Where are we now? It’s a question we’ve been grappling with here at Notes since the bizarre events of March 9, when equities took off on a wild run. They haven’t stopped since.

The bull run/bear market rally has had three major phases. This from our favorite underground analyst, David Rosenberg:

1. March 9 to May 6 when financials led the way

2. May 6 to July 10 when it was all about defensive growth and strong balance sheets (tech and health care leading the way)

3. Since July 10 it’s all been about basic materials and consumer discretionary stocks.

Whatever way you look at it, however, it’s clear that we underestimated the level of euphoria backing this rally.

The recent run-up in stocks has been closely linked with the “green shoots” hypothesis, as we pointed out in yesterday’s Notes. We’re deeply suspicious of this hypothesis, however.

First, the data points don’t support a V-shaped recovery, something the green shoots hypothesis implies. Tyler Durden and David Rosenberg made this point loud and clear in their joint recent white paper on the recession. (You can read it here).

Second, we believe that the scrutinizing over numbers is a red herring. We know that the economy is getting worse. Whether or not the pace of the plunge is slowing or not is unimportant. Those who focus on this “second derivative” recovery miss the big picture analysis: the US economy in the most perilous position it’s been in since the Civil War.

Yesterday, Strategic Investment editor James Dale Davidson made this point loud and clear to the underground. Despite the $23.7 trillion TARP overseer Neil Barofsky reckons the feds have promised to backstop the economy, James is convinced that we remain in a secular bear market. And he reckons the S&P500 will retrace its March 9 lows before the recession/depression ends.

This is a Depression, a credit cycle gone bad that still has many chapters to    unfold.

If I am right, you can expect the stock market to work its way, after many adventures, to valuations lower than the March lows. Secular bear markets seldom, if ever, bottom at 13 times earnings, where the S&P 500 stood on March 9. That is approximately twice as rich as the multiples you can expect to see at the ultimate bottom if history is any guide.

Two further points.

Over the past century, the stock market has yielded an average dividend yield of 4.4%. Today, the S&P 500 yields just 2%. This implies well below average returns from here on in.

Another fact you should consider in plumbing the bottom is that financial sector profits, illusory though they may have been, accounted for as much as 75% of all corporate profits in the US in the early years of this decade. These financial sector profits were exaggerated by the explosion of leverage in the corporate sector at that time.

As deleveraging is now the rule of the day, a return to highly leveraged earnings in the financial sector is unlikely. It is far more likely that stock valuations will “revert to the mean.”

And this means a much longer bear market than anyone on CNBC imagines.

3. Since July 10 it’s all been about basic materials and consumer discretionary stocks.

3. Since July 10 it’s all been about basic materials and consumer discretionary stocks.

1. March 9 to May 6 when financials led the way

2. May 6 to July 10 when it was all about defensive growth and strong balance sheets (tech and health care leading the way)