Relief rally shows investors keeping the faith

Investors, it appears, were right on their assumption the politicians are working hard to avert a default and end the shutdown.

The Dow Jones industrial average soared 323 points Thursday to 15,126 in the stock market's second best day of the year as investors let out a collective sigh of relief. For now, at least, it looks like investors were right to have faith that agreement will replace the brinkmanship in Congress that has resulted in a government shutdown of more than a week.

Investors had been remarkably unbothered by the game of financial chicken being played in Washington over the debt ceiling, with stocks barely reacting to the week-long shutdown of the government until this week. The Standard & Poor's 500 index never lost more than 5% from its Sept. 18 record close even when fears started to pick up earlier in the week.

"The relief rally is both predictable and despicable," says Michael Farr of Farr Miller and Washington. Congress "brought us to the precipice, brought us back from the precipice, but to no where in particular," he says.

MARKETS: Dow closes up more than 300 on budget thaw

Even after Thursday's big runup, the Dow and S&P 500 are barely above the levels where they finished last week. While the bull market has taken a pause during the government shutdown, it hasn't crashed as some doomsayers warned it could. The Dow Jones industrial average is essentially flat from Oct. 1, the day the government shutdown started.

In many ways, the gain Thursday simply returns the market into a rally that is justified, says Doug Sandler of RiverFront Investment Group. There have been many investors who have been waiting on the sidelines as the stock market has soared by double digits this year, hoping for a pullback so they could get in. "The pullback had come," he says. Investors are eager to jump into stocks, after they hit some turbulence this week, before the bull market resumes in force.

It's a mistake, though, to assume that the bull is back of! f to the races, says Karl Mills of Jurika, Mills and Keifer. Investors are assuming that the process in Congress will go smoothly, when in fact, there are ample opportunities for further arguments, delays and problems. For instance, if all Congress does is postpone decisions about the budget and debt limit for 60 days, investors will get little real relief. "Just what we need is another fiscal cliff," Mills says.

And while investors might be relieved that Congress appears willing to at least talk about solutions, that doesn't mean the stock market is a bargain. The S&P 500 is currently trading at 16.6 times its trailing operating earnings, says S&P Dow Jones Indices. That's below the market's average 18.8 P-E since 1988, but still up considerably from the 14.7 P-E at the end of 2012.

Investors are paying higher prices for stocks, even as Congress still doesn't have a deal. Congress "is playing with matches and gasoline. Accidents do happen," Mills says.