Capitulation? Not Just Yet for the Stock Market

Call the latest banks-inspired stock market selloff whatever you want, but don't call it a capitulation.

Oliver P. Quilla for CNBC.com

That's wishful thinking, according to many market pros, who say that despite Merrill Lynch's warning that banks are in capitulation and on their way to dividend cuts, the phenomenon hasn't spread to the larger market.

Capitulation is considered a point at which stocks are oversold and setting themselves up as bargains. That would be bad news in the short term as it would mean equities have fallen to perilously low levels, but good news in the long range in that it would signal a bottom and a point off which the market can rally.

Analysts and investment advisors say that a lack of sustained panic-selling indicates we're just not there yet despite Merrill's call on bank stocks, which have been the biggest weight on the broader market.

"I think capitulation's a strong word," says Brian Gendreau, investment strategist at ING Investment Management. "When you get a capitulation trade you get a feeling of total despair and darkness in the market where people just completely throw in the towel, and I don't see that at all."

One measure getting a lot of attention as the market heads toward testing new lows is the Chicago Board Options Exchange's Volatility Index

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[VIX  Loading...      ()   ], which moved up sharply on Friday but remains well off the highs it generally shows during a market bottom. A reading above 20 in the VIX generally indicates substantial volatility, but the number typically has reached the 30s during times of market bottom like in 2002 and 2003.

As long as the VIX remains in the 20s, analysts see little reason to expect a bottom.

"It's almost lethargic, this selloff," says Michael D. Cohn of Atlantis Asset Management in New York. "The one thing I'm always watching is the VIX, and the VIX hasn't really ratcheted up to any degree. When we were down (in stocks) at this level the last time we were in the 30s on the VIX, which created a capitulation bottom. This is by no means a capitulation bottom."

For investors, the lack of a real market bottom creates both peril and opportunity.

Some advisers actually are looking toward financials in the hopes that the battered sector can show leadership for a future rally. Merrill said it expects dividend cuts at Bank of America

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[BAC  Loading...      ()   ] and Wachovia

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[WB  Loading...      ()   ] and some other large-cap regional banks.

"Some of the stuff that's been really badly beaten up is going to start to rally on the hope that we are more than 75 percent done with these writedowns," Cohn says. "We're heavily oversold and we're going to be heavily oversold today. I think by the middle of next week we could start to come up with some kind of constructive summer rally."

Look for some of those banks to start consolidating, as weaker ones find it impossible to raise needed capital and get absorbed by their larger competitors, says Quincy Krosby, chief investment strategist at The Hartford.

"Have we reached the bottom with the banks? Probably not, until you begin to see how much money they all have to raise and more dividend cuts," Krosby says. "We suspect that with the regionals we're going to see consolidation, not necessarily banks going under, but consolidation."

That will be one of the ingredients needed to form a market bottom, she says, but there's no assurance as to when that will happen.

"The conventional wisdom is that when the dividend cuts come in more and more and more, that's when you start to see a bigger selloff and that leads to institutional investors coming in and taking longer-term positions," Krosby says. "But we may be in a place where conventional wisdom doesn't look. This recovery should have started by now in terms of share prices and the indices. This one is playing out a little bit longer. This is kind of a downturn in slow motion."