Market rides the line between bull and bear

The shelling of the market by cornered, forced sellers has quieted for the moment. But is it a lasting truce, or are they simply re-loading?

Yesterday in some respects was a missed opportunity for a nice “turnaround Tuesday” bounce in stocks. The S&P 500 (^GSCP) had a nasty Monday and was again looking stretched to the downside, with bleak investor attitudes and Carl Icahn’s doomsday market call serving as what could’ve been an ideal ironic Buy signal.

Yet the early rally mostly fizzled, credit markets stayed squishy, bank stocks kept bleeding and biotechs stayed under pressure.

Still, the relative calm yesterday and the return of several key market gauges to the low of Aug. 24 is prompting debate over whether this might have been a proper, low-drama “retest” of these earlier market depths. Today’s decent early bounce in indexes will intensify this argument.

The Russell 2000 (^RUT) small-cap gauge undercut the Aug. 24 level. The equal-weighted version of the S&P 500, a measure of the “typical stock” that’s traded under Guggenheim S&P 500 Equal-Weight ETF (RSP), closed lower than it finished that day. And the intensity of the stock purge eased somewhat, with lower trading volumes and less-urgent demand for downside protection.

The reason market watchers are parsing the coded messages of the tape so closely is this: The line between bull and bear market is nearby to us, and fine enough to cross without really noticing.

This is, at least, a mature bull market that will surrender the benefit of the doubt if it fails to rally amid putrid investor sentiment and global easy money for much longer.

Of course, the majority of stocks have already dropped 20% from their highs, so the semantics of what to call the market are perhaps beside the point. But it matters a lot to those wanting to stay in the market or add to investments now or later.

The market is not cheap, but is a lot cheaper than it was. It certainly could keep dropping, to price in diminished growth prospects, but nothing says it needs to. The Fed’s likely course of action is no clearer today than a few days ago, but no more obscure either.

The market is simply responding to the fact that, near inflection points, the prospect of some policy error inherently rises. Two years ago there was worry that, having passed on a chance to ease back on QE in September it would never do so – yet it did, in December, and it was fine.

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Meantime, deflationary data in Europe has spurred louder talk of more easy money there, so who knows what policy cues will matter first.

The most recent whipping around of the indexes close to the yearly lows has mostly been about those trapped institutions liquidating positions under pressure or to meet expected withdrawals, by most appearances and accounts.

The commodity and emerging-market bust has raised solvency issues in parts of the bond market, big hedge funds have had a lousy year and face investor defections, and the stuff they own in heavy concentration has been purged.

Has this purgation run its course for now, mostly done before the final day of the month and quarter? Have enough voices warned that October will be spooky that the scared money has already left before it arrives? Is this morning's bounce simply a matter of traders front-running expected quarterly bond-to-stock rebalancing by pension funds, after equities underperformied so horribly the past three months?

This morning’s bounce will be inspected rigorously for clues that could lead to some answers. But it’s crucial to stay open to multiple possibilities. I’ve aired the idea that a “mild” bear market might be the least expected outcome with a shot at happening, but it’s far from a bankable call.

Almost exactly four years ago - the day after what proved to be a climactic bottom in world markets - it was taken for granted in many circles that a new bear market was unfolding. It was logical, based on valid observations, but proved wrong, as stocks and risky bonds went on to soar for nearly four years without a severe setback.

The only decisive difference between a lull in the fighting to reload and a lasting peace is time.

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