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In "Bipolar Disorder?" I explored a theme I've touched on before: the Alice-in-Wonderland disconnect between stocks and bonds, stocks and the economy, and stocks and the so-called "fundamentals" (e.g., valuation).

Well, after thinking about it for a while, I've think I've found at least one explanation: investors are suffering from brain damage. Otherwise, how else can you explain some of the "insights" contained in the following Bloomberg report that summarizes the action in today's U.S. equity markets [note: my comments are in italics]?

U.S. stocks rallied, sending the Dow Jones Industrial Average to a record, as investors speculated the worst may be over for banks and construction companies hurt by subprime mortgage losses.

[Based on what? Are these the same people who never saw the subprime mess coming to begin with? Or who still don't seem to realize that the problem has only gotten worse each step along the way?]

Lennar Corp. (NYSE:LEN) and D.R. Horton Inc.(NYSE:DHI), the two biggest U.S. homebuilders, advanced after Citigroup Inc. said the industry's 50 percent decline this year has made the stocks attractive. Citigroup led financial shares higher after the largest U.S. bank said it expects "a normal earnings environment" in the fourth quarter and former Federal Reserve Chairman Alan Greenspan said the credit slump may be ending.

[According to Bloomberg data, the analysts at Citigroup (NYSE:C) were bullish on these stocks when prices were more than double current levels, and only cut their rating from "buy" to "hold" on July 2 of this year, near the lows. Why does anyone pay any attention at all to these so-called "experts"?]

The Dow's record caps a six-week recovery from a slump that helped wipe out almost $2 trillion in U.S. market value. The 30- stock gauge added 191.92, or 1.4 percent, to 14,087.55, above its previous closing high of 14,000.41 set on July 19. The Standard & Poor's 500 Index increased 20.29, or 1.3 percent, to 1,547.04, 0.4 percent shy of a record. The Nasdaq Composite Index gained 39.49, or 1.5 percent, to 2,740.99, the highest in six years.

"The market has realized that yeah, we had some problems with subprime, but it's not the end of the world," said Lincoln Anderson, who helps manage $150 billion as chief investment officer of LPL Financial in Boston. "With that behind us, you think, `Where do we stand?' Where we stand is with excellent fundamentals, and that's what's helping the market."

["Excellent fundamentals?!?"?!?! I wonder if he is referring to decelerating profit growth, credit markets that are more-or-less closed for business, or the myriad indicators that point to an impending recession?]

Stocks, which last week completed their fifth straight quarterly advance, also rose after manufacturing grew in September at the slowest pace in six months and a gauge of prices declined, increasing expectations the Fed will cut interest rates at its next meeting. The S&P 500 has rallied 4.8 percent and the Dow has added about 5.1 percent since the Fed reduced its benchmark rate by 0.5 percentage point on Sept. 18.

Homebuilders Rally

Homebuilders advanced after Citigroup unit Citi Investment Research advised buying shares of Lennar, D.R. Horton, Pulte Homes Inc. (NYSE:PHM), Centex Corp. (CTX) and Ryland Group Inc. (NYSE:RYL), saying the builders may rally.

"It is precisely when things have gotten this bad that the stocks start looking good," wrote Citi analysts led by Stephen Kim.

[I suppose if you keep reiterating that message all the way down you eventually hit the target. A stopped clock strikes twelve twice a day, right?]

Lennar gained 62 cents to $23.27. D.R. Horton rose 65 cents to $13.46. A gauge of homebuilders in S&P indexes climbed 4.3 percent as all 15 members increased.

Countrywide Financial Corp.(CFC), the largest U.S. mortgage company, added 95 cents, or 5 percent, to $19.96.

Citigroup rose $1.05 to $47.72. "We expect to return to a normal earnings environment in the fourth quarter," Chief Executive Charles Prince said after the bank reported third- quarter profit fell 60 percent because of $5.9 billion of credit and trading losses on loans and mortgage-backed securities.

'The Bad News is Out'

The bank helped push the S&P 500 Financials Index up 2.1 percent, the biggest advance among 10 industry groups. Merrill Lynch & Co., the third-largest securities firm, jumped $2.59 to $73.87. JPMorgan Chase & Co., the third-biggest U.S. bank, added 99 cents to $46.81. Financial stocks are collectively the worst performers in the S&P 500 with a 4.9 percent loss this year.

"What you've finally seen is all the bad news is out," said Jerry Jordan, who helps oversee $500 million at Hellman Jordan Management Co. in Boston. "You've got a situation where they've kitchen-sinked the quarter and everything that could be bad is now out there."

[The credit cycle is only just beginning to turn for the worse, many derivative and fixed-income markets have seized up or vanished completely, and securitization-origination volumes going forward are unlikely to come even close to the mind-boggling extremes seen during the housing bubble/speculative frenzy of recent years, but somehow it's all looking up for the banks after one bad quarter. Am I missing something?!?!]

Stocks also climbed as news of deals, including Nokia Oyj's $8.1 billion purchase of digital mapmaker Navteq Corp., spurred speculation that takeovers will reaccelerate.

`Cheering Some of the Deals'

"The market is cheering some of the deals that were announced this morning, especially the Nokia-Navteq one," said Ryan Larson, senior equity trader at Voyageur Asset Management in Chicago. "People are really relieved that deals are going to continue."

[Even the girzzliest of stock market bears don't discount the possibility that there will continue to be mergers-and-acquistions activity instigated by corporate buyers and sellers. The real area of concern for those who actually know what is going on relates to all the dubious, rape-and-pillage deals that were done by private equity firms using boatloads of debt and the $300 billion backlog of LBO financing that remains stuck in the pipeline, and on banks' balance sheets.]

Nokia American depositary receipts, each representing one share of the biggest mobile-phone maker, rose 3 cents to $37.96. Navteq lost $1.52 to $76.45.

ABN Amro Holding NV (ABN) completed the $21 billion sale of its Chicago-based LaSalle unit to Bank of America Corp.(NYSE:BAC), moving a step closer to sealing the biggest bank takeover. Bank of America climbed 37 cents to $50.64.

An average of 65 takeovers of publicly traded U.S. companies, worth a combined $107.1 billion, were announced each month in the first seven months of 2007, data compiled by Bloomberg shows. The pace of acquisitions slowed in August and September, with the value of announced deals plummeting 82 percent to an average of $18.8 billion a month. The number of announced takeovers also declined by a third to 43 deals a month in August and September.

Utilities Gain

Utility companies gained 1.6 percent as a group. Exelon Corp.(NYSE:EXC) Chief Executive John Rowe said his company, the largest operator of U.S. nuclear power plants, is interested in mergers and acquisitions, Crain's Chicago Business reported.

Rowe told investors and analysts at a conference yesterday that he'd be willing to give up the chief executive officer's position in a merger, Crain's reported, citing an unnamed person who was at the gathering. Exelon climbed 43 cents to $75.79.

McDonald's Corp. (NYSE:MCD) reached a record, gaining $1.54 to $56.01. The world's biggest hamburger chain forecast its expanded offering of drinks will boost sales by more than $1 billion annually, Crain's Chicago Business reported, citing documents obtained by the publication.

About six stocks advanced for every one that fell on the New York Stock Exchange, making it the broadest rally since Sept. 18. Some 1.4 billion shares changed hands, 14 percent less than the three-month daily average.

Fourth Quarter Gains

Today's rally came on the first trading day of the fourth quarter. The S&P 500 has bigger gains on average during the fourth quarter than at any other time of the year, according to data compiled by the Stock Trader's Almanac going back to 1950. The index has posted gains in 11 of the past 12 fourth quarters.

Not all investors are convinced the rally will last. David Tice, who runs the $786 million Prudent Bear Fund, said stocks are poised to fall on slower U.S. economic growth and a tightening credit market. The S&P 500 may drop at least 40 percent in the next 12 months, he said.

"There were massive write-downs here at Citi," said Tice. "We've impaired confidence in Wall Street finance."

[Finally, somebody who actually knows what he is talking about.]

Walgreen Co. fell the most in at least 27 years, plunging $7.08, or 15 percent, to $40.16. The largest U.S. drugstore chain reported an unexpected 3.8 percent drop in fourth-quarter net income, hurt by higher expenses and lower profits from generic drugs.

Other drugstore chains also fell. CVS Caremark Corp. (NYSE:CVS) slipped $2.48 to $37.15. Rite Aid Corp. (NYSE:RAD) lost 15 cents to $4.47.

Manufacturing Report

In economic reports, the ISM's index of factory activity fell more than forecast to 52 in September from 52.9 in August. A reading over 50 signifies growth and the index averaged 53.9 in 2006. The report showed the institute's measure of prices paid dropped to 59 from 63, showing inflation may be easing.

The Russell 2000 Index, a benchmark for companies with a median market value of $647 million, advanced 2.4 percent to 824.74. The Dow Jones Wilshire 5000 Index, the broadest measure of U.S. shares, gained 1.4 percent to 15,575.76. Based on its advance, the value of stocks increased by $267.3 billion.

I think I have a headache.

Source: Are Investors Suffering from Brain Damage?