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. Last Updated: 07/27/2016

U.S. Stocks Rally In Surprise Surge

A powerful rally in U.S. stocks is shaking Wall Street out of its summer torpor amid signs that individual investors -- the market's major money source since 1991 -- are once again flocking to buy.


Last week, the Dow Jones industrial average reached 3,881.05 Friday, its highest close since March 18. A 70.90-point Dow surge Wednesday was the blue-chip index's biggest one-day gain since April 5.


The week's surprise buying spree caught many vacationing investment professionals unaware and may be setting the stage for an even steeper climb in September when they return, some analysts say.


The newfound bullishness, after more than four months in which stock prices mostly drifted in a narrow range, appears to be rooted in investors' belief that the economy is finally slowing enough to forestall further interest-rate increases.


The Dow's Wednesday rally, for example, followed the government's report that factory orders for big-ticket goods in July took their steepest drop in 2 1/2 years. On Friday, the government revised its estimate of second-quarter economic growth to 3.8 percent, well below the 4 percent-plus figure that many economists had expected.


The excitement on Wall Street over weaker economic statistics, while seemingly counter-intuitive, reflects the market's hope that the Federal Reserve Board has engineered an elusive "soft landing" for the economy.


By raising short-term interest rates this year for the first time since 1989, the central bank's goal was to keep the burgeoning economy from overheating and thus keep inflation under control.


With the latest rally, some market pros say investors are effectively declaring the Fed victorious in its quest to maintain a moderately growing, low-inflation economy. "I think we've got the best chance for a soft landing that I've seen in my lifetime," said veteran market strategist Stefan Abrams at Trust Co. of the West, an investment management firm in Los Angeles.


In theory, at least, a moderate pace of growth should stretch out the nation's economic expansion, allowing corporate profits to continue rising while keeping a lid on interest rates. Yet belief in a soft landing wasn't the sole driving force behind stock prices last week, Wall Streeters say. Some of the gains were due to so-called technical forces that have been magnified by the relative lack of players in the market during August's dog days.


Of Wednesday's 70.90-point Dow rise, for example, 20 points were added in the final seconds of trading -- the result of trading games played by institutional investors using futures and options contracts to capture relatively small market moves.


What's more, an unknown amount of the week's buying was by "short sellers," traders who had previously sold borrowed shares, betting on a renewed market decline. Such short bets have reached record levels this summer.


In selling borrowed stock, short-sellers plan to repay the loaned stock later by buying back the shares at a cheaper price, assuming the market indeed falls. They profit from the spread between prices.


But when stocks rally instead of falling, short-sellers often rush to close out their positions by buying shares on the open market, to avoid serious losses. That buying can add new fuel to any rally already in progress.


Aside from technical influences in the market, however, some analysts say this week's rally may largely be a product of the same force that has pushed the bull market since 1991: Buying of stock-mutual fund shares by individual investors.


Despite the stock market's spring dive, relatively few individual investors were shaken out of stock funds.


Instead, they have in total continued to add to their funds all year, putting cash in the hands of portfolio managers who may have let it build up until now.