An Uncertain Rebound In Stock Markets

Yesterday’s (Monday) large rally in the Dow (^DJI), S&P 500 (^GSPC) and Nasdaq (^IXIC), followed by massive gains overnight in Asia, sure makes it feel as if a bottom has been set. But has it?

My gut says Friday was a bottom, at least in the short-term. Actual data and current trends, however, paint an uncertain outlook.

Heading into Monday, equity markets were severely oversold worldwide. In the U.S., the VIX (^VIX) - a measure of volatility - topped 70 last week. (Typically, spikes in the VIX above 30 signal fear on the part of traders.) Technical indicators, such as the Wilder RSI, were practically screaming that a rebound would occur. Not to mention the fact that many companies with solid fundamentals had dropped.

Multiple central banks continue to do everything they can think of to “un-freeze” the credit markets. The latest proposal is direct investment in U.S. banks. Under the plan, announced this morning, the government will buy preferred shares in several major banks. In addition, the government will invest another $125 billion in several smaller banks.

Adding to the good vibes are discussions about new economic plans. House Speaker Nancy Pelosi may call a lame-duck session to vote on a new stimulus package. Presidential candidates Barack Obama and John McCain are unveiling new economic packages of their own.

Although positive, none of this masks the fact that worldwide economic growth is stagnating.

Even the more optimistic forecasts have the U.S. unemployment rate rising over the next several months. Slowing growth in Europe not only hurts companies abroad, but also those in the U.S. that have benefited from previously strong demand for exports. Housing remains in a slump, not only in the U.S. but also other countries. And retailers are scared about the upcoming holiday shopping season.

Therefore, any rally we see right now might be more respite than recovery. I would be remiss if I didn’t tell you that even lower lows is within the realm of possibilities. Then again, the markets could settle into a protracted trading range, with Friday’s close representing the bottom of that range.

For investors, the strategy remains the same – buy fundamentally sound companies with rising earnings estimates that are trading at attractive valuations. Examples include General Dynamics (GD) and Pfizer (PFE).

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