Did you read the stories yesterday that reported Tuesday’s rally in the financials? The headline writers seem confounded:

Financial Times: “Banks rally in face of gloom” 

Associated Press: “Investors question financial sector rebound”

Wall Street Journal: “Five Banks Post Losses -- and Their Stocks Soar” 

New York Times: “Bank Investors Expect Less as Losses Mount”

For its part, Reuters was completely undone, and tried to ignore the stocks’ moves altogether: “Wachovia, other banks post dismal results,” it simply said, with no mention until the sixth paragraph that “dismal results” or no, Wachovia’s stock price was zooming. The stock closed the day up nearly 30%; the S&P Financials overall rose by 8.4%. 

I’m confused why everyone is so confused. Of course stock prices will rise well in advance of any material evidence of fundamental improvement. That’s the way the stock market works. If anyone thinks a bell will go off at the bottom to indicate all’s clear at last, he’s in the wrong business.

Which is why I’ve been amused over the past few weeks as wags have begun to come up with their what’s-got-to-happen-before-I-turn-bullish-on-the-financials lists. They are comical. As I mentioned here earlier this week, OpCo’s Meredith Whitney says she won’t turn positive until the banks can demonstrate they can “grow again,” which no one doubts won’t happen until, oh, 2010 or so. Thanks, Meredith. Helpful! 

Similarly—to pick out a list at random that’s as representative as any—commenter “DSB” at SeekingAlpha, remarking on my article Tuesday, says he doesn’t expect the financials to bottom until the following events occur:

1) Defaulting debt returns to normalized levels

2) We have a ratings agencies overhaul, which will allow IB's to trade paper as freely as before they lost trust.

3) Oil falls & remains below $130

4) We have clear indication that unemployment has stopped increasing, CPI is 'contained'

5) We have 2 consecutive quarters without a large/mid sized bank encountering problems. 

All very sensible. There’s just one problem. By the time DSB’s laundry list comes to pass—two straight clean quarters from the banks, an overhaul of the rating agencies—the stocks will have long since begun a tear.

In the real world, it’s not unheard-of for cycles to turn when no hopeful evidence is apparent to account for the price reversal. Or if there is any, it’s so subtle that, by definition, it’s overlooked by the vast majority of investors. “Defaulting debt returns to normalized levels” doesn’t fit the bill.

Even so, there’s been no shortage of signs lately that the worst of the credit crunch is past, or soon will be. As we’ve talked about here for awhile, new delinquencies among the loans that make up the ABX subprime mortgage index have been declining for months, while delinquency roll rates have been improving. Lower delinquencies now mean fewer defaults down the road. Bingo! End of problem in sight. 

Similarly, in the article in yesterday’s Los Angeles Times trumpeting “Record home losses in California” came this nugget: