Stocks roared higher Tuesday, as investors cheered the latest unscheduled move by the Federal Reserve to float the banking system and unlock credit for individual and corporate borrowers.
But by most accounts, the market was looking for an excuse to rebound.
Major indexes posted their best one-day advance in more than five years. The Fed’s announcement before the opening of trading sparked an early rally, which swelled in the final two hours.
The Dow Jones industrial average jumped 416.66 points, or 3.5 percent, to 12,156.81. Broader market indicators posted even bigger percentage gains, including a nearly 5 percent rally in the Russell 2000 small-company index.
Financial-services stocks, led by the nation’s largest banks, were the biggest winners in Tuesday’s session. The health-care sector was the only loser, reflecting a downbeat outlook late Monday by insurer WellPoint.
After what seemed like a relentless pounding for stock market investors this year, few analysts were willing to deny the power of the Fed to jolt the stock market higher.
“After the fact, we’re all geniuses,” said David Klaskin, chief investment officer for Oak Ridge Investments. “But it was not so much what happened [Tuesday], but Monday’s steep decline. With all the sellers at the end of last week and coming in after the weekend, that could have been enough panic to say there’s going to be some relief here.”
In the previous three days alone, the Dow had lost more than 500 points, including a nearly 150-point slump Friday after the Fed’s previous surprise rescue move for the banking system.
The Fed’s move Tuesday was the fifth time since August that the central bank announced an aggressive bank rescue program before the opening of Wall Street trading. And it drew by far the best response.
Noting that the Dow had lost nearly 1,000 points in the previous eight sessions, James Bianco of Bianco Research termed Tuesday’s action “a retracement rally.”
The clearest clue of an impending rebound was the miserable state of investor sentiment as the week began, said technical market analyst John Kosar of Asbury Research. All dozen sentiment readings he follows were strongly negative.
For example, nearly 52 percent of investors were bearish in the latest weekly survey by the American Association of Individual Investors. The long-term average bearish reading in the survey is 29 percent.
“You’ve had all investors on one side of the boat,” Kosar said. “When everybody is expecting the end of Western civilization, a piece of good news throws everybody off kilter.”
The Fed announcement was indeed good news, said Bianco, because it allows banks and other financial institutions, in effect, to temporarily substitute some their troubled assets with safe assets borrowed from the Fed. The safe assets, in the form of cash and Treasury securities, should be a firmer basis for renewed lending, he said.
But the key to Tuesday’s market action was the sudden reversal of market sentiment. The ability of stocks to advance in the final hour of trading, long after the preopening Fed announcement, indicates the rally could have legs, said Bruce Bittles, chief investment strategist for Robert W. Baird.
“If it didn’t rally like that, I would say the market was really vulnerable and the Fed is running low on ammunition,” he said.
Noting that New York Stock Exchange trading volume in advancing stocks was an extraordinary nine times as great as the volume in losing stocks, Bittles said, “The downside momentum that has been in force since December may be broken.”
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Klaskin said he wasn’t sure. “I don’t think the corner has been turned,” he said. “If you still want to buy a stock at the [price at which it opened Tuesday], the chances are it will pull back.”
Moreover, Bianco noted that the Fed’s latest rescue attempt does not directly solve the main problem affecting Wall Street.
“The financial system is shrinking in size” because of losses being recognized on bad assets, especially bad mortgage loans and securities created from mortgage loans, he said.
As financial institutions shrink, they have less money to lend. The Fed’s move does not provide additional money but higher-quality money.
“The ultimate fix is that the financial system stops contracting, and the way it stops contracting is that home prices reach a bottom,” Bianco said.
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Bill Barnhart’s columns run Tuesday through Friday. To read previous columns, go to chicagotribune.com/barnhart.