As April's earnings season got under way, we saw some welcome news. Positive surprises from financial companies added to some signs that the economy's freefall may be slowing, sending markets far above the March lows.

Financial firms, including Wells Fargo, Goldman Sachs, J.P. Morgan, and Citigroup, reported earnings that beat analyst expectations, sending the financial sector higher. When we looked beyond financials, first quarter numbers from companies in the S&P 500^® Index appeared to be much stronger in general than those we saw at the end of 2008.

Economic data shows some signs of hope
After several discouraging months, some positive news for the economy is beginning to appear. Data from the housing market, which has been at the center of recent problems, suggests that inventory is not growing any worse and that affordability is up. The manufacturing sector reports that new orders have increased and that consumer spending has improved from the fourth quarter.

There are some things to like in the trends we're seeing, according to Dirk Hofschire, vice president of market analysis at Fidelity. "Now, this data hasn't shown an economic recovery," says Hofschire. "It's really showing that we're still contracting, but we might be contracting at a slower pace."

Manufacturing: Slower rate of contraction
When a manufacturer gets a new order, it means they will be producing and selling something in the near future. The Manufacturing New Orders Index measures those orders to try and predict if the economy is shrinking or growing. The increase in new orders seen in March, shown in the chart below, may be a positive sign that the recession is slowing.

 
Source: Institute for Supply Management, Federal Reserve Board, Haver Analytics, FMRCo (MARE) as of March 30, 2009.

Signs of hope in housing? Affordability up, supply did not get worse
The supply of new homes on the market can have a big impact on housing prices. This chart shows that the supply of homes did not grow worse in the first quarter, a positive sign for the housing market.

 
Source: National Association of Realors, Census Bureau, Haver Analytics, FMRCo (MARE) as of February 28, 2009.

What's behind the rally
In early March, the markets reached lows that had not been seen since the mid-1990s. But since then the markets have rallied: from March 9 through April 20, the S&P 500^® Index is up 23.3%, and international markets, as measured by the MSCI EAFE^® Index, are up 24.2% over the same period.¹

Hofschire explains that the rally has been built on a combination of sentiment and changes in economic conditions. In the early months of this year, investor sentiment was bleak. The fourth quarter of 2008 was the worst earnings quarter in 80 years, and it created what Hofschire characterizes as massive pessimism.

"Sentiment got so bad that it set an extremely low bar for future expectations," notes Hofschire. "You mix a few better-than-anticipated indicators with really low expectations, and that's been fuel for the stock market rally."

The rally has been broad based, with all 10 S&P 500 market sectors posting gains. International markets have risen as well, benefiting in part from the leveling off of commodity prices and economic stimulus packages from major global players like China.

However, with the severe losses of the last two quarters and the November—January bear market rally still fresh in investors' minds, Hofschire says many investors are taking a wait-and-see approach.

"I think at this point after all the carnage that we've had in the markets over the past year or two, people are going to wait it out before declaring this the next bull market," he says.

Source: FMRCo (MARE) as of March 31, 2009. Past performance is no guarantee of future results. Investing in sectors may be more volatile than diversifying across many industries. You cannot invest directly in an index. Sector returns are represented by S&P 500 sectors.

Reacting to the markets
Waiting for headlines describing an economic recovery may mean missing out on market gains, according to Hofschire. History shows that bull markets tend to start four to six months before the economy begins a recovery—and that the early phases of a bull run typically deliver the largest returns. (For more details, read How Will the Bear Market End?)

"Most people should try to focus on what they can control, and that's your own appropriate individual asset allocation and getting back to it if you strayed from it over the past several months," advises Hofschire. "If you use history as a guide, there is a real risk here of waiting too long to get back to that plan and missing out on a potential rebound."