How Does A Market Move Up 400 Points On Bad News?

Rally caps were out in force yesterday with the Dow moving up almost 400 points. How and why it did that in a day of predominantly bad news is hard to fathom. The FT mentioned that much of it was short covering. The pink-colored paper noted "bankers and analysts cautioned that the rally could also reflect the large number of hedge funds and other investors who had bet that prices would go down and were retreating from short positions"  But that is an inadequate explanation for such a big surge

The list of negative data posted as the day went on was a shaking of the foundations of the US economy. It has been a very long time since car sales fell 18% at the nation’s largest auto company, GM (GM). The head of sales at Ford (F) said that company expected the second quarter to be worse than the first.

For some reason, Wall St. saw the fact that Lehman (LEH) raised $4 billion as good news. It is not. The notion that a major investment bank had to go into the market for that kind of capital can only be viewed well in light of the fact that it got any money at all. When a major US financial companies have to raise one cent, the storm flags are out.

Notable as well, Reuters reports spreads on junk bonds, or corporate debt rated below "Baa3" by Moody’s Investors Service and "triple-B-minus" by Standard & Poor’s are at 821 basis points over comparable Treasuries — or levels not seen since December 2002, according to Merrill. To put that in English, the smart money is betting that things will get worse and companies which have mediocre balance sheets will be hit with defaults over the next several months.

Cash continues to move into 10-year Treasuries, a safe-haven for big institutional investors who don’t like the look of the equity and bond markets. Those firms could miss out on a big rally, but they don’t think so.

At base, the market has to believe that most of the subprime problems which kicked-off all the trouble are coming to an end. That projection is for suckers. Nationwide, 1.5 million subprime adjustable-rate mortgages will reset to higher interest rates this year – with May and June being peak months, according to CNN Money. Congress will move at its own glacier-like pace and will miss any window that might save the poor souls who own these homes.

The optimism in traders in never ending. It is how they make their living. For them, trading the market up is like breathing  But, they ought to read the newspapers.

Douglas A. McIntyre