Stock market encourages investors to stick around till rally's end

One of the oldest adages on Wall Street is "Buy in October, sell in May." However, investors who followed that logic this time around may have left the game a bit too early.

The rally that began in early March has now extended for three months. That includes gains in May of 3.7 percent for the Nasdaq composite index, 2.6 percent for the S&P 500 stock index and 1.8 percent for the Dow Jones Industrial Average.

One analyst says there is a historical precedence for the rally to continue, pointing to a surprisingly similar scenario in 1982.

"In August 1982, as today, the unemployment rate was very high and would rise for several more months before peaking close to 11 percent. The economy was embroiled in the second-leg of back to back recessions, which many felt represented the worst economy since the Great Depression," said James Paulsen, chief investment strategist at Wells Capital Management.

He also pointed out that the government was "awash in red ink, the size of which was never seen before outside of war times."

And, the banking industry was in shambles and the household sector was "widely felt to be overextended after a decade of massive consumer spending."

But it was at the bleakest moment that a powerful stock market rally began.

"It rose by more than 35 percent in the first 44 days off its lows. It rose inexplicably and unbelievably and indeed, like today, most were highly suspicious of its advance. Yet, in 1982, the first 35 percent stock market advance would be followed by another 35 percent advance in the ensuing six months," said Paulsen.

Often forgotten is the fact that the stock market is a leading economic indicator. As was the case in 1982 and today, current conditions look quite bleak. But, looking down the road six to nine months, stocks are suggesting better times to come.

Back in March of this year, confidence levels had cratered. Yet, it was precisely at that time the stock market rally began. Now, consumer confidence is beginning to change as well.

The Conference Board reported on Tuesday that its Consumer Confidence Index rose in May much more than had been expected.

"Consumers are considerably less pessimistic than they were earlier this year, and expectations are that business conditions, the labor market and incomes will improve in the coming months. While confidence is still weak by historical standards, as far as consumers are concerned, the worst is now behind us," said Lynn Franco, director of the Conference Board Consumer Research Center.

Of course, the stock market began telling us that was the case in March.

Correspondingly, a survey by the National Association of Business Economics found that 90 percent of economists believe the current U.S. recession will officially end before the finish of 2009.

Again, that is what the stock market began indicating back in March.

However, it is important to note that a stock market rally and rising consumer confidence does not suggest the economy will improve at a corresponding rate. The economists surveyed by the NABE believe that the unemployment rate probably won't peak until some time in the second quarter of next year.

That opinion is shared by Professor Alan Gin of the University of San Diego. Gin released his most recent reading on the local economy last week. The Index of Leading Economic Indicators for San Diego County rose by 0.2 percent in April. It doesn't sound like much, but it was only the second time in the past 37 months that the indicator was positive.

Yet, despite the April advance, Gin is not sold on the possibility that the worst is behind us.

"Since economists typically look for three consecutive moves in one direction for a leading index to signal a turning point, it remains to be seen if a turnaround is in sight. Even if a bottom is reached, it is likely that the rebound from there will be weak. Indeed, there could be a significant period where the local economy remains flat after reaching that bottom," said Gin.

But, in the meantime, the stock market is still encouraging investors to stick around. Only time will tell how long the rally lasts.