After Huge Two-Day Selloff, Stocks Near Recent Lows

Forget a post-election rally. Stocks now appear likely to retest their most recent lows—and  possibly head even lower.

A big Election Day rally led some to think that market psychology was improving due to the dramatic victory of Barack Obama. But stocks have sold off sharply since then as worries about the economy overshadow enthusiasm for an Obama presidency.

"Now the focus is squarely back on the economy—and the economy stinks," says Matthew Tuttle, president of Tuttle Wealth Management. "The (economic) numbers that are going to be coming out are not going to be encouraging, so we think there is some more downside here."

The three major stock indexes are now approaching the recent lows of early last week, when the Dow Jones Industrials was at 8,176, the S&P 500 was at 849 and the Nasdaq at 1506. Since then, the market had been trying to claw its way back.

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"We had a nice little bull rally in a bear market, up 18, 20 percent in six days—pretty impressive," Warren Meyers, of Walter J. Dowd, said on CNBC. "That's not sustainable, obviously. The trend is still down in this bear market. And because of that, you're going to have this massive volatility that we've been seeing. It's going to continue for the foreseeable future."

Surging unemployment and a dour forecast for the holiday shopping season have helped pushed the market lower since Tuesday. And investors are expecting more bad news on Friday, when the October employment report is expected to show at least 200,000 jobs were lost last month.

In such an environment, the best investors can hope for is to break even for a while, with stocks bouncing along the bottom, and perhaps a sustainable recovery coming next year when the worst of the economic and earnings reports pass.

"There's some kind of realization that the economy's worsening and I think that's going to be with us for a while and working on the downside of this market," says James Paulsen, of Wells Capital Management, an analyst who forecasts more of a flat market. See full interview at left.

"I think the lows we've put in are about as low as we're going to get even if the economy does get worse," he adds. "But I'm just saying for a while there may be a struggle to go a lot higher until we get further into this recession."

Indeed, that seems to be most optimistic view for now.

What could take things from bad to worse, then, are economic numbers that come in significantly beneath expectations—a distinct possibility in the wake of a sharp increase in layoffs foreseen for the biggest Wall Street firms and an auto industry teetering on the brink of major destruction.

"The market's already factored in bad news," Tuttle says. "So it's just: 'Is the news worse than the market has factored in? Is the news better than the market has factored in?'.."We'll have to see a string of numbers coming out that are starting to look better. We don't have that euphoria about the election, and the sole focus now shifts to the economy."

As such, traders are watching technical levels closely. Should the markets successfully break the late-October low range, some analysts see bigger trouble ahead.

"I am not surprised that equities are coming off the boil. You don't sustain 30 percent in a 10-day period," Tom Hougaard, analyst at City Index, told CNBC. "Where you go from there? I say you probably have to go back and retrace a little bit." See the video at left.

Actually, Hougaard thinks the market could retrace a lot. A move below 850 in the Standard & Poor's 500 could trigger a tumble to a sub-7,000 Dow by mid-December, he said.

The Good News

But even someone as pessimistic as Hougaard sees the market movement as only natural considering the various dynamics at play.

And Tuttle says he's a bit less bearish than he'd been a few weeks ago, even taking a long bet on the Standard & Poor's Depository Receipts exchange-traded fund which pays off for moves upwards in the S&P 500.

At the same time, though, he is betting the tech-barometer Nasdaq will go lower, using the Short QQQ Proshares ETF to capture gains on the inverse of the index's performance.

"I'm not as convinced that the market will be going down a lot from here as I was maybe a couple of months ago," Tuttle said. "We're playing it a little more cautious now to see how things go."

Paulsen is no optimist either, but he thinks there could be glint of hope in the markets.

"Anything short of the Great Depression and we probably don't go much lower than we've already been," he says. "If we lose 250,000 jobs here Friday, most of that is already known. And out there the question is when do the reports start getting a little better than feared. At that point I think there's considerable upside."

© 2009 CNBC.com