Too Far, Too Fast?

The rally gets the benefit of the doubt for now.

SO MANY OF US HAVE BEEN LOOKING THIS GIFT HORSE OF A RALLY in the mouth, we enter the weekend with the smell of nag’s breath in our noses.

It isn’t simply a lack of gratitude that is leading many investors to find flaws with the Dow’s 25% run-up in the past six weeks. Many plainly wish this move to be another ill-fated bear-market triumph of hope over experience.

This is another way of saying lots of folks wish they had bought in, want prices to fall and hope that if stocks oblige by cracking lower, they will have the fortitude to be aggressive bidders.

If this widely shared sentiment is reason enough for the market not to stumble, other aspects of the rally leave us scratching our head. For one, many stocks have had a great year in the past six weeks, auguring a rest or retrenchment at minimum. The equal-weighted version of the Standard & Poor’s 500 — a proxy for the average big stock, represented by the Rydex Equal-Weight S&P 500 exchange-traded fund (ticker: RSP) — is up 40% since mid-March. The straight indexes to date have outperformed every lift-off rally that came after a major bear-market low. So even if March 6 represented a decisive low, which is unknowable now, this move has gotten awfully far, very fast.

Under the surface, this rally has been driven not so much by economic stabilization or banks’ revival or government stimulus, or even short-covering, but the surge in buying of extremely low-priced stocks. So conclude quantitative strategists such as Matthew Rothman of Barclays Capital, who notes that in March stocks under $5 essentially doubled in price.

Rich Repetto, analyst at Sandler O’Neill, calculates that in March the five most active stocks on the NYSE had a volume-weighted average price near $5 and accounted for 25% of all volume, compared with 8% of volume and an average price close to $20 a year earlier.

Online-broker customer volumes were up around 15% last month. The Direxion Financials 3X Bull ETF (FAS), which delivers triple the daily move in the Russell 1000 financial sector, began trading 300,000,000 shares a day and more as the rally got underway.

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