Is It a Bear Market or a Bull?

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With the stock market having gained more than 25% from its early-March lows, whipsawed investors are wondering if the bear market is really over.

Many market pros are now thinking that stocks have likely seen their worst levels. Still, the road ahead is far from clear.

Consumers continue to struggle amid collapsed home values and a bleak job market. Banks remain hamstrung by big pools of soured loans that make new lending difficult. Meanwhile, thanks to the big rally, stock prices are no longer at bargain levels. As a result, there's a sense that shares are due for a good-sized pullback.

However, when the market's most recent lows were hit in March, it was against a different backdrop. Not only was the economy in a free-fall but there were serious concerns about the fate of the global financial system.

Now the efforts to stabilize the markets by the Federal Reserve and governments around the world seem to be having concrete results. And with signs that the pace of the U.S. economy's decline is slowing, many now believe that the bottom for stocks has been set. 'It's highly likely that we've seen the lows,' says Barry Knapp, strategist at Barclays Capital.

But this isn't the first time since the bear market began that stocks have staged a significant snap-back. Late last year, the Dow Jones Industrial Average climbed 19% from Nov. 20 through the end of the year.

And for the first two months of this year, many investors were convinced that the Nov. 20 low of 7552.29 would prove to have been the bottom. But in mid-February, amid renewed concerns about the nation's banks, the market sliced through that low, eventually falling another 1,000 points -- or 13% -- to 6547.05.

Short-Term Up, Long-Term Down

Since then, stocks have marched higher in a rally that has surprised many with its speed and scope. (The Dow closed down 3.6% last week, only its second losing week in the last 10.)

So is this rally for real? That depends on whether you are looking for a new 1990s-style multi-year climb in stock prices or just a strong rally in an extended downturn.

The Wall Street Journal narrowly defines a bear market as a fall of at least 20% from a peak in the Dow Jones Industrial Average and a bull market as a rise of at least 20% from a trough. By that measure, from 1930 through 1939 there were 11 separate bull markets, three of which saw the Dow rise more than 90% before falling back.

And depending on where you stand, the Depression decade can look better than you might think. Yes, the Dow ended the decade at less than half its 1929 pre-crash high, but it finished up nearly 300% from its 1932 low.

It was a similar story in the 1970s, when the Dow fell 45% between January 1973 and December 1974 and then bounced 76% in a rally that lasted through September 1976.

It turned out that the 1974 low was, in fact, the bottom for the Dow. However, it subsequently dropped back 27% by the end of February 1978.

In both cases, these rallies occurred during what analysts at Ned Davis Research refer to as 'secular' bear markets -- downturns that can last more than a decade. While the current move meets the criteria for what the firm calls a 'cyclical' bull market, we're still stuck in a long secular bear market that actually began nine years ago.

About as High as It May Get

'You can get these kinds of monster rallies,' in the middle of a long-term bear market like the one we are in now, says Ed Clissold, senior global analyst at Ned Davis Research. 'Looking back several years from now, there will likely be points in time where the market is not significantly higher than it is now.'

Amid a market that could remain volatile, and potentially not move much overall for some time to come, many advisers are recommending that investors should be flexible with their allocations to stocks.

That means being willing to cash out profits during rallies, especially when valuations start to get stretched. In turn, that will provide a cushion of cash that can be put back to work as the market moves lower.

Barclay's Mr. Knapp offers reasons to be cautious about the outlook from here. For one thing, Mr. Knapp is concerned about another down-leg in home prices.

In addition, he says stocks are looking relatively pricey compared to earnings. That's not uncommon when stocks first make a turn from a bear to a bull market. But today's lack of easily available credit will make it tough for companies to 'grow their way' to those higher prices, he says.

'We're going to have a hard time getting an earnings recovery with a credit-less recovery,' Mr. Knapp says.

But providing a likely floor for the market are some positive factors that weren't clearly in evidence back in early March.

Most important, says Barclay's Mr. Knapp, are improvements in the credit markets, which had been the source of the market's most serious woes. For example, there's evidence that banks are more willing to lend to each other. And many of the nation's biggest banks have been able to raise money in the stock and bond markets to shore up their finances.

'The capital markets are sending a pretty clear sign,' Mr. Knapp says. That's crucial, he says, because the economy and the markets seem to have broken a 'negative feedback loop' seen last year where bad news in the markets hurt the economy which in turn spiraled back to do more damage to the markets.

As a result, he says, 'if we got a decent-sized pullback in the market, I think you would find buyers.' That would probably keep the market from falling deeper than its March low.

TOM LAURICELLA

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