Investors Get Second Chance at Bull Market

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NEW YORK ( TheStreet) -- Bulls and bears can defend their turf every day, but when it comes to the stock market, key signs are pointing up.

U.S. companies of various sizes from different industries are beating analysts' second-quarter forecasts, banking and lending have come back to life, and consumer and housing reports are less dour.

Since the end of March, the benchmark S&P 500 Index has gained about 23% and is close to crossing 1,000 for the first time since November. While the barrier has more to do with emotion than anything else, it suggests investors are slowly becoming more optimistic. As hundreds of thousands of jobs are still being lost each month, hard times are far from over, but investors unwilling to part with their money are missing an optimal time to buy on the cheap.

General Electric ( GE), IBM ( IBM) and Caterpillar ( CAT) have soundly exceeded estimates. There have been surprisingly good results nearly every day, save for a few ( Microsoft ( MSFT) and Ashland ( ASH)). The backbone of the economy may indeed be in better shape than previously thought.

Even ground zero for the economic meltdown has shown signs of a pulse. Financial firms Goldman Sachs ( GS), Wells Fargo ( WFC) and JPMorgan Chase ( JPM) surpassed forecasts by 40% or more, while the walking dead, Citigroup ( C) and Bank of America ( BAC), also surprised on the upside.

During this run of good fortune for the economy, a key gauge known as the volatility index, or VIX, has been steadily improving. The VIX measures the amount that options investors expect the S&P 500 to change over the next 30 days, quoted as percentage points.

In the following graph of the S&P 500 against the inverted VIX, it's clear that the implied volatility in the stock market has decreased greatly this year. Volatility is still higher than the 10-year average, but it's less than a third of what it was during the panic in 2008.

S&P 500 vs. VIX
Source: Yahoo Finance

As volatility falls, so do the opportunity for huge gains. Those trying to time the bottom of the market probably missed the boat in the first quarter. Investors who pulled money for fear of a total market collapse should think about jumping back in. While some choppiness may remain for several months, most major gauges suggest a much stronger confidence could mean the often-discussed "testing of the bottom" may not be in the cards.

In addition to the improvement in the VIX, the State Street Investors Confidence Index, or SSICI, also shows a vast improvement in recent months. The SSICI is based on the asset holdings of some of the world's most sophisticated investors. As those investors' risk appetites increase, measured by the composition of their portfolios and the weighting of risky assets, so does the SSICI. That signals bullishness. After the gauge hit an all-time low after Lehman Brothers' collapse, it's been steadily gaining and is now at the highest level since August 2007, four months before the U.S. economy officially slipped into a recession.

Strength in these gauges means little if stocks are selling at a premium. But that's not the case. Over the past 25 years, the S&P 500 has traded at a price-to-earnings ratio of just over 23. It's now at 16.5, suggesting equities are undervalued in historical terms. Even when adjusting for the heady days of the late 1990s, the stock market is still inexpensive.

With the benefit of hindsight, investors should have jumped into equities with both feet in early March, when the S&P 500 briefly slipped into the 600s. While that sort of timing would probably have more to do with luck than skill, piling in now would probably be wise for investors seeking to gain back some of the losses sustained during the meltdown.

As volatility drops and confidence rises, investors can expect less nausea from stock investments. With relatively cheap prices still to be had, equities look like an attractive bet for the second half of this year. Investors had the opportunity of a lifetime in early March. Here's a rare second chance.

-- Reported by David MacDougall in Boston. Feedback can be sent to david.macdougall@thestreet.com.

Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level II CFA candidate.

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