The stock rally that wasn't

It looks like the government isn't going to let Citigroup fail. But that wasn't enough to save the market Monday.

At first, it looked like an explosive rally in Citi (C, Fortune 500) and other bank stocks was going to lead to a jubilant day for stocks, a Wall Street equivalent of the celebratory "Slumdog Millionaire" musical number on the Academy Awards. The Dow shot up about 75 points shortly after the market opened. Jai ho!

But the rally was short-lived. The overall market fell more than 3% by the end of the day, even though the S&P Bank Index had gained more than 2%, led by a 3% pop in Bank of America (BAC, Fortune 500) and 10% gain in shares of Citi.

What gives? Well, for one, the Citi news isn't really so great. The government may save Citi from complete collapse...but probably at the expense of existing shareholders.
Talkback: Would a government takeover of Citi be good or bad for the economy and markets?

And investors have plenty to be worried about beyond the banks.

In the tech sector, Hewlett-Packard (HPQ, Fortune 500) dove about 6%. The computer and printer maker cut its outlook for fiscal 2009 last week. Rival Dell (DELL, Fortune 500), which will report its latest quarterly results Thursday, fell about 5%.

Industrials and materials firms, two groups whose fortunes are closely tied to the economy, also sunk Monday. Dow components Alcoa (AA, Fortune 500), Caterpillar (CAT, Fortune 500) and DuPont (DD, Fortune 500) each fell about 6% to 8%.

"If it's not one thing, it's the other. Even though there may be more certainty about what's going to happen with banks, the focus is back on economic weakness," said Bill Stone, chief investment strategist with PNC Wealth Management in Philadelphia. "Industrials, materials and tech are three very cyclical groups."

It's a disturbing trend. I pointed out last week that even though bank stocks were getting kicked, there were some pockets of strength, particularly in the energy, healthcare and consumer staples sectors.

But now, it is starting to look like worries about how long the recession will last could weigh even on some of the "safer" areas. Companies across all sectors may have to cut back if there are no signs that the economy will at least stabilize, if not recover, soon.

"Investors are worried that economic deterioration will threaten capital spending," said Jack Ablin, chief investment officer with Harris Private Bank in Chicago.

Along those lines, investors seem to be flocking to other types of securities. The price of gold is hovering around $1,000 an ounce. And the yield on the U.S. 10-Year Treasury is now at about 2.78%, down from above 3% earlier this month. (Bond yields and prices move in opposite directions.

"Quite frankly, the worries are that business in general is so weak right now. So there shouldn't be much interest in stocks," said Subodh Kumar, an independent market strategist based in Toronto.

Ablin added that since fixing the banks could require so much attention from the government, investors may now be wondering how successful the broader stimulus bill -- signed into law last week -- will wind up being. In other words, the government may have too many balls in the air at once.

"There may be a perception that these bank bailouts are going to channel resources from broader stimulus," Ablin said. "It's one step forward, two steps back."

Add all that up and you have a decided lack of confidence. Kumar said that even corporate executives, known for being a bit more bullish than most, are starting to talk about how gloomy the economy is. And even though their pessimism is warranted, it's probably not helping the markets.

"Corporate titans are saying thing are getting worse and worse," said Kumar. "To be sure, CEOs are not the best judges of turning points. But they impact investor psychology. CEOs were ebullient a year ago and now in the past three months they have become particularly despondent."

So even though bank stocks are enjoying a moment in the sun -- for a day at least -- the rest of the economic headlines are too bleak to make anything else matter.

"Obviously, we need to get financials taken care of first, but right now, there's a complete lack of confidence," said John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala. "People don't see the light of the tunnel. It's a never-ending hit to the face and that is leading more and more to a bunker mentality."