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Are Stocks Near Bear Market? Some Pros See Danger Signs

While the stock market bear may not have made his way quite to Wall Street yet, he's at least in the neighborhood.

CNBC.com

The major averages have eclipsed the correction level—or a 10 percent drop from their most recent highs—and now investors are wondering whether a full-blown bear market, or 20 percent drop, is somewhere on the horizon.

Market dynamics suggest that the bear is close at hand. Aggressive late-day selling that has punctuated wild market swings since the April 23 highs is one of the hallmarks of a bear market.

"We fear that we are in the infancy of this bear market, as much as it pains us to say that, so henceforth watch how the market trades," Dennis Gartman, hedge fund manager and author of the daily Gartman Letter, advised clients Tuesday. Watch "it open firmer, trade a bit better, slow down its strength, begin to wane and then close hard upon or toward the day's lows late in the sessions. When the pattern changes, we'll change."

Gartman is not alone in his observations.

Market pros are noting the erratic behavior and bracing for more damage after the market's historic 81 percent rally from its March 2009 lows and its 14 percent fall since the most recent high.

"It does look like we're slipping into bear territory again. There's a lot of fear in the market now," says Emily Sanders, CEO of Sanders Financial Management in Atlanta.

The change is noteworthy, even if investors aren't nearly as panicked as they were before the S&P hit its intraday low of 666 on March 6, 2009.

"Back in spring there was an uncommon lack of fear, which was disturbing in itself," Sanders says. "The pendulum is just swinging at this point. There's an overreaction to a lot of the little things, but when those little things are taken together it does create one big panorama of global uncertainty."

To be sure, bearish sentiment is far from unanimous.

Goldman Sachs strategist Abby Joseph Cohen told CNBC on Monday that the US market looks strong and likely has priced in all the contagionfrom the events that have plagued the market.

Other analysts believe that even if the market does come back to bear status, investors can capitalize by finding bargains, perhaps in technology and elsewhere as valuations come down.

Any number of factors have converged to influence the downturn: The European debt crisis, persistently high unemployment and intensified financial regulations are but three.

Those fears have manifested themselves in a flight from not only US stocks but also those around the world, with Chinese markets dropping 23 percent and Spain equities off 27 percent. The dollar has strengthened, gold has hit new record highs and the 10-year Treasury yieldhas fallen beneath even the most extreme projections, to below 3.20 percent.

An overreaction to relatively benign problems?

Perhaps, but investors still remember the ride down from the October 2007 highs and remain skittish at any signs of trouble.

'Batten Down the Hatches'

"There seems to be no norm these days," says Andrew Wilkinson, senior strategist at Interactive Brokers, which specializes in options trading. "They can't be happy, they have to be ultra-happy. They can't be bearish, they have to be ultra-bearish."

Wilkinson says options trading is not indicating a strong winner between bulls and bears. But he thinks the S&P 500 will need to test 1,000 before a clear direction can be declared.

"The market needs a washout before investors will be prepared to jump back in," he says. "That 1,000 level on the S&P is likely to be in my opinion something that would spark buying once again."

Or selling.

Other analysts believe that if the market doesn't find support soon, the floor could be the limit.

"If we don't get a rally this week, batten down the hatches," says Kathy Boyle, president of Chapin Hill Advisors in New York. "The only things that will work are cash and bear funds."

David Rosenberg, chief economist and strategist at Gluskin Sheff, warns that if the S&P fails its 1,040 low on May 25, then a move to the 1,008 Fibonacci level is likely. Fibonacci tests look at trendlines and divide by a series of ratios. Further Fibonacci retracements would happen at 943 and 878.

"And, if we slice below that level, then it is quite possible that what we will endure is a classic retesting phase of the March 2009 lows," Rosenberg writes. "This correction, in all probability, has further to run."

Indeed, other sectors indicate that a bear market is closer at hand than the averages suggest.

Exchange-traded funds that track the energy and financial sectors on the S&P 500 have dropped 17 percent each, while the KBW Banking Index is off 19.7 percent.

In fact, some may argue that the bear has never really left the building. The market remains 32 percent from its historic high in October 2007, suggesting the market benefited from a trend expressed in terms only an analyst could love: A cyclical bull inside of a secular bear, which has returned with full force.

Banking analyst Dick Bove of Rochdale Securities revised his prediction that banks would drop 25 percent, expecting them to fall still more even though he rates the big banks a buy and believes they will recover by year's end.

And that may be where the hope rests—that a sharp retracement can set up a buying opportunity and catapult the S&P to an area like 1,250, which is the Goldman Sachs forecast that Cohen announced earlier this year.

"For the long-term investors there are some good buys out there," says Sanders, specifically citing strong tech names in the mid-cap space. "A (13) percent correction is not an extreme movement at all—probably a necessary pause. I would call this a selective buying opportunity."