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October 13, 2008

Is the Stock Market Crash Over?
by Michael Swanson

Chaos and uncertainty rule in this market. People are scared and are in a panic. I'm sure you feel it yourself, especially if you have 401K's or other long-term investments in the stock market. Even though I've made a lot of money this year trading against the market and have been in cash for weeks now, I felt the fear myself after I tried to go long last Friday and took a 2% hit in my own portfolio for sticking my toe in the market just for a few hours.

The anxiety and fear people are having about their investments in the stock market is growing. The DOW had its worst week EVER in point and percentage terms last week with a 22.1% loss while the S&P 500 had its worst week since 1933. This is a stock market crash. Take a look at this interactive comparison chart if you want to see for yourself. The drop in the past twelve months is worse than what was seen in the first year of the bear market of the Great Depression.

And it is a crash within a bear market that began a year ago we are experiencing now. The DOW finished the week down 40.3% for the year.

People are losing lots of money and there is pure panic - and uncertainty right now. I'm sure you feel it too. I believe we are in the process of putting an end to the current correction, but I'm doubtful a rally from here will mean the bear market is completely over. We could see the market rally into the end of the year and fall next year.

For one simple reason. I got this email from a reader this morning:

Do you agree with the WSJ?
Wall Street Journal:
"Secular bear markets can last for 14 years or longer, like the one from 1968 to 1982. Typically, such bear markets are accompanied by repeated economic disappointments, as excesses that developed during long periods of growth are unwound. That was true during the 1970s, and it seems to be the case now, although the underlying economic issues are different."

"Can we still have a swift recovery in the stock market while the economy takes years to repair?
Thanks."

I had been hoping the what we are witnessing is the final sell-off in this bear market and that when it ends the market would begin a new transition phase into a bull market - a bull market that would probably start after a year of base building. But I have to say after looking and thinking about things over the weekend I have my doubts for exactly the reason you state. A year ago I talked about the Fed "Mishkin study" that projected an economic recession that would last into 2010 due to the collapse in real estate prices. Now the Fed projected a trough in the downturn would happen in the Fall of next year as real estate put in a bottom.

If that is the case then it is possible that the stock market will fall again next year into the trough of the recession or bottom a few months before the bottom in real estate, which is still a year off. I was asking myself why should the bear market end now if the recession and economic problems aren't going to end for a long-time?

Only two reasons - because we all want it to and because it has simply fallen so much. But neither of those are valid reasons - not good enough reasons to act on.

Hope isn't a strategy and simply because something falls a lot doesn't mean it can't fall more.

In the end none of us really knows. But that is fine. Because all we need to do is stick to the long-term indicators, such as the 200 and 150 day moving averages to know when it is safe to invest with a long-term time frame again. When a stock or market is below these moving averages you can't try to be a buy and hold investor.

As for a secular bear market I actually believe we are in one and it began in 2000. The bullish scenario would compare the current secular bear market to the one from 1968 to 1982 and then view this current bear market as the one that came in the middle in 1974.

But this has been the worst one week drop for the DOW ever - worse than even during the 1929 stock market crash. It is still best to be cautious in the market and not become a long-term investor until the indicators say the market is safe again. People have been trying to guess the bottom all of the way down and have lost a lot of money, because they refused to face the reality of a bear market and ignored the long-term moving averages. Using the long-term moving averages won't get you in on the exact bottom of a bear market, but they'll get you in when a new bull market starts and keep you in until it is no longer safe to stay in.

I've been looking for a huge volume capitulation day in the markets to signal a climactic bottom to this correction. We got the type of volume I was looking for on Friday - in fact for the S&P 500 it was the highest volume day ever. We also saw the VIX "fear index," which measures the premium investors are paying for puts, spike up to a level not seen since the 1987 stock market crash on Friday.

The huge volume and high VIX levels are both indicators that are showing us the type of fear that we should see at a major stock market bottom. I've been looking for this to happen to show us a bottom.

But I'm just not sure that we saw the bottom. The market did not finish in the green Friday and it is hard to tell if the market really rallied because all of the sellers in the market are gone or out of hope that the G7 finance ministers would come up with a new plan for the market over the weekend. If the latter is the case then the market is likely to fall again just as it has after every promise of government intervention has been passed or announced in the past few weeks.

I had a bad feeling watching the market on Friday. The market had a huge high volume sell-off in the morning, which was pure panic. I have watched the market bottom in times of panic - in fact it is such panic that makes the market bottom. Bottoms like that seen after the Bin Laden terrorist attack against the US and in July of 2002 came on days of panic. But there was more panic than I had ever seen before in the market on Friday, and we did not get a convincing reversal day.

My fear on Friday was simple - if the market isn't going to bottom with this type of fear and selling how much more selling and losses are going to have to come to end this? That is the question I don't want to see the market have to answer. I believe the odds favor a retest of Friday's low and then a move higher from there into the end of the year. It is possible that the market actually violates Friday's low and falls another 1-5% before turning up.

If we get a retest of the lows that holds I will likely take a long-position in the S&P 500 again.

The way I see it either we are on the verge of a total wipe out or else the market is going to go through a bottoming process this week to build a new floor under the market. I hope this is what happens, but things are just too uncertain for me to have a confident opinion about it at this moment. I simply am going to have to watch how things play out over the next few days before I can draw some conclusions. The huge volume and panic on Friday is the first indication we have had that we are near the end of this market panic - but there is a risk that the panic phase could last longer.

That doesn't make me feel anxious though. Because there are things that we do know about the market - and all we have to do is to focus on that to make money.

The rest of this article is available in the WSW Power Investor Members area.

Michael Swanson,
WallStreetWindow.com

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