Big Rally = Big Trouble?

SAN FRANCISCO -- As one who's tried to make the

bullish case of late, I know better than to look a gift rally in the mouth, especially one accompanied by solidly positive market internals.

The

Dow Jones Industrial Average

rose 2.6% today, while the

S&P 500

added 2.7% and the

Nasdaq Composite

climbed 6.1%.

Advancers bested declining stocks nearly 7 to 1 in

New York Stock Exchange

trading while new 52-week highs led new lows 102 to 35. Gainers led 27 to 11 in over-the-counter activity although new 52-week lows led 94 to 63. Trading volume was solid, but not overwhelming, at 1.35 billion in

Big Board

activity and 2.2 billion in

Nasdaq

action. Up volume bested down 11 to 2 in NYSE trading and 19 to 1 in Nasdaq.

The advance was all the more impressive because it persisted despite comments from

St. Louis Federal Reserve

president William Poole, who declared "the U.S. investment climate remains robust" and gave 50% odds for a "gradual increase in economic growth as 2001 progresses," according to

Reuters

. He also expressed concern about inflationary pressures, which were reflected in a 4.4% rise in crude futures.

Poole's comments were widely interpreted as damaging to prospects for an intermeeting rate cut, for which many were salivating just

yesterday. That stocks were able to sustain their rally despite Poole's comments, along with the higher crude prices, contributed to a big selloff in bonds. The benchmark 10-year Treasury bond tumbled 1 7/32 to 99 10/32, its yield rising to 5.087%.

The risks after a rally such as this are myriad. If

Herb Greenberg

weren't on vacation, I suspect the first thing he'd say is that nothing fundamentally changed today to justify the big percentage gains sported today by

Ciena

(CIEN) - Get Ciena Corporation Report

,

JDS Uniphase

(JDSU)

,

BEA Systems

undefined

, or

Applied Micro Circuits

(AMCC)

, just to name a few.

Many investors feel those names -- among many others -- had traded down to levels where the "worst case scenario" was factored in. But the danger is the rally gets ahead of itself, leaving shares more vulnerable to the widely expected bad earnings news when it finally is reported. Moreover, what happens if the news proves even worse than feared?

Consider

Qualcomm

(QCOM) - Get QUALCOMM Incorporated Report

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, which rallied 7.9% today. If the spy-plane standoff with China intensifies and results in a trade embargo, isn't Qualcomm one of the companies that first comes to mind at being at risk?

A more concrete example is

Motorola

(MOT)

. After the close, the firm reported a

first-quarter loss of 9 cents a share that, despite the company's previous warnings, was still 2 cents wider than the consensus estimate, as well as its first quarterly loss in 15 years.

After rising 13% to $13 in the regular-hours session, Motorola's shares were down in after-hours trading as investors focused on the disappointing bottom line, its slumping handset business and plunging operating margins, as well as the firm's comment that "order growth weakened across all of the company's business segments."

Motorola's results question the notion that stocks have priced in the worst case scenario, an outlook that has proven erroneous on a number of recent occasions, noted Thomas McManus, equity portfolio strategist at

Banc of America Securities

. "If you look at Motorola, it's possible the news was poor enough that no one counted on things being this bad," he said.

McManus, our

Guru of the Year for 2000, recently upped his recommended equity

allocation but does not believe the market has seen a "final bottom," mainly because of a belief that earning estimates need to fall further still.

"You need to see a period of revisions that will bring down second-, third- and fourth-quarter

earnings estimates and perhaps 2002" as well, he said. "It will be hard for stocks to do extremely well in the face of that kind of headwind."

In a reference to the

liquidity concerns swirling around the company, Motorola's

press release stressed that "cash flow from businesses,

including net proceeds from investments

, was positive in the first quarter."

Motorola reported "gains on sales of investments and business" of $614 million vs. $101 million a year ago. Several market sources expressed confusion at trying to decipher Motorola's earnings statement. But given that the company had net earnings including interest, taxes, depreciation and amortization of $327 million, you could conclude the company had negative cash flow in the quarter, excluding the investment gains. Considering that the firm reported a net loss from ongoing operations of $206 million, Motorola's assertion of positive cash flow rings rather hollow.

One hopes Motorola will more directly address the cash flow/debt funding issues in its conference call tomorrow morning at 8 a.m. EDT (a time arguably designed to make my life miserable).

Meanwhile, Scott Wyman, the firm's director of financial communications, returned my phone call Tuesday afternoon. He declined to comment on the

Gimme Credit

reports, claiming Carol Levenson never contacted the company to discuss her concerns. Wyman did, however, agree to review a list of questions submitted in writing. If and when he replies, I'll report it here.

In an email exchange, Levenson conceded she had not contacted Motorola: "As a rule I work with publicly available information and draw my own conclusions," she wrote. "I can't recall ever hearing anything from any management that made me change my credit opinion on a company."

Half Full or Full of It?

Prior to Motorola's announcement, the potential for the worst case to get even worse was far from most investors' minds, reflecting an abrupt

change in psyche.

"I think this was the first time you saw people getting back into the water en masse," said Doug Myers, vice president of equity trading at

IJL Wachovia

in Atlanta. "The shark alarm has been off long enough for people to forget" and feel it's safe to buy stocks again.

Eloquently summing up the point I'm laboring to make, the trader added that, "hopefully we build a little base to at least have some type of sustained rally. But I would much rather see up 10, 20 or 30 than 300."

Along those lines, memories of what occurred Friday after last Thursday's huge upswing remain fresh. But go a little deeper into the memory banks -- back to mid-October, when the Nasdaq produced two days of 7%-plus gains within a week of each other. As with the more recent combination (today and last Thursday), those gains generated optimism a "bottom" was finally at hand. But we all know what happened thereafter.

Trying to look at the market from a glass-is-half-full perspective, it is noteworthy that far more market participants are dismissive of the recent advance vs. the attitude last October.

"I am still skeptical and still think we

need a lot of time to work a base and consolidate," said Ned Collins, executive vice president of U.S. stocks at

Daiwa Securities America

. "I think earnings comparisons are going to be difficult for another 12 months, which says we are probably going to have to do some work."

Still, Collins expressed hope that he's wrong and acknowledged "we probably could get a helluva rally because everybody is so negative and we're way oversold."

To summarize his message: Enjoy the rally, which may continue. But don't get carried away and start thinking the stock market is suddenly a friendly, fun, risk-free place again.

But you weren't thinking that, were you?

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.