TOO MANY TRADERS TO BEGIN a New Year perusing the stock market like a hawk convinced that January sets the tone for the next 11 months. But just this once, cast your eyes away from it — because the real money is parked on the sidelines.
Stocks kicked off 2009 with a sprightly rally, but the longevity of that start will ultimately depend on stocks' ability to attract that record amount of cash to come off the sidelines into the game.

And it's quite a cache of capital. The amount of money stashed in money-market mutual funds had surpassed that in stock mutual funds as of the end of November, according to the Investment Company Institute, a national association of investment companies. In contrast, money-market funds were just 48% of stock funds when 2008 began. "If all the money currently sitting in U.S. money-market funds left and went into buying shares of the Standard & Poor's 500 index, it would absorb 42%" of that benchmark's market value — the highest in at least 25 years, says a Wall Street analyst.

That's not all. Stocks' 38.5% pummeling in 2008, their third worst year ever and the biggest annual loss since the Great Depression, had sent investors scurrying. Today, Americans are setting aside just 42% of their investment money for stocks, says the American Association of Individual Investors. At the same time, 42% of their portfolio is in cash, the highest ever. "Never before have these investors allocated as much or more to cash as they have to stocks," the analyst says.

Individuals aren't alone, and even professional money managers are hiding in short-term Treasuries that yield next to nothing. A time will come when earning zero interest starts to get old.

Luring that cash and winning investors over won't be easy. The economy will worsen before it begins to show the benefit of aggressive government stimuli, and last week an index of manufacturing activity fell to a 28-year low. Companies will report ugly fourth-quarter earnings come February, and panicked decisions made during the credit crisis could surface and bring fresh torment.
All that makes for an unsettled market, but it helps that expectations are muted; even strategists paid to drum up investor interest are penciling slim gains for 2009. A jumpy S&P 500 swung through an average 6.9% between its intraday highs and lows last October and 5.4% in November, its two most volatile months ever, says a Philadelphia investment manager.  And while December felt calmer, its 3.9% vacillations were still the fourth worst ever. Is it unreasonable to hope that a market that has absorbed so much pain will flinch less in the year ahead?

On 2009's first trading day, the Dow Jones Industrial Average jumped 2.9% to climb over 9000 for the first time in two months. The S&P 500 rallied 3.2% and the Nasdaq Composite Index added 3.5%.

Just how predictive is January? Since 1900, a winning January has spurred positive annual returns nearly 71% of the time, with the median change a 10.4% rise, says one market observer. So there's something to be said for the swell of fresh allocations and the endurance of hope.

Still, there are exceptions to the rule, and fresh-year optimism can be punctured by, say, escalating violence in these tougher times, or the failure of a big foreign bank in countries where government bailouts are less in vogue. The Dow has risen in five of the past six thinly traded sessions, and a tentative market tends to pull back until it becomes surer.

Last week, the Dow snapped a four-week losing streak to gain 519 points, or 6.1%, to 9035. The NASDAQ surged 102, or 6.7%, to 1632 and, like the S&P 500, has rallied in three of the past four weeks.

For the record, the 2008 losses totaled 33.8% for the Dow, 38.5% for the S&P 500, 40.5% for the NASDAQ and 34.8% for the Russell 2000. Crude oil ended a six-year winning run and fell 53.5%, while gold gained 5.8%.

"As much as we hate to say it and people hate to hear it, 2008 was a necessary event for the financial markets," notes a market strategist. "The U.S. financial system and the economy were employing notably higher amounts of leverage in order to achieve marginal gains." Purging that excess, painful as it was, weeds out the marginal and overleveraged players, paving the way for new growth.

He says that despite a 24% bounce from its Nov. 20 low, the stock market is still deeply oversold. The crop of New York Stock Exchange stocks holding above their 200-day averages shrank to 2% at one point and ended the year near a still-low 7%. Says one firm's chief market technician: "There is only room for expansion in this measure of breadth, in our opinion, but it could be a long, drawn-out process." (Source: Barrons On-Line).