Since peaking at an all-time high in October at 89.53, the CBOE Volatility Index or VIX has plunged 56% as stocks seemingly attempt to form a bottom off the November 20 lows. The S&P 500 Index has now risen a cumulative 16.8% since November 20th while the Dow is up 10.5%.

Is this the beginning of a new bull market or an extended rally after more than 18 months of total carnage and nonstop selling?

Though investors have indeed stopped dumping equities since late November, the buyers are largely absent in a market that offers poor earnings, declining domestic consumption and soaring unemployment. There’s still no compelling reason to buy stocks even if many issues are indeed considered cheap; valuations alone don’t mark a bear market bottom.

Historically, the relationship between domestic consumption or the consumer and corporate earnings in the United States is a highly correlated phenomenon. It’s a relationship worth watching closely because without a strong consumer it’s hard to make a case for stocks.

When the consumer is spending – responsible for about 70% of GDP – earnings thrive. This was the case in the post-1982 bull market where consumers leveraged their balance sheets by purchasing homes, cars and all sorts of domestic and, especially, imported goods. Credit thrived from roughly the mid-1980s until 2007. Now that binge is over.

Consumer sentiment is currently at a 35-year low with household balance sheets purged by a plunge in housing values, stocks and most bonds since late 2007. Hedge funds, mutual funds and ETFs have all been bashed over the last 18 months. It’s no wonder the U.S. savings rate, near zero just 12 months ago is now at 3% and likely to head much higher as consumers rebuild cash balances and become thrifty again.

A higher savings rate is therefore bearish for stocks and corporate earnings. I still think we’ll witness a spectacular rally over the next 24-36 months under Obama. This scenario fits the bill with FDR’s first New Deal back in 1933, which resulted in a tremendous rally for the Dow – up more than 350% from mid-1932 until 1937.

Stocks will probably muster more of these so-called bear market rallies and eventually these gains should culminate into a powerful calendar year gain for equities, maybe in 2010.

But in my book, the damage done to consumer confidence is so entrenched that it’s hard to envision a major long-lasting bounce off these levels. I don’t think 2009 will be a good year for stocks because we won’t see any improvement in earnings until at least mid-2010; also, the spending bill still being debated in Congress will take months to filter through the real economy not to mention what Treasury plans to do with the largest banks, which are insolvent.

Many smart investors, including mutual fund and hedge fund managers, turned net long in November because they believed stocks were historically cheap and pointed to previous crises as great buying opportunities. That might indeed be true; but like most investors, including professionals, they’ve badly underestimated what a credit-inflected bear market means to domestic consumption. This marks the first deflation in asset values in more than 75 years and historical models are almost useless.

Any stock market rally should be viewed as an opportunity to sell. We remain in a deep bear market and rallies like this one now will eventually fade once more. The big bottom has not arrived.

Finally, a correction from yesterday’s blog; The Canadian government plans to spend about C$60 billion dollars over the next 12 months as part of its 2009-2010 budget; I incorrectly stated that sum was C$165 billion dollars.