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The Bear Market Low Is Made

The Bear Market has been building to a crescendo, and it was reached this past week in the most volatile trading in the history of the stock market. I've never seen large cap stocks trade up and down as they did this past week as the seesaw activity in the markets required a healthy dosage of dramamine to fight off the dizziness.

The bankruptcy of Lehman Brothers and near collapse of AIG Group had the market believing our financial system was going to come to an end in a pile of worthless rubble. On Monday and Tuesday, the market had priced in the total collapse of our banking system.

There was a run on money market funds on Wednesday as stocks were crashing like water over Niagara Falls, forcing the Federal Government to take immediate and decisive action.

It's hard for me to believe or really understand how 3 million questionable mortgages could cause so much devastation. It's really all about balance sheets and leverage in the banking system. Those 2005 to 2007 exotic mortgages did it, and it was just plain unbelievably ugly.

On Wednesday I bought Goldman Sachs (NYSE: GS) at $100, and sold it 40 minutes later at $112. That's absolutely amazing. On Thursday I watched the stock trade to $87, and Friday it was back up to $140. It is unlikely there will ever be another three day period like that in my lifetime.

It all changed from Tuesday to Thursday. It started with the $85 billion bail out of AIG (US taxpayers now own 85% of the company- fine with me). I wonder if Ben Bernake just sends a wire to AIG's bank account for $85 billion.

Later in the week RTC version 2 was announced by the US Government. For those of you who weren't around back then, we had a similar disaster in the 1980's. The entire Savings and Loan Industry was wiped out by- you guessed it- excessively aggressive real estate lending practices during a residential building boom.

In the 80's, the Resolution Trust Corp (RTC) was established to take possession of all the real estate securing the defaulted mortgages, and slowly but surely resell that property back to the private sector as the environment improved. It worked.

The US Government will be setting RTC version 2. This agency will purchase the toxic mortgage portfolios from the struggling banks at a discount to their face value, organize them, and slowly but surely resell them back to the private sector over time. This will allow the market to stabilize, unfreeze capital, and restore the banking system to normal. As a taxpayer, I believe this is a good investment. There's a good chance our government will make money on the transactions. Even if we take some losses reselling the notes, we will make it back through a healthier economy, fueled by a fully functional banking system.

Looking back at the charts, I can easily conclude we've been in a bear market since November. It wasn't totally evident until we got in the February, but we were definitely in a Bear market.

In my view, this past week marked the end of the Bear, and the resurgence of a very small and weak baby bull. All widely shared irrational hallucinations come to an end. Parabolic moves to the upside and to the downside are always resolved in the opposite direction. When oil peaked at $145, most of the "experts" believed it was going to $200. Wrong. The hard part is always calling the top or the bottom.

The chart I've provided represents the evidence that we hit the market low this past week. I've generated a chart that looks at the Volatility Index (VIX) over the S&P 500 (SPX). This is a monthly chart, which is the only way I could get 12 years into this small space. Notice the Volatility Index (shown in red) peaks at or just above 40 at each important market low- The 1987 crash, the 1990 bear market, the 2002 Post 911 market low, and the low of this past week. The VIX spiked to 42 on Thursday. It's depicted by the circle, but won't make this chart until the end of September. The VIX breached 40 again, which likely marked another market low.

This chart of the S&P 500 goes all the way back to 2003. Note, this past week the S&P almost completed a perfect 61.8% retracement of a five year move- that's a major positive technical indicator.

Also- consider this on the value side- In 2003, the S&P 500 was trading at about 18 times earnings. This past week, the S&P 500 was trading at about 12 times earnings.

So, if I'm right, and we're on the cusp of a baby bull, does this mean microcap stocks are ready to start charging back up the charts? No. It's going to take some time.

First, large caps will being performing better, led by Alternative Energy, Health Care, and Consumer Non Durables. The big discount retailers will continue to do well.

As faith is restored, small stocks will start to trade up again. It won't take much as many of these issues are severely beaten down. Low volume rebounds will be the eventually be replaced with higher volume levels as pricing improves.

At long last, better times are likely ahead as the market perceives improving conditions are on the way.

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