05/16/2009 05:12 am ET Updated May 25, 2011

Feeling Good in Bad Times

2008 was the worst year for the U.S. stock markets in over 75 years. January 2009 was the worst January in over 75 years, and February 2009 was the worst February in 75 years. The two-month (January and February 2009) period set a new record for the worst two-month start in S&P 500 history of negative 18.6 percent. Over the weekend, the New York Times printed quarterly mutual fund results. They calculated that the average U.S. large capitalization blend (neither growth-oriented nor value-oriented) mutual fund fell by 11 percent over the quarter. What is ironic is that the market is actually up over 27 percent from its low point on March 6th and has risen for five weeks in a row, something that we have not seen since 2002.

The market rally is the result of a thousand small events, none of which would seem significant but which have the cumulative effect of amounting to something life giving. I have pointed to some of these in past letters: the refinancing of homes is giving some families more money in their pockets each month.

In good times, bulls may not place much weight on these signals. However, today they come at a moment that by most conventional means of measuring value, U.S. stock prices are undervalued. Furthermore, the S&P 500 is still 46 percent off its high of 1,565 on October 9, 2007. And markets generally rise. ICMA-RC gathered data for the past 83 years to the early days of what is today's S&P 500. They found that 71 percent of the time, or for 59 calendar years, the Index posted positive returns, while only 24 years were negative. Overall, the average return for the period was about 10 percent. Prices are low and tend to rise; a good context will allow them to.

The context has much to do with investor confidence. The federal programs to reinvigorate the economy and credit markets are enormous by any standard. Only World War II has seen such a high level of federal spending. The scale is giving confidence. Yes, you do hear many people worrying over future deficits and the potential for inflation, but investors are moving in.

On the regulation front, the administration is doing more talking than acting. But here too I see reason to hope. The recent announcement that the subsidies of student loans, a direct transfer from the taxpayer to banks, is being restructured to take the banks largely out of it indicates that, though slow, regulations are moving ahead. But I still see no structural approach to investment limits. Hedge funds and investment banks bid up many raw materials with no intention of owning them. This leads to inflated pricing and speculation. It also leads to worrisome results. Recently we read an unsettling story about the fact that Lehman Brothers owns enough uranium cake to make a nuclear bomb. Although they never meant to take possession of it, they speculated on the uranium and couldn't sell at a good price. So the company is holding on, hoping for higher prices to sell its position, while also working to unwind its assets in their bankruptcy process. It boggles the mind that such circumstances are legal in our current financial regulatory structure. When will we reinstate the uptick rule for short sellers?

On the geo-political front, we see progress that is truly indicative. My fascination with Secretary of State Hillary Rodham Clinton continues. She seems to be exactly the right balance of sophistication and energy for the job. For the first time in decades, there seems to be a willingness in the mid-East and in Iran to work toward peace. Again, this gives comfort to investors. I also admire her willingness to admit that there is a problem with violence and drugs in Mexico; it is most refreshing.

The feel-good aspect of American sentiment ought not be overlooked. Most Americans were touched by the new puppy, a Portuguese Water Dog, named Bo, that was delivered by Senator Edward Kennedy and his wife Victoria to Malia and Sasha Obama. We Massachusetts residents were doubly pleased knowing that this has always been Senator Kennedy's favorite breed. And what about yoga on the porches of the White House on Easter Sunday? It got a grin out of me. Then there is the $200 organic garden Michelle Obama spends photo-op time with Secretary of Agriculture Tom Vilsack in. This last feel-good seems to have upset the chemical industry. MACA, which represents agribusinesses like Monsanto, Dow AgroSciences and DuPont Crop Protection, issued a statement saying, "As you go about planning and planting the White House garden, we respectfully encourage you to recognize the role conventional agriculture plays in the U.S. in feeding the ever-increasing population, contributing to the U.S. economy and providing a safe and economical food supply."

A final building block to recent market strength has been the trickle of good news for specific companies. Today I read that Goldman Sachs believes it will be able to return bailout funds shortly. Wells Fargo, another major recipient of TARP money, announced earnings that far exceeded analysts' expectations due to strong increases in its lending business. The market had been anxiously awaiting any sign that our banks were improving, and this earnings report was taken as a broad sign that the frozen credit markets may finally be thawing. It isn't the consumer discretionary spending companies yet, but it is still good news.

Still, at the end of the day, the market depends on the economy and the U.S. economy is two-thirds the consumer. The consumer is not yet healthy. Retail sales were reported as off 1.1 percent in March, reversing gains seen in January and February. Job losses, now running at more than 600,000 a month, are expected to continue well into next year. And The National Federation of Independent Business says that its index of small business optimism fell 1.6 points to 81.0 from February, the second-lowest reading in the organization's 35-year history.

The big challenge is jobs. The administration is spending tiny amounts on jobs compared with bailouts. Perhaps one in 30 people (just my guess) is able to hustle a bit of cash by selling sofas found on trash day over the internet for cash or by designing applications for the iPhone (two stories I read this past week), but it doesn't jump start the economy.

The recent rally has allowed us to breath. No one is predicting a V-shaped recovery, which I find interesting. It sure has looked like one so far.