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WHAT THE MARKET WANTS: Nov. 2008

November 4, 2008 5:25 PM   The bear market intensified in October, one of the most volatile and worst months on record. The major indices crashed to five-year lows during the first couple of weeks as all-out panic and fear gripped Wall Street and Main Street.

Cooler heads emerged during the latter part of the month as a successful retest of the early October lows helped cushion the blow. In the end, it was still the worst month for the markets since the '87 crash.

Contributing factors to the severe weakness last month were massive hedge fund redemptions and the unwinding of mammoth commodities positions that had paced the market higher for the last several years. This was aided by a general sense of "It may get worse, before it gets better" attitude in relation to both stocks and the economy. And as credit markets fell into further disarray because banks all but stopped lending to each other, much less consumers, the market tanked in early October amid fears that the global financial system was at a standstill.

The carnage was widespread. Everything was down big in October, ranging from -14.1% for the DJIA to -22.9% for the Russell Midcap Value. The DJIA and S&P 500 fell below the hallowed 10,000 and 1,000 levels, respectively. For the month, the S&P 500 tumbled 16.9% and the Nasdaq, 17.7%. The damage could have been much worse, save for a huge rally in the final days of the month. All of the indices we track are now down 33 - 45% since peaking last November.

Large-caps showed some relative strength versus the other market cap segments, and value outperformed growth on a relative basis in the small-cap and micro-cap segments. Small-cap value, which had been a relatively safe haven year-to-date, succumbed to the general market weakness and swooned 20.1% in October.

As we head into the seasonally bullish final two months of the year, we expect the market will continue to be volatile with so many unknowns remaining. It's clear the U.S. economy is in recession -- the key question now is whether it will be a short-lived affair or something more serious. The "D" word, as in depression, has even begun to make its rounds.

While valuations remain at very tempting levels from a historical perspective, analysts' projections have not yet begun to price in anything more than a mild recession. If credit (which has been one of the driving forces of the economy for a generation) continues to be restrained and job losses continue to mount, the fact is that the Fed's trillion dollar intervention will have little impact on the short-term spending habits of the strapped consumer. This could lead to further economic weakness.

Still, the market has shown some constructive behavior over the last couple of weeks. The early October lows were successfully retested later in the month, and the major indices are now in consolidation mode as we head into what has historically been a very good time of the year for stocks.

If buyers can muster enough strength to push the major indices through their recent highs, then we would expect a retest of DJIA 10,000 and S&P 500 1,000 in the coming weeks. But we worry that this rally could be nothing more than a bear market bounce that could ultimately take out last month's lows. We hope we are wrong, due to the historically low valuations.


Next update:  First week of December.