Waiting for stocks to rally? Don't hold your breath

A key thing to watch, Stack says, is if the broader S&P 500 can stay above the 1273 low it hit in March at the peak of the credit crisis. Wednesday, it closed at 1262, raising alarms. But one day does not make a trend, and if the large-stock index can climb back above that key level, that could signal that a horrible outcome is not in the cards.

After Wednesday's nearly 2% drop, the S&P 500 is 19.4% off its record high and flirting with a bear market, defined as a drop of 20% or more. The tech-packed Nasdaq composite and small-stock Russell 2000 indexes are already in bear territory.

A mega-bear at Societe Generale,analyst Albert Edwards, warns of a deep recession caused by the fallout from the unwinding of the debt bubble. The ensuing sell-off, he says, will knock the S&P 500, now trading at 1262, all the way down to 500. That equates to a drop of 60% from current levels.

But most forecasts are not as bearish. Citigroup's Levkovich says the market is on the final "V" of its "W" recovery pattern, suggesting that the current decline will eventually morph into a nice recovery.

Don't give up on the second-half rally just yet, says Phil Orlando, chief equity market strategist at Federated Investors. He expects frothy oil prices to pull back and predicts Fed rate cuts and tax rebate checks to stimulate the economy enough to jolt stocks out of their bearish phase.

"The second half will be better than the first half," he says. "The lion's share of the pain is behind us."

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