Not Just a Bear, but a Slow-Bleed Bear!

Do you like my furrrrr?

What Does Bear Market Mean?

A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and selling continues, which contributes to further pessimism. Although figures can vary, for many, a downturn of 20% or more in multiple broad market indexes, such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 Index (S&P 500), over at least a two-month period, is considered an entry into a bear market.

A bear market should not be confused with a correction, which is a short-term trend that has a duration of less than two months. While corrections are often a great place for a value investor to find an entry point, bear markets rarely provide great entry points, as timing the bottom is very difficult to do. Fighting back can be extremely dangerous because it is quite difficult for an investor to make stellar gains during a bear market unless he or she is a short seller.

And now we have the "slow-bleed bear"! waaaaaaa!

More Bloodletting For Slow-Bleed Bear Market

Here's a new twist on volatility. There's an absence of panic as the market plunges to new lows.

News that the U.S. government would increase its stake in Citigroup (nyse: C - news - people ) to 36% scuttled any hope of a positive finish last week. Making matters worse, the Commerce Department reported early Friday that gross domestic product declined at a seasonally adjusted annual rate of 6.2% in the fourth quarter, marking the worst contraction since 1982. Against this backdrop, the Dow finished February with a loss of 11.7%. Elsewhere, the S&P 500 Index (SPX) dropped 11% for the month, while the Nasdaq Composite (COMP) dipped 6.7% in February.

Even though stocks came into last week oversold and trading just above long-term support levels, they ended the week below these support levels and still "oversold." In days where we read about financial models going bad, one has to wonder if those seeking portfolio insurance by purchasing calls on the CBOE Market Volatility Index (VIX) made a dangerous assumption that, should the market test the November lows, the VIX would again be trading in the 80-90 area. While buying VIX calls sounds good, did VIX call buyers consider the possibility of a new phenomenon--a slow-bleed bear market in which volatility (though still high) actually recedes? We find it interesting that the 30-day historical volatility on the SPX was at 72% when the SPX was trading near current levels in November, whereas now it is only 33%.

The "fear" index comes into the week trading right on its 160-day moving average, as the compression between its 80-day and 160-day moving averages continues. VIX pullbacks to this trendline in early January through February were not good times to be long stocks.

So did last week's 4.5% haircut in the S&P 500 Index (SPX) create the type of fear that has generated meaningful short-term rallies within this bear market? In looking to the options market, we again saw nothing of note that would suggest a large number of traders were looking for continued downside.

For example, the 10-day moving average of the International Securities Exchange's all-equity buy-to-open call/put ratio currently stands at 1.37. The SPX is down 11.1% during the period of this calculation. On Feb. 9, this ratio stood at 1.36, but the SPX was slightly higher during the days included in that calculation. As we have mentioned previously, the March, July and November 2008 short-term bottoms occurred when this ratio pointed toward buy-to-open put and call volume that was about equal. Should past be prologue, this would suggest a meaningful rally is not yet in the cards.

The National Association of Active Investment Managers (NAIM) weekly survey, which polls money managers each week on their equity exposure, confirms what we are seeing in the options markets, that is, an absence of an extreme in fear. The Feb. 25 survey indicated that there is more long exposure now relative to October and November 2008, and the short-term bottoms we discussed above.

From a technical perspective, the Dow Jones Industrial Average, SPX and the S&P 100 Index (OEX) are now trading significantly below their respective 2002-2003 lows. The danger is that those who bought stocks or funds in 2002-2003 are now underwater, which could prompt these investors to finally bail on their positions. Moreover, the SPX closed last week slightly below its November intraday low at 741.02 and the Dow closed below 7,100, which is the half-high of its all-time peak of 14,198.10 in October 2007.

Finally, the OEX closed below 367.25, half of its October 2007 high of 734.51. If there is any bright side to this, the Nasdaq Composite (COMP) remains above its November lows at 1,295.50, and above its 2002 bear market low of 1,108.50. These levels define potential support for the COMP in the weeks ahead. Meanwhile, the Dow will fight to hang on to the 7,000 millennium mark in the days ahead.

What do the bulls have working on their side? Seasonality. We have moved out of the month of February, which we mentioned last month tends to experience negative returns on average. March has seen positive returns approximately 60% of the time. Moreover, the market experienced key short-term bottoms in March 2007 and March 2008.

Well, at least this guy seems happy about it:

lol!