes this is the "most cyclically attractive market since 1980," but said a lasting recovery will depend on the timing of a rebound in corporate earnings and the time it will take for corporate scandals to "fully play out."

Of course, not all analysts are convinced the market is cheap. Despite the recent drubbing, Richard Bernstein, chief strategist at Merrill Lynch, said stocks aren't "drastically undervalued" as others have suggested. His biggest concern is that future earnings estimates vary wildly among analysts and that earnings predictability is the worst in 60 years.

Goosing the Numbers

Analysts have generally been advising investors to ignore 2002's depressed earnings and look out to more normalized profit growth in 2003. But Bernstein said: "one can make any stock look inexpensive by incorporating earnings far enough in the future."

While he conceded that stocks do look cheap on the Federal Reserve model, which compares the earnings yield of the S&P 500 to the yield on the 10-year Treasury note, he believes this tells investors little about where the market is headed.

The Fed model showed that stocks were cheap in the late 1970s and early 1980s, for example, when equities performed poorly. It also suggested that investors continue to stay out of stocks during the bull market of the 1980s.

"The indicator's track record is spotty at best," he said. "Note that the bullish signals of 1989 and 2001 were prior to bear markets, not bull markets."

Bernstein also contradicted the argument that because inflation is low, the risk premium in equities should also be lower. He notes that the PE on the S&P 500 together with the inflation rate as measured by the consumer price index should roughly equal 20. Despite the low rate of inflation today, Bernstein said the market continues to be overvalued.

Don Hays, president of Hays Advisory, disagrees. Citing an article in Forbes over the weekend, he said the highest PEs ever were seen in 1920, 1932 and 1982-- three of the best buying times in history. "So when someone tells you that XYZ is still selling at 26 times current earnings, take that for what it's worth."