THE GIST

>> Over the past six months, the financial sector led one of the biggest market rallies since the Great Depression. Suffering financial companies got a boost when the government stepped in and backed them up, improving investor confidence. But once the Fed stops propping these companies up, they’ll sink or swim based on performance – not just investor confidence.

THE FULL STORY

September is over, and it’s time to look back at what happened in the market over the past six months. First, the big news: from March to the end of September, the S&P 500 gained 58% – that’s one of the strongest market rallies since the Great Depression! The biggest mover in the market was the financial sector, which gained 142%, but other sectors (materials, consumer discretionary, and industrials) each also gained more than 70% over the same time period.

Before March, many stocks were priced so low that they seemed doomed to failure (because their companies were, in fact, about to fail). But when the federal government (specifically “The Fed”) stepped in to bail them out, these once-shaky companies suddenly became much safer investments, and their stock prices skyrocketed. This was actually a historic event in the financial world, since the government basically said that companies “too big to fail” should be protected by taxpayer, not investor, money. That dramatic change from low investor interest to high investor interest is responsible for a lot of the increase in the market over the past six months.

But while any improvement in the market is a welcome change from these recession doldrums, there’s a reason to be cautious here. The financial sector didn’t post huge gains because it found a new market, or improved profitability, or created a newer, better way of doing business. Its stock prices actually fell and rose independent of these factors. What drove the change in stock prices was perceived risk. To oversimplify a bit: when investors thought the companies were going to fail, they sold. When they saw that the same companies were going to be bailed out by the government, they bought.

At some point, though, investors are going to return to their old ways of evaluating whether a company is a good investment or not – studying the management, market share, profit margins, operating costs, and valuations of a company. And when that happens, these companies may find the price of their stock dropping once again.

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