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Stock Market Nears Correction Mode but Pulls Back

Monday, 22 Feb 2010 09:33 AM

 

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Call it the almost correction.

A jump in stocks last week is a sign that the market is stabilizing after a slump that began in mid-January. The drop sent the Standard & Poor's 500 index down 9.2 percent — short of the 10 percent pullback that generally defines a correction.

The clearest evidence yet of stocks' new strength came after the Federal Reserve said it was raising the interest rate it charges banks. The announcement didn't sink the market although it was the kind of news that only weeks ago would have sent stocks tumbling.

The market's drop and latest bounce underscore the importance of occasional pullbacks, even if they can't be called corrections. Analysts worry when markets leap higher that investors are getting too optimistic, too complacent or too greedy. Those attitudes can set the market up for a plunge when economic or corporate news turns bad.

A correction might be healthy for the market but can be hard on investors. They start worrying that the slide will accelerate and turn into a bear market. That's a plunge of at least 20 percent.

The S&P 500 index jumped 3.1 percent for the week. That advance doused some of the concerns that investors would keep dumping stocks after a year of almost uninterrupted gains.

"You never know if it's going to be the pause that refreshes or the beginning of a new bear market roar until you get through it," said David Bianco, head of U.S. equity strategy at Banc of America Securities-Merrill Lynch in New York.

Bianco is encouraged by the market's recovery after it neared the correction threshold.

"We got there and then we rebounded," he said. "That strikes me as a good signal."

The latest climb is all the more impressive because the Fed said late Thursday it would raise the discount rate, the interest it charges banks for short-term loans. The move is part of the central bank's plan to dismantle emergency supports it put in place as the financial crisis grew. Weaning the market from low-cost cash is necessary to head off inflation but clipping supports too soon could send the economy spinning.

The Fed had earlier signaled its intentions about bank loans and analysts said the rate increase was in some ways just symbolic because it affects a small slice of loans. Still, it's important that investors didn't panic. Low interest rates have been one of the biggest drivers of the market's rally in the past year. Many analysts looked at Fed's move as a welcome sign that economy has rebounded enough to endure some tough love.

Standard & Poor's Chief Investment Strategist Sam Stovall said in a research note that the rate change was an indication that "the training wheels are off, and we are once again on our own."

The Fed's decision could have pounded the market if investors hadn't already begun to expect more restrained lending conditions. Just as important, the recent drop in stocks calmed fears of an overheated market.

A tame report on inflation Friday also reassured investors that the Fed will be able to keep interest rates for consumers low to help revive the economy. The Labor Department said consumer prices excluding food and energy fell in January for the first time since 1982.

Stocks have yet to see a full-blown correction since they began surging off of 12-year lows in March. Until the latest drop, the steepest slide had been 7 percent from mid-June to mid-July.

The most recent tumble came on worries about shaky finances in Greece and China's efforts to keep its economy under control.

Concern grew that the slide would be a repeat of last year. By March 9, the S&P 500 index had fallen 56.8 percent from its peak in October 2007. It's still down 29.1 percent from its high.

"When they begin to see some of that retrenchment again it certainly brings back some memories of what we've been through in the last 18 months," said Jim Baird, partner and chief investment strategist for Plante Moran Financial Advisors in Kalamazoo, Mich.

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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