Market Acting Like a Bear, Even Though It's Not

When it comes to figuring out this stock market, the bear is in the eye of the beholder.

As things stand, only the Nasdaq has entered what is technically considered a bear market: a 20 percent drop from the most-recent high.

The Dow Jones Industrial Average and the Standard & Poor's 500 are still short of that mark, though they might as well be in a bear market, analysts believe. Market sentiment is so low that traders are behaving as if stocks had been in a bear market for months.

"If I were to describe the environment as it is now it's certainly a bear market environment," said Todd Salamone, director of trading at Schaeffer's Investment Research. "As far as how long it persists, I think the jury's still out there."

In addition to numerical benchmarks, bear markets are distinguished by their psychology. Investors develop an overriding sense of pessimism that the market is unlikely to recover soon, and their behavior is reflected in what they do with their money.

In this particlar bear run, investors have tended to sell into rallies and buy on the declines. Rallies have been short-lived, consistent with the notion that rallies in a bear market are brief and falter when volume is low.

High volume is seen as showing confidence in the market, and most of the trading days for the past several months have been marked by the comparatively low amount of shares trading hands.

"As far as sentiment is concerned it definitely has all the earmarks of a bear market," said Quincy Krosby,chief investment strategist at The Hartford. "Certainly the temperament of the market is you don't see the follow-though that you'd like. The sentiment certainly seems to be negative."

Before pulling out of bear territory, investors generally need to see undeniable signs of a bottom--something that hasn't happened yet despite the howls of pain emanating from Wall Street.
Analysts hearken back to the market-bottoming of October 2002 for the template on what needs to happen to cure the 2008 version. At that point the market saw a huge selloff, particularly in mutual funds, and the Volatility Index (Chicago: VIX) hit unprecedented levels.

In this market, after regaining the highs of last October several times, stocks tested their lows but never went below them.

The word "capitulation" comes to mind--where panicky investors just sell everything--though it's a word money managers try to avoid.

"Many veterans would like to see a kind of major selling that is commensurate with a major spike in the Vix, and we haven't gotten there yet," Krosby said. "They feel it really hasn't gotten negative enough to spark the kind of selling that they would equate with a market bottom."
While the selling may not have been quite as dramatic, it has been steep.

The Nasdaq (NASDAQ: .NCOMP) has crossed the path of the bear, with a 22 percent decline off its high. The S&P (Chicago: .SPX) has tumbled nearly 18 percent, while the Dow (Dow: .DJIA) is off nearly 16 percent.

Salamone, though, said the S&P in particular has broken an 80-week trend line, indicating to him that the bears are in control. He sees the S&P needing to test the 1,250 area before a bottom can be established.

As for navigating out of the bear market, Salamone advises a three-pronged strategy: Using put options to limit risk; moving into cash; or to find sectors bucking the larger trends.
A put allows, but does not require, an investor to buy an option from a put writer, or seller, at a specific time for a specific price. Cash moves, meanwhile, provide security but are short on returns these days, with yields on Treasurys their lowest in years and CDs tumbling over the past year as well.

Salamone recommends commodity-focused ETFs including Street Tracks Gold Shares (NYSE Arca: GLD), which mimics gold prices, and Market Vectors Global Agribusiness (AMEX:MOO - News), which follows agricultural commodities.

As for Krosby, the formula is more traditional.

"This is the reason we always stress diversification," she said, "simply because there will always be something that moves up when the other parts of the market are down."