Stocks Rally on Schedule, Catching Hedge Funds Off Guard

So far, so good. In a post before the stock market opened Wednesday, I highlighted a report by Citigroup (C) showing that hedge funds were making one of their biggest bets on record against stocks.

Citigroup's analysts (and I) concluded that this was a sign of excessive pessimism, the sort that precedes a rally. Right on cue, stocks put in their best session in nearly two months, and they were up again in midday trading Thursday, albeit more modestly.

At a time like this it's best to remember the Analyst's Credo, as recited by Hugh Johnson, a well respected Wall Street veteran: "When you get it right, try not to laugh."

Just how right the bullish call was remains to be seen. MoneyWatch is not aimed at in-and-out traders, so a bit of staying power to the rally seems like a minimum requirement.

The move Wednesday occurred on fairly strong volume for the week before Labor Day, and market breadth - the number of advancing stocks relative to the number of decliners - was impressive at about 6 to 1. That's healthy enough to expect further gains, especially after four months of declines that have entrenched a collective miserable mood among investors.

With the monthly employment report coming out Friday morning, a pullback late Thursday wouldn't be out of line. If stocks rise after that, watch breadth and volume, as well as the way professional investors spin it.

If the market continues to look like it did Wednesday, the rally could have legs. If instead a handful of blue chips inflate the averages, concealing ever narrower participation, and commentators ignore it and sound the all-clear, then it's time to get worried again.