Small caps finish off historic down month with a four-day rally

In an ironic twist, small-cap stocks finished off one of the worst months in history with a four-day rally fueled by improving credit conditions, month-end bargain hunting and a willingness by investors to look beyond current weak economic fundamentals. The Russell 2000 (NYSE:IWM) closed up 23.32, or 4.53% at 537.49 and is now down 30% for the year. The Dow is down 30% for 2008, while the S&P 500 is off 34%.

Central bank officials around the globe slashed interest rates this week (and more are expected next week as well) and the inter-bank lending rate continued to slip lower, suggesting that banks are now more comfortable and trusting and that perhaps the worst of the credit crisis for financial firms is in the rear-view mirror. The Libor rate has declined 14 consecutive trading sessions, tumbling from more than 5% to 3%, spurring hope that various central bank rate cuts and federal bail-out packages have helped unclog credit lines.

Financial stocks played a key role in the rally today, after lagging on some bounce attempts earlier in the week. The Financial Select Sector SPDR Fund rose 3.3%. Large-capper JPMorgan Chase and Co. (NYSE:JPM) rallied 6% as the firm said it would restructure procedures for some $110 billion in mortgages and would halt foreclosure actions. Small- and mid-cap banks and financial institutions were noted all along the top percentage movers today on various exchanges.

Stocks also received a lift from asset allocation trades out of Treasury markets and into equities, Nick Kalivas, vice president of financial research with MF Global, said in an email.

“Regional small-cap banks performed well today,” Kalivas said. “I think easing credit tensions helped. REITS also traded strongly today. Vornado (NYSE:VNO) boosted its dividend and it helped the entire sector while giving some confidence . . .

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