Stock proxies extended their streak of gains this week, but Friday's session provided a stark reminder of the pitfalls that may lie ahead. Paradoxically, that might be healthy for the market, as it reinforced the skepticism that has greeted the recent advance.

For the week, the Dow Jones Industrial Average rose 1.1% while the S&P 500 gained 1.3%, the fifth-consecutive weekly advance for both proxies. The Nasdaq Composite rose 1.4% for the week, its third-consecutive weekly gain.

Friday saw the Dow fall 2% to 8872.96, the S&P drop 2.3% to 940.86 and the Comp 3% to 1380.57. The session left the Dow below the psychologically important 9000 level and the S&P below 950, which represents the neckline of its technically significant head-and-shoulders pattern, as discussed here.

Nagging issues about corporate malfeasance resurfaced Friday in the form of a New York attorney general's probe into the role chairman Sandy Weill may have played in Citigroup ( C) winning underwriting business from AT&T ( T) in 2000. Citigroup shares fell 3.4% Friday. Additionally, AOL Time Warner ( AOL) slipped 9.3% after The Wall Street Journal revived questions about its accounting practices.

Separately, investors were reminded of the ongoing struggles of technology companies as Bear Stearns lowered estimates for Intel ( INTC); Banc of America Securities cut estimates on chip-equipment makers, including Applied Materials ( AMAT); and Goldman Sachs forecast significant order cuts by Taiwan Semiconductor ( TSM), which the firm said could have particularly negative implications for Novellus ( NVLS).

The Philadelphia Stock Exchange Semiconductor Index fell 5.9% Friday, ending the week down 3.5%.

Prior to Friday's setback, the SOX was up 25.8% since Aug. 5 while the S&P 500 was up 15.3%; the Comp was higher by 18%. Such gains, as well as rallies in previously beaten and battered names such as AOL, Tyco ( TYC) and Dynegy ( DYN), drew catcalls from skeptics. The advance was based on flimsy fundamentals, they said, and largely was the result of short covering and/or the absence of senior money managers during Wall Street's prime vacation season.

Cries of "I told you so" were practically audible during Friday's reversal, although bulls countered that trading volumes were particularly light, even for this time of year. About 1.1 billion shares traded on the Big Board on Friday, 33% below the three-month daily average, according to Bloomberg.

Where Have You Gone, Rodney Dangerfield?

Indicators such as put/call ratios and anecdotal evidence indicate a revival of optimism among traders, but, clearly, many investors continue to doubt the rally.

On Wednesday, Investors Intelligence reported a rise in the level of bearish sentiment to 40% this week from 37.4%, while bullish sentiment fell to 36.7% from 38.5%. Additionally, the level of short interest on the Big Board set a record for the month ended Aug. 15, The Wall Street Journal reported.

As noted above, optimists believe such skepticism is healthy.

"Clearly, you can't be as aggressive as the last two to three weeks," said Brad Ruderman, managing partner at RCM Partners, a Los Angeles-based hedge fund with about $100 million under management, who noted "lower-quality" names are starting to rally, and that the market's seasonally worst time is approaching. "But the market always frustrates the masses," he added. "Which is why, as more people become skeptical of the rally, the more likely it is to go higher."

Ruderman didn't venture a guess as to how much further the rally can climb, nor does he believe owning stocks is without risk. But the fund manager observed the market has recovered from some severe selling, and suggested "the single most positive thing going on right now in global markets is the drastic narrowing of credit spreads in the last two weeks."

Indeed, Standard & Poor's Speculative Grade Credit Index, which mirrors the trend in spreads between high-yield bonds and Treasuries, fell to 1330 on Thursday after hitting a record high of 1385.3 on Aug. 14. Simultaneously, spreads on Merrill Lynch's investment-grade bond index narrowed to 220 basis points on Wednesday from an Aug. 13 peak of 239 basis points.

"Although spreads remain wide by historical standards, the recent abrupt narrowing suggests that investors may be less pessimistic about the economic outlook and more willing to take risks," Anthony Crescenzi, chief bond strategist at Miller Tabak observed on

In addition, corporate bond issuance "has increased markedly," he noted. This week's offerings included deals from Citigroup, Goldman Sachs ( GS) and General Motors Acceptance Corp., whose bond sale Thursday was increased in size to $2.5 billion from a planned $2 billion due to strong demand.

Furthermore, the Federal Reserve's survey of bank lending officers, released early in the week, showed fewer financial institutions were tightening lending standards and some were even easing them.

Some will challenge the merits of increasing risk tolerance, but the evidence suggests investors and financial institutions have overcome the fears prevalent in June and (especially) July.

The Recap

The week got off to a solid start Monday amid optimism about results from Lowe's ( LOW) and Toys R Us ( TOY). The gains came despite a 0.4% drop in the Index of Leading Economic Indicators for July, the largest drop since September 2001.

Averages stumbled on Tuesday after UBS Warburg downgraded the Baby Bells, while oil's rise above $30 per barrel reinvigorated concerns about the global economy. (On Friday, oil prices retreated 0.7% to $28.63 after a Saudi official told Dow Jones Newswires that "using oil as a weapon does not accomplish anything" and suggested "moderate oil prices" -- of around $25 a barrel -- are also "in the Saudi interest.")

Shares rebounded Wednesday despite a profit warning by Radio Shack ( RSH) and Salomon Smith Barney downgrade of several big brokerages. Aiding the averages were a guilty plea by former Enron executive Michael Kopper, which raised expectations for arrests of other former Enron chieftains, and a Byzantine deal between AOL and AT&T that was embraced as "good" for both firms.

The gains accelerated Thursday and rallies in shares of Microsoft ( MSFT) and others helped propel the Dow back above 9000 for the first time since July 9.

The advance came to an abrupt halt Friday, leading to more consternation about its staying power.
Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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