Back in August 2007, I discussed the absurdity of frequent references by market cheerleaders to stocks climbing a "wall of worry" as the reason for still higher stock prices. I had pointed out that, in spite of the already deepening subprime mortgage crisis, the majority of institutional investors exhibited little worry in their trading.

The LBO frenzy was still alive and well. The June 2007 $7.4-billion buyout of 80.1% of Chrysler was an example of no worry on behalf of one of the most prominent "masters of the universe," Cerberus Management LP. Pension funds, facing miniscule yields on high grade bonds, were eagerly participating in LBO deals such as the ill-fated April 2007 $51-billion bid by the Ontario Teachers Pension Plan for BCE, Inc.

Pension funds were also allocating assets to hedge funds, who in turn were placing bets on LBO plays, commodities and various exotic derivatives. Equity mutual funds, facing competition from hedge funds and ETFs, had no time to worry about the overheated market. By July 2007, their already low cash reserves dropped down to 3.5% of total assets, the lowest level ever.

Without trying to discredit the validity of the "wall of worry" theory, I had concluded at the time that it is more realistic to look for the market to climb the wall after the economy slides into a recession and investors hate stocks, rather than to use it as a bullish argument in an overheated market.

A bit more than a year later, fear has replaced greed as the dominant sentiment among all investor groups. LBOs have gone the way of the dodo bird and the stocks of publicly traded LBO companies have collapsed. Blackstone (BX $6.26) recently traded as much as 88% below its "timely" June 2007 IPO price. Pension funds are now taking their much diminished hedge fund allocations back, forcing funds to dump their holdings and, in some cases, even to close down completely.

Mutual fund firms are experiencing alarming redemptions from stock funds. From the market top of October 2007 to the end of October 2008, the cumulative net redemption from U.S. mutual stock funds reached $95.8 billion. Combined with a decline of more than 41% in major U.S. market indices, the net result has been a plunge in total assets of stock funds from $6,942 billion to $3,003 billion.

Considering the deepening economic slowdown, this should be the time for the market to display its wall-climbing ability. Last week's rebound from the new bear market lows, on the reduced trading volume of Thanksgiving week, was the first big four-day or longer winning streak in more than 12 months. That was enough for "TV talking heads" to insist, once again, that the market has already discounted the worst of the economic and financial malaise.

Unfortunately, like any market maxim, the discounting phenomenon is hardly reliable. It is unlikely to be of much guidance when the monetary and market tools that have worked well over the last 50 years have been found lacking during this financial and economic crisis. In summary, I'm moderately bullish, but very cautious, not expecting the rebound to take the S&P 500 much above 1,000 (currently at 896).

Profit Confidential

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