Can the Rally Last?

Bear markets are infamous for short-lived rallies ("head fakes," in Wall Street jargon) and this cycle is no exception. Time and again since stock prices peaked in October 2007, the broad averages have staged daily advances so powerful as to suggest that the negative sentiment was turning. But there's been no follow-through.

Here are some specifics: Since July 1, ten times (or more than once a week, on average) the Dow Jones industrial average has been up 100 points sometime during the day, only to finish the trading session with a loss. Whatever news appears bright in the early promise of a new trading day fades to black by quitting time.

Many of the short-lived rallies were triggered by news -- the reorganization of Fannie Mae and Freddie Mac, for example -- that seemed to presage a long-term boost for shareholders of banks and other financial institutions. Go back to March, right after the government pledged to backstop JPMorgan Chase's takeover of Bear Stearns, and the Federal Reserve reduced short-term interest rates by 0.75 percentage point, to 2.25%. Investors then concluded, logically, that the Fed's actions would restore liquidity to the credit markets and bid up share prices. The Dow soared from 11,975 to 12,525 in a day and a half.

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But by the end of that second day, the average fell all the way back to 12,099. The given reason for the dipsy-doodle was analysts' comments that, the accommodative Fed notwithstanding, Merrill Lynch and Lehman Brothers would need to take bigger write-offs on mortgage investments than they previously said they would.

Of course, that's what the newspapers reported. A more likely reason the March charge went nowhere fast is that the economic troubles remained too numerous to count. Just before the Bear rescue, the dollar hit a record low against the euro and gold passed $1,000 an ounce. And, by the way, the government was busy issuing awful jobs and retail-sales reports.

Hardly the stuff of a sustainable bull charge, unless you're eager to buy shares of companies such as big exporters that benefit disproportionately from a devalued dollar. But if a weak dollar is so positive for exporters, why are such global powerhouses as Boeing (symbol BA), Caterpillar (CAT) and 3M (MMM) all in the double-digit-loss column for the year?

The answer is that a fresh bull market requires more than one-day gains based on scattered news events. The rescue of Fannie and Freddie is already engendering predictions along the lines of "now that the government did A, the banks can do B and C and consumers will be in good shape again, which would be great for D and E." But those processes take months to evolve.

The bailout is designed to free mortgage credit by reassuring investors that the U.S. stands behind mortgage-backed securities and other debt obligations of Fannie and Freddie. But that by itself won't arrest the housing slump. People won't buy real estate at prices that strain their budgets just because it will be easier to negotiate a loan next month than it was last week -- as long as they fear losing their jobs or are working harder for less. Last week, the government announced the eighth straight month of a shrinking American job base. If that turns, you could see an honest stock-market advance that lasts more than a few hours.

The latest rally was nice -- the Dow finished up 2.6% and Standard & Poor's 500-stock index rose 2.1% September 8. But that's not the kind of massive payday you'd have expected, considering that the Dow opened up 3% at 9:30 a.m. Bank stocks, the presumptive beneficiaries of this government's move to make credit more available and mortgage investments more liquid, rallied sharply, rising 6.6% September 8, as measured by KBW Bank exchange-traded fund (KBE).

The gains were erased, though, September 9 on news that Lehman Brothers's efforts to raise capital had failed -- sparking fears that the firm might not be able to stay afloat. The Dow fell 280.01 points and KBW BANK ETF lost 5.7%.

For the bank rally to endure, and for banks to report better earnings and be able to restore dividends they have been cutting, we need strong, broad-based economic growth. That will lead to fewer borrowers defaulting on their loans and a steeper yield curve, which will mean a bigger gap between what banks pay their depositors and what they collect on loans. Bank profits will zoom, and the heavy dose of financials and quasi-financials, such as General Electric, in the major stock indexes, will finally end the up-down-up pattern. Then we should have a sustained bull market, not a series of smiles followed by frowns.

But that won't be built on daily headlines. It will take hard work and time.