Based on the first few days of 2009, you might have thought that we'd solved all the economic problems that have plagued the markets for more than a year now. Unfortunately, despite the more positive attitude investors adopted in the New Year, you shouldn't expect stocks to go straight up from here on out -- as today's market action shows.

After a year as bad as 2008 was, you might have expected to see bargain-hunting investors show more interest as they rebalance their portfolios and put new money to work in the markets. Looking at the broad market indexes, the gains we've seen so far in 2009 aren't unreasonable. Before the market opened this morning, the Dow and S&P were both up around 3%, while the Nasdaq had risen just less than 5%. And considered in light of losses between 30%-40% in 2008, the January bounce we had seen seemed minimal.

The return of hot sector stocks?
A closer look at some individual stocks, however, showed some much bigger gains. In particular, stocks in some previously beaten-down sectors like energy and materials have shown particular strength so far in January:

Stock

YTD 2009 Return

1-Year Total Return

PotashCorp (NYSE:POT)

14.5%

(39.7%)

ConocoPhillips (NYSE:COP)

7.5%

(32.3%)

DryShips (NASDAQ:DRYS)

42.9%

(77.1%)

Valero Energy (NYSE:VLO)

15.3%

(60.1%)

Arcelor Mittal (NYSE:MT)

19.7%

(57.4%)

USG (NYSE:USG)

42.7%

(66.2%)

Navistar (NYSE:NAV)

43.8%

(42.5%)

Source: Yahoo! Finance. As of Jan. 6.

And the trend went beyond stocks. While Treasury-bond prices have tumbled, several funds that invest in municipal bonds have seen double-digit percentage gains over the past week or so. High-yield corporate bonds have also seen strong performance.

Is the bear market over?
Optimistic investors might see these gains as indicators that the end of the bear market is near. After all, because the financial markets are forward-looking, you would expect that markets would rise long before the economy actually started recovering, anticipating a recovery based on leading indicators and other encouraging data.

Yet today's market drop serves as a stark reminder not to count the bear out for good. Consider a few things:

  • During the last bear market, stocks saw significant gains in mid-2001, and after Sept. 11, 2001. Yet those bear-market rallies lasted only a short time before markets fell back to retest and set new lows, and they didn't hit bottom for more than another year.
  • The recent rally suggests rising expectations for a new administration and an economy that seems like it couldn't get any worse. Yet investors expecting a quick fix could find themselves disappointed if consumer sentiment doesn't turn around fast enough to support a lasting recovery -- or if struggling businesses continue to lay off workers, feeding a vicious cycle of economic slowdown.
  • As far as stocks fell last year, even a much larger rally wouldn't get us anywhere close to 2007 levels. Meanwhile, many investors who avoided panicking in the short term last year will be looking for opportunities to raise cash, creating selling pressure that may make any gains short-lived.

The other side of the equation, however, is that there's a lot of money on the sidelines right now. If the rally resumes, it could scare investors back into the market. Fear of missing out on gains often feeds on itself, extending rising markets far beyond where the fundamentals suggest stock valuations should go.

As you put new money to work, keep in mind that your emotions can work against you in rising markets as well as falling ones. Don't let recent gains create a false sense of urgency that clouds your judgment. If rising prices push a stock beyond a comfortable valuation, put your plans on hold and look for more reasonable investments. The odds are good that you'll get a chance to invest on your terms -- and even if the price of a particular stock never falls back, you shouldn't have any trouble finding others that could perform even better.

Further bear-proof Foolishness:

To find the market's best bargains regardless of whether the bear lives on, check out our Motley Fool Inside Value newsletter. You'll find great recommendations of stocks that have a margin of safety to get through tough times well. See for yourself with a 30-day trial -- it's free and there's no obligation to subscribe.

Fool contributor Dan Caplinger expects more pain for a while, but that isn't stopping him from grabbing some bargains now. He owns shares of Arcelor Mittal. USG is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy works in bear and bull markets.