Is greed overcoming fear in the stock market?

NEW YORK (Reuters) - U.S. stocks typically rebound six months before the economy, but investors worry that the current 25 percent rally since the market’s March 9 low could be a red herring.

Trading specialists look at computer screens at the New York Stock Exchange, March 27, 2009. REUTERS/Eric Thayer

At the same time, lack of investor conviction -- or simple fear -- can be considered a sign of a healthy market.

Reasons to be pessimistic about the economic outlook abound: unemployment is the highest since 1983, house prices are still falling by record amounts and persistent questions remain about which banks will still be in business next year.

Many investors are holding out for clearer signs that the worst financial crisis in generations is over before they commit to jumping back into the stock market. They worry that more bad news awaits in the months ahead to trip up the latest rally.

Declining volume tells part of the technical story. The average total value of stocks traded each day on the Nasdaq has fallen about 40 percent from 2008 levels so far this year through March.

Wall Street’s fear gauge, the CBOE Market Volatility index, also remains stubbornly high, only dipping below 40 in recent sessions despite trading below 30 in more normal times.

Still, stock prices may have reached a bottom in early March, said Linda Duessel, a market strategist at Federated Investors in Pittsburgh.

“Insofar as ‘Will investors jump back in like they have historically?’ I think the numbers are showing that they are much more reluctant,” she said.

The S&P 500 Index is up 25 percent from a 12-1/2 year low in early March. Last week, a Reuters poll of Wall Street dealers showed seven of 11 economists forecast a turnaround starting in the third quarter.

Yet investors big and small have been hit with huge losses, with the benchmark S&P 500 index down 46 percent since hitting an all-time high in October 2007.

The equities market in the past has rebounded anywhere from three months to nine months before the economy reverses its slide, with the average time about six months.

“The market consensus right now is for positive GDP in the third quarter,” said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York. “The worry is, that might be a little bit premature.”

The U.S. economy is on track for the worst recession since World War Two, leaving investors warier than in other downturns in recent years.

Wall Street has made several attempts to move higher since last October, only to be pulled back to new lows each time.

Bruce Bittles, chief investment strategist at Robert W. Baird & Co in Nashville, would like to see even more investor skepticism, as the point of maximum optimism is typically the top of the market.

“The more skepticism we see (in the market), the better the chances the market has of going up,” he said. “We don’t want to see optimism here, that would be a negative for market.”

Given the view that the economy will turn around in the third quarter, some investors have returned to the market.

“People may be getting in sooner than the six months,” said Carl Birkelbach, chairman and CEO of Birkelbach Investment Securities in Chicago.

“I think that people will always pit fear against greed and once the market starts moving up, greed will start taking over.”

Editing by Dan Grebler