Wall Street's bears are back in charge

After a tense weekend that raised further doubt about the strength of the U.S. mortgage market, the stock market drew some reassurance from news that the Treasury and Federal Reserve stood ready to come to the rescue of mortgage finance giants Freddie Mac and Fannie Mae.

But, despite a relatively mild Monday selloff, there was no question that a bear market is well underway, the latest sign that the economy is probably in recession. If history is any guide, both the economy and the stock market have a way to go before they hit bottom.

Stock prices have been near bear-market levels for weeks but officially landed there last week when the broad Standard and Poor's 500 index fell to more than 20 percent below its October peak level. The more narrow Dow Jones industrial average already had fallen more than 20 percent from its latest peak, the standard definition of a bear market.

Bear markets and recessions often go together. When companies see bad weather ahead and mark down their profit forecasts, investors take cover and sell stocks.

But the relationship is not perfect. The market has seen big pullbacks before without the economy tipping into recession; the Crash of 1987 is one of the best recent examples. Conversely, in the back-to-back recessions of 1980-82, one of the worst downturns of the past 50 years, the S&P 500 index was actually higher at the end of the event than when it began.

Over the past hundred years, the average bear market has lasted a little over a year and seen stock prices fall by about 30 percent. By that measure alone, investors can expect stock prices to continue to continue falling.

Corporate profits, meanwhile, are coming under pressure. And because stock prices generally are heavily influenced by corporate earnings, the bear market isn’t likely to end before those profits begin to recover.

That’s why, over the next few weeks, investors will be looking carefully at not only at what companies report they earned in the second quarter, but the guidance they give for the next few quarters. Those forecasts have been getting progressively worse so far this year.

“When we started the year, we thought we would see about a 4 percent increase in earnings for the S&P 500 in the second quarter,” said Sam Stovall, chief investment strategist for Standard and Poor's Equity Research. “Now based on new guidance, additional writedowns and so forth we're looking for closer to a 10 percent decline.”

A lot, of course, depends on how well or poorly the economy performs. Though the latest data show the GDP has turned in small gains in growth, a series of six months of job losses and a five-month decline in industrial production point to an economy that is shrinking.

Merrill Lynch economist David Rosenberg is among those who believe that a recession is already under way.

Although the nation's gross domestic product rose 1 percent in the first quarter, according to the government, Rosenberg said in a recent report that he expects that figure to “undergo massive revisions.” When the final numbers are tallied, the results could show the economy began shrinking late last year. Such revisions marked the beginnings of both the 2001 and 1990-91 recessions, said Rosenberg.

Even as economic growth appears to have stalled, higher prices for oil, food and other commodities are fueling higher inflation both in the United States and around the world. That’s forced the Federal Reserve to halt a series of interest rate cuts deigned to keep the economy moving. Central bankers in Europe and elsewhere already have begun raising rates in an effort to curb inflation.

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