The recent market volatility has resulted in one of the most difficult and challenging trading environments that I can remember. Despite all of the recent violent up and down price moves in the market, the Dow Jones Industrial Average is virtually unchanged over the past six months. 

The current market environment is similar to the one that occurred in the fall of 1998. There was a crisis in the financial sector that emerged in August of 1998 that centered around emerging market debt held by banks and financial institutions that could not be valued and had to be written off. In late 1998 corporate profits were down year over year and there was a lot of recession talk in the financial media. Market pundits were calling for a bear market in stocks with the S&P 500 trading at 25 times earnings and the yield on the T-Bill at 5%. But after the correction in the fall of 1998 the bull market continued in 1999 with the S&P 500 Index returning +19.5%.  

The current environment is very similar to the 1998 scenario with sub prime debt creating a crisis that emerged in August of 2007. This time around the stock market is cheaper with the S&P 500 Index trading at 15 times earnings and interest rates are lower with a 2.9% T-Bill yield. The process of appraising and writing down sub prime loans has begun. There is record short interest in the stock market and the put/call ratio is typical of the ratio seen at the bottom of bear markets. I think this will lead to a stock market rally in 2008 similar to the rally in 1999.  

Over the near term I think the S&P 500 Index will trade within its recent range between 1510 and 1400. A decisive rally above 1510 could be the beginning of a new leg of the current bull market. If the S&P 500 closes below 1400 it would signal a break of the bullish trend line that started at the end of the last bear market in 2003 and stocks would probably enter a deeper correction or bear market. I think the odds are good we will see the S&P 500 trade above 1510 which will indicate a breakout from the recent consolidation and a new bull market in 2008. Stay tuned.