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Bull or Bear Market in the Making?

The Daily Ticker
Daily Ticker

By Yahoo! Finance's Michael Santoli

Market bulls and bears can always find something to disagree about, as The Daily Ticker's Henry Blodget and I discuss in the accompanying video. But when the major stock indexes start cracking through big round numbers and threatening their all-time highs, the argument can get louder and more emotional.

Amid some loose talk last week that the Federal Reserve might become tighter with its balance sheet and Italy’s anti-austerity weekend election, the Dow Jones Industrial Average (^DJI) suffered its first notable dip of 2013, declining 2%.

Beginning mid-day Tuesday — as Fed Chairman Ben Bernanke worked to reassure Congress that his resolve to suppress interest rates and support credit growth hasn’t wavered – the Dow ramped by 250 points and is less than 1% away from matching its all-time peak of 14,164 hit in October 2007.

Related: Bernanke Defends Bond Buying: Hubris or Harbinger of Stability?

The bullish read on this action is this: The market is proving its resilience, the first dip was bought eagerly by investors who feel they don’t have enough exposure to stocks, the slow-and-steady economy is fine for companies to thrive and restrain inflation, housing continues to recover, stocks are reasonably valued and bonds unattractive. They see the three-month rally as only the beginning of a Fed-supported exuberance phase of this bull market getting underway.

The bears, sensing an opportunity missed perhaps, point out that the indexes twice topped out almost precisely at these levels both in 2000 and 2007, the U.S. economy stalled in the fourth quarter, the “sequester” spending cuts will be a real drag on growth in 2013, the market is no cheaper than when it peaked in 2007 and the potential for shocks out of Europe and China remain higher than average.

A thoughtful investor, recognizing there is always talk of major inflection points and yet such pivotal turns are rare, can integrate the messages coming from these opposing high-conviction camps. Yes, the Fed and the sturdy credit markets are supportive of equity values. Corporate America is in strong shape financially and competitively. If the public is about to broadly participate in the market after hiding in bonds and cash for years, now that many big-picture risks are receding, this would be an added tailwind.

Yet, after a 15% gain since Thanksgiving, the market deserves, and is due for, a breather. The sequester may be largely baked into economic forecasts, but if it were combined with further signs of struggle on the consumer front, the market wouldn’t absorb the blow too easily. Ten-year Treasury yields (^TNX) remain below 2%, failing to give a green light for risk-seeking trades. Meanwhile, the little Italy scare exposed some crowded institutional trades – betting heavily against the Japanese yen (JYP=X), gold (GDX) and equity volatility (VIX), in favor of stocks and the euro (EURUSD=X) – that could be sources of further turbulence.

Related: The Sequester Is Awful And Obama Didn't Even Try To Stop It: Prof. Bill Black

The bottom line is that the market seems to have exited the gentle, upward-glide phase that prevailed through January and most of February, and now appears to be in for a jumpier, two-way trading environment for a bit.

As noted here in a market-analysis piece, this occurred the past two years, stocks “rising by 6% to 8% by Valentine’s Day, then losing some altitude into March. In the prior two years, stocks regained their footing and ticked to a new year-to-date high in April before undergoing a deeper retreat. The market doesn’t often track the same pattern three years running, but this one bears watching.”