Do Markets Really Think Stimulus Plan Will Work?

Despite hopes that the latest dismal jobs report would force a stimulus plan into action, deep pessimism remained over whether Washington could do anything to fix the economy.

CNBC.com

As news that the labor market had shed 598,000 jobs in January confirmed that the economy is in rough shape, market psychology looked on the bright side and pushed the indexes higher on optimism for an aggressive government stimulus plan.

But skepticism abounded as to whether the rally could be sustained.

"This is a classic case of the market taking this dismal number in hopes that Washington will be motivated to do more," says Michael D. Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y. "It's becoming very clear that something has to be done now. We really are reacting to external influences, not to the market seeing through to a better future."

Market veterans have seen this before.

A series of stimulative measures in 2008—including the Troubled Asset Relief Program and aggressive Federal Reserve rate cuts—led to temporary buy-the-rumor and sell-the-news market rallies.

Following that thinking, Kresh says he's continuing to use stock surges as selling opportunities.

He's staying away from banks, despite a strong pop in Friday trading, though he's nibbling at other sectors when the market moves lower.

At the same time, some market bears are holding short positions, while one fund manager says he's continuing his strategy of dumping stock-based funds until there's more clarity in when a turnaround might happen. Gold has become an increasingly popular shelter from the storm, while energy stocks are getting a mild push on hopes that the oil market may have found its bottom even as the stock market looks for its own capitulation point.

"There's an underlying pessimism and a lack of consumer confidence. It's going to take a lot to bring this thing around," says Vern Hayden, president and mutual fund manager of Hayden Wealth Management, in Westport, Conn. "A sinking economy, soaring unemployment and a shattered financial industry--you don't overcome those things overnight, even with government bailouts. I'm not sure the government can bail it out."

Indeed, the verdict was far from unanimous on what the employment weakness and the subsequent stimulus and bank rescue plans ultimately will mean to the economy and the stock market.

The market is closely watching for details next week on the good bank-bad bank plan to get toxic assets from banks' books, as well as the stimulus plan and its grab bag of various capital improvement projects and capital injections.

Some think the market is overdue for another leg up in a bear market rally that started after the November lows. Talk of that rally grew Friday after the jobs report and the ensuing anticipation of government action.

"There is a massive bear market rally building somewhere out there," Art Cashin, director of floor operations at UBS, said on CNBC. "And I think it may occur shortly, before St. Patrick's Day." See Cashin's full commentary in video.

Disciples of that school of thought piled into financial shares Friday, sending previously battered Dow components Bank of America , Citigroup and JPMorgan Chase sharply higher. The SPDR Financial Select Sector exchange-traded fund was up more than 5 percent during the rally.

Energy, Gold and Quick Feet

But the enthusiasm for stocks that seem to have little upside other than a government rescue left some market advisers queasy.

"The major banks have not come close to solving their troubles and I certainly would be staying away from financials until we see some clarity and see some real transparency in their assets," Kresh says. "People moving in here and playing this momentum gain are playing it at a very, very high risk. There may be a reward, but as I see it the risks are way, way out of balance."

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"I think the market is deluding itself," adds John Jacquemin, founder and principal at Mooring Intrepid Opportunity Fund, in Vienna, Va., where he managers hedge funds. "As the market goes up on this bad news that means that markets are anticipating that a recovery is near. I don't believe it. Frankly (the recession is) much too deep to go into recovery in three to six months."

Jacquemin is holding all short positions for the institutional funds he manages and will continue to do so until the housing market shows sure signs of a turnaround, regardless of any bear rallies that come along.

"We are gearing our investments for a recovery sometime down the road, at least a year or perhaps two years," he says. "We start with a macro view and we stick to that view, and we are looking for segments we think are going to be the weakest. Until that changes we don't really worry about bear market rallies."

Jacquemin finds particular weakness in financials, housing and credit card companies, which will continue to be plagued by defaults as employment and the broader economy weaken.

For his funds, Hayden is nearly completely out of equities, except for an energy fund he participates in through T. Rowe Price that holds Chevron , Kinder Morgan Energy Partners , and the XTO Energy ETF as a 5 percent energy component for his portfolio.

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He's also holding a 5 percent gold component through the SPDR Gold Trust ETF and First Eagle Gold Fund .

Overall, he's stressing flexibility and a quick recognition for what's working and what isn't in this rapidly changing and fickle market.

"Every portfolio needs an offense and a defense," Hayden says. "I'm not a buy-and-hold guy. Buy and hold, especially in this kind of environment, is a suicide mission."

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