Stock Market Report, March-September 2009

We have all seen (and felt) the stock market drop to new lows in March 2009. Since then, the market has rebounded and recovered approximately one-third of the losses it had sustained. How was the stock market able to get back this much within the last six months? The answer to this question has three components to it.

The first part is relatively straightforward. In a steep selloff, the stock market always overcorrects itself, such that the market is realistically lower than it should be. Hence, by pure reflex action, the stock market bounces up. Therefore, the first leg up is termed as the dead cat bounce (the saying goes, “even a dead cat bounces”).

The next component is government support. The Federal Reserve and Treasury have poured hundreds of billions of dollars into financial institutions and businesses to shore up and stabilize the economy. This shoring creates a floor in which the stock market can build off of.

The last thing is that many companies have been able to maintain their profit margins throughout this crisis. This may come to you as a surprise; however, the answer is quite logical. The value of a stock is primarily governed by the company’s ability to generate a profit. The basic definition of a profit is revenues minus expenses. Since the economic crisis began, we know that revenues have dropped as Americans have curtailed their spending. Therefore, the only way companies could maintain their profit margins was to slash costs. All the job layoffs and budget cuts you heard about on the news have gone to cut costs to maintain profit margins. As earnings were reported on Wall Street, stocks made nice moves upwards as these reports were better than expected.

These three components have worked together to provide a good start to rebuilding the stock market. Remember, however, that we have only regained one-third of stock market losses incurred. Therefore, the next question is: What will it take to get the rest back? We will cover that topic in the next post.