We have been on record for the past month with the view that a major market bottom was made in early March, when fears of financial and economic Arma­geddon peaked. The technical market action over the course of the past two months' rally is much more characteristic of a sustainable new uptrend than a short-lived bear market reprieve. The downward spiral in the economy and markets has been broken (regrettably at the cost of a massive extension of gov­ernment credit and obligations). Leading economic indicators and consumer confidence readings have improved to a degree that indicates the worst of the economic downturn is behind us. Consequently, in­vestors have begun the process of moving away from the heavily defensive posture of two months ago. We have seen a broad-based rally in risk assets, and a si­multaneous retreat from "safe havens" such as Treas­uries, cash, and gold. Emerging markets stocks surged 17% in April, the best monthly gain in 20 years, and high-yield corporate bonds returned 11% in April, the best monthly performance for that asset class in its history.

Short term, risk assets are overbought. The S&P 500 has gained 30% off the March 9 bottom, and has not suffered more than a two-day pullback over this pe­riod. "Higher beta" equity indexes have run up even more: MSCI's U.S. extended markets (small- and mid-cap stocks) and emerging markets indexes have gained approximately 40% from their lows. A period of cor­rection or consolidation could begin at any time, but if a durable rally phase has indeed begun, which we sus­pect is the case, pullbacks on the S&P 500 will be lim­ited to no more than 10%, and probably closer to 5%.

Looking out over the balance of the year, the risk/reward in stocks still appears favorable. Al­though the bullish camp is gaining more adherents, there is still ample skepticism for risk assets to climb the "wall of worry," which is so typical fol­lowing a major bear market low. There is a bearish argument that any significant rise in prices will be met with selling from investors seeking to recoup earlier losses, or move to the safety of cash until they can "figure out" this confounding investment environment. But that hasn't happened—at least not yet. The stock market has held up extremely well in spite of overbought conditions. Instead, there seems to be a bullish "selling vacuum" at work. The chart below suggests that at the depths of first-quarter lows, U.S. households collectively had already moved into such a defensive position with respect to their stock allocations that selling pressure literally dried up.

Despite a strong initial rally from the March 9 low, stocks remain near the bottom of their ten-year range. From its present level, the S&P 500 would need to gain 10% per annum for six years to return to the peak levels reached in 2007 and 2000 peaks.

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