By Barry Arnold
The Primary Trend
Let's put this argument to rest: by many measures, the U.S. stock market has already slid it into the embrace of a bear market. It is almost idiotic, and most certainly futile, to debate the issue just because the S&P 500 Index and the Dow Jones Industrial Average have yet to fall below the "-20% threshold" that has typically defined bear market territory.
Take a look at the four charts. The indices represented by these charts are easily the face of the stock market - blue-chip/red-chip, large cap/small cap, conservative/aggressive - these four charts cover the canvas.
 With the January sell-off, the DJIA has dropped -18.1% from its October 11, 2007, intraday high of 14,198.10 to its January 22, 2008, intraday low of 11,634.82. The S&P 500 has fallen -19.4% from its October intraday high of 1576.09 to its January intraday low of 1270.05. These are both painful declines no matter how you slice it. The fact that they haven't reached -20% is moot.
It's an especially moot point when one considers the other two charts. The Nasdaq Composite which some (not us) market observers believe is the leadership area, is definitely in a bear market with a three-month decline of -23.0% from peak to recent trough. The Russell 2000 Index has been bloodied by -24.1%. Interestingly, the Russell 2000 actually made new highs in July with the rest of the market but failed to make newer highs in October as did the other benchmarks. This divergence caught our eye but was only a "caution flag" at the time to us. Mistakenly so.
 The two quick down off of the October highs (Oct/Nov and the Dec/Jan) have definitely left bear tracks on the market. And after the 1000-point rebound rally that the DJIA just enjoyed over the last nine days, we may be entering a third leg down phase in stocks, which may or may not take us to new lows. By the time Wall Streeters are done debating weather we are going into a bear market or already in one, stocks will most likely have bottomed.
But here are a few key bear market factoids (data courtesy of The Leuthold Group) to help us navigate through the early 2008 "noise":
- The typical post-WWII bear market sees stock prices declines of 30% (as measured by the S&P 500) over a spam of 15 months. This would put the S&P 500 near the 1100 level one year from now. We believe that is a worst case scenario, not most likely.
- Bear market rallies are typically short and violent affairs...gains averaging +10% over five weeks. We just had a 10% rally in two weeks.
- 3 of the 4 bear markets have lasted less than 4 months. This includes their 1990 recession induced bear market...a time period that we believe most resembles today. If this script plays out, we should find a bottom sometime this month - either testing the January 22nd climactic selloff or making a new capitulation low.
 The bear tracks that are making obvious imprints in the U.S. financial markets are extending themselves internationally too. The U.S. DJIA is off -7.7%; the U.K. FTSE 100 -11.3%; China Shanghai Composite -12.6%; India Sensex -13.6%, Japan Nikkei Stock Average -13.7%; Hong Kong Hang Seng -15.6%; France CAC 40 -15.9%; and Germany DAX -16.5%. Are we in a global bear market? Our supposition is that worldwide, we are in a "pause that refreshes," even if our domestic economy hits the recession slope. Despite many professional investors claiming that the Pacific Rim is immune from exogenous economic factors, it is quite obvious that when the U.S. sneezes, the rest of the world can still catch a cold. We've cautioned risk-averse investors to avoid "anything Chinese" and we still echo those sentiments, especially in light of the increasingly attractive values here at home.
 This credit crunch started with a housing market on steroids. It was exacerbated by the subprime implosion. And it could very well seep into the realm of consumers' penchant for credit card and auto loan overindulgence. We also believe that some of this selling is being done in anticipation of a Democratic victory in November. Despite the rhetoric one might hear in the media, higher taxes are not an ally to the economy or the stock market, yet that is exactly what Clinton and Obama have promised. The fourth quarter of 2007 may go down as the beginning of a recession.
Our Cup is half full, however:
1. Overall valuations are hardly expensive and some sectors are downright cheap.
2. The stock market is a forward-looking mechanism - it does not wait for government statistics to be reported or Wall Street to form an opinion. The U.S. economy will already be on the mend and the stock market recovering by the time that CNBC confirms "Recession is here."
3. The Fed is priming the pump by cutting the discount rate from 4.75% to 3.50% in just the last month alone. "Don't fight the Fed" comes to mind.
4. Equity mutual funds reported net outflows of $33.4 billion in January - its largest net redemption since July 2002. On the flipside, $160.8 billion in net cash inflows to money market funds occurred in January. Assets in money market funds now total $3.3 trillion - more than 20% of the value of the U.S. stock market.
5. Technically, the stock market had another climactic sell-of in January. Yet, despite the S&P 500 trading 7.3% below its August climactic low, only 1114 stocks made new 52-week lows on January 22 versus 1132 new lows on August 16.
6. Insider Buying has increased significantly, especially in financials.
7. The New York Giants won the Super Bowl, which gives the market a "thumbs up" in 2008. While the Super Bowl Indicator is Wall Street whimsy, it does have an 80% success rate!
We are not Pollyannas, however. There is definite uncertainty in the marketplace, which has proven to be the stock market's #1 obstacle time and time again. Cracks are visible in the stock market, the economy, the real estate market, the credit markets and even in our political path.
If we were traders, we would probably get enveloped by the headlines of pessimism and wait for "the absolute low." But we are not traders (and oh by the way, nobody can pick the bottom). We are long-term investors with an appetite for a value and a penchant for contrary thinking. We believe investors aligned with this philosophy should put some money to work in equities, especially if the stock market works its way lower. We may not be at the bottom, but a year from now we suspect we will be out of recession and in the throes of a new cyclical bull.
In today's volatile climate, however, it is important to stay disciplined..don't chase strength..and adhere to buy limits. Our favorite buy candidates are the following (in no particular order): General Electric up to 33; Intel up to 22; Eli Lilly up to 55; Microsoft up to 29; Pfizer up to 25; Citigroup up to 30; JPMorgan Chase up to 46; D.R. Horton up to 15; KB Home up to 25.
Editor's Note: Barry Arnold is editor of The Primary Trend, 700 N. Water St., Milwaukee, WI 53202,1 year, 12 issues, $80. www.primarytrendfunds.com.
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