Getting Closer to the Bottom

10/13/2008 2:30 pm EST

Focus: STOCKS

James Stack

President, Stack Financial Management

Jim Stack, editor of InvesTech Research, says fear and panic are at extremes, and that's typical of the end of a bear market.

There are only three times in my past 35 years of investing experience that I can remember headlines as dire as those being seen today. They were in October-December 1974 (at the final stage of the biggest bear market since the 1930s), in 1982 (near the end of the longest recession since the 1930s), and in October 1987 (after Black Monday saw the biggest one-day loss since the 1929 crash set the course into the Great Depression).

According to Dow Jones Factiva, the "D-word" has now become more common in economy-related articles than it was after the 1987 crash. Does that make a depression a more likely scenario? Or, as The Economist says, "Perhaps the only thing we have to fear are the fears of journalists themselves."

This has already become one of the longer bear markets in post-World War II history. One might also find encouragement in the fact that small-cap stocks in the Russell 2000 index are holding up better than the big-cap Standard & Poor's 500 stocks.

Although the Russell 2000 has broken under its March low in the past two days, this resilience in small caps is still a hopeful sign that a far more severe bear market can be avoided.

Lastly, on a positive note, bearish sentiment extremes have reached levels that typically precede or coincide with past "Best Buy" opportunities in stocks.

The question is whether the past 70 years is still a valid comparison, or whether the systemic risk of a 1930's debacle has taken over. The Federal Reserve's major problem is as much (or more) a crisis in confidence as it is problem mortgages.

The liquidity problems represent an "event" risk that can be addressed-all it takes is looser money, and lots of it. With the $700 billion that Congress has now approved, plus the hundreds of billions that the Fed has already injected to support commercial paper and bank obligations, the odds favor this risk subsiding in the weeks ahead.

There are no guarantees in this high-stakes game, but the stability of the dollar-and almost record strength against the euro-substantially reduces the systemic risk that this will turn into a financial meltdown or depression scenario.

It's difficult to maintain sanity when everyone, it seems, is going insane!Yet we need to objectively point out that large daily losses or selling panics do not come at the early stages of a bear market, but more notably near the end. They are often a result of the gloomiest of headlines that accompany the depths of the bear market.

Barring a depression scenario, odds strongly favor higher stock prices six months from now.

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