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Why Bear-Market Rallies Are Different These Days

While the recent stock market rebound may not last, it has come with something Wall Street hasn't seen in awhile—buying into a rally.

NYSE Traders
Oliver Quilla for CNBC.com
NYSE Traders

Since stocks entered bear-market territory during the summer, investors have been notoriously skittish during rallies. Often there are late-day selloffs as investors move to book quick profits or worry that the rally just won't have legs.

But that hasn't been the case lately. The Dow is now up over 1,000 points in the past four trading days, even in the face of worsening news about the economy.

The market closed sharply higher on Wednesday, pushing the Dow up over 8,700, in the first four-day gain since May.

"The sentiment's starting to switch a little bit," says Nadav Baum, managing director of investments at BPU Investment Management in Pittsburgh. "People are talking that this is a bear market rally, but it could go on a little bit."

There are several factors behind the rally this week. Many think stocks are still heavily oversold, which has led to bargain-hunting. The Fed's decision on Tuesday to help unfreeze consumer lending also gave the markets a jolt. And President-elect Obama's naming of his economic team, including Timothy Geithner as Treasury Secretary, was greeted enthusiatically on Wall Street.

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In addition to snapping up some of the bigger market movers, investment advisors are pushing their clients into broad-based exchange-traded funds that take advantage of moves higher in the major indexes without as much risk as buying individual stocks.

Also, municipal bonds are getting a lot of attention as market pros look for ways to protect principal while also trying to squeeze out at least modest yields.

"Most of the tax selling is done and the hedge fund redemptions are over," Baum says. "Hopefully we can turn the old Santa Claus rally into year's end. There are some great companies out there that are trading at major discounts."

Investors also have been finding value in a variety of exchange-traded funds, or ETFs, and a handful of strong companies.

Baum has been using the Vanguard Value ETF, which tracks the MSCI US Prime Market Value index. Some of the companies in the fund include ExxonMobil , General Electric , Johnson & Johnson and Chevron . The fund also pays a 5 percent dividend.

In addition, Baum likes some the Select Sector SPDR, or "Spider," ETFs that are popular among investors and play the broad indexes. He advocates the S&P Deposit Receipts which tracks the movement of the S&P 500.

"You can buy these great baskets of equities and get returns of individual equities," Baum says. "That's a very smart thing to do for individual investors--spread out the risk and still get nice returns."

Emerging Markets, Plus Playing Santa Claus

Emerging Markets Back?

Market rebounds also provide opportunity to ride stocks that were beaten down and are due for a snapback.

Infrastructure plays were the rage earlier in the year as emerging markets continued to explode, but then backed off in the third quarter as global economic gloom set in. But now may be the time to get back on board, especially in light of the Obama administration's likely reliance on public works projects as stimulus to kick-start the economy and the expected resurgence of some of those foreign economies.

"We've stretched the rubber band significantly in one direction," says David Twibell, president of wealth management for Denver-based Colorado Capital Bank. "Nothing goes up or down in a straight line. We've seen this movie before."

CNBC experts discuss how to make money in this market, in video at left.

Twibell has been directing clients gingerly back into infrastructure plays including McDermott International and Shaw Group .

"The whole theme of development in emerging markets, I don't think we're anywhere near done with that. That's something that's going to go on for decades," Twibell says. "We hit a big pothole here, but I think the outlook for these companies is incredibly strong."

He also is looking at some ETF plays that capitalize on holiday rallies, which he says could be led by small- and mid-cap companies.

Differing Strategies

Needing to capitalize on a Santa Claus-rally is a microcosm of current investing strategy, with differing schools of thought on whether the buy-and-hold three- to five-year investing strategy allows investors to be nimble enough to profit on short-term moves.

Those playing municipal and corporate debt are doing so mostly on a short-term basis, not wanting to get pulled into the longer end of the yield curve. Yields move higher when investors dump bonds and take on more risk in the stock market.

For Investors

"For longer-term clients we've been buying (stocks) all along," says Randy Carver, president of Carver Financial Services in Mentor, Ohio. "Our philosophy is more of a diversified long-term allocation versus a market-timing trading one. So I think there's some great value out there but you need to be three- to five-year equity investors."

Yet Carver also says investors need to find places to shield themselves from risks, so he's buying municipal debt as well as certificates of deposits to protect cash.

On the equity side, he's in a variety of ETFs, playing some of the SPDR funds as well as the iShares S&P 500 Index fund and the iShares Russell Mid-cap ETF.

BPU's Baum says investors do need to be nimble, but should use caution. He advocates sort of a reverse dollar-cost averaging into stocks, where investors should capitalize on momentum and buy stocks on the way up rather than trying to catch bargains on the way down of companies that are trending lower.

"I would use the nimble thing going in slowly. If you want to invest $10,000, you go in $2,500, take a look at it, and if it goes higher maybe put another $2,500 in," he says. "One thing retail investors don't do a good job of is buy in the way up. Retail investors tend to dollar-cost average on the downside. I would rather buy today on the way up."