You know stocks have been down hard the past few weeks, but you may not have realized it’s been an historic period.

Wednesday was a 90% downside day—one of those sessions in which 90% of the total volume is down and 90% of prices were down. During bull markets they are rare, but they emerge and become increasingly intense in bear markets.

The 90% downside day Wednesday was the nineteenth since the October 2007 market high, which is the most seen in any bear market in the past 75 years, according to statistician Paul Desmond at the institutional research firm Lowrys. I promised you that they would start to cluster up as the ball got rolling down hill, and that has certainly happened: Wednesday was the fourth 90% downside day in the past 20 trading days.

Since 1950, there have only been 17 prior occasions when the market has fallen intensively enough to produce four such 90% downside days in a 20-day span, says Desmond. And now you probably want to know what tends to happen next. Thirteen of them were followed by a major buy signal in the form of a 90% upside day within one week. That sounds good. However in two of the outliers, the fourth 90% downside day was quickly followed by another 90% downside day, leading to much lower prices and then another cluster of six 90% downside days. Ouch.

In one of the other outliers, which was in December 1973, a 90% upside day was produced 14 days after the last 90% downside day. That was too long to wait.

If the 90% upside day does not happen swiftly after the last 90% downside day, it tends to be a weak signal. In that case, the downtrend was definitely interrupted for a few months, but then the bear market continued in force, leading to a horrific plunge amid the Watergate hearings to a 1974 bear market low a year later.

Some Good News

So how about those 14 times the fourth 90% downside day was quickly followed by a 90% upside day? OK, I’ve finally got some good news for you: According to Desmond’s research, in each case, the 90% upside day started at minimum a tradable NYSE rally. Several of the cluster of 90% downside days followed by a 90% upside day did occur near the end of a bear market, but in other cases—such as on March 14 of this year—the ensuing rally was just a short interruption of an ongoing bear.

While it’s useful to look back in history at such data and anecdotes, there are definitely big differences between the market now and the market in the 1950s, ’60s and ’70s. For one thing, the abolishment of the old Uptick Rule—which permitted short selling only on upticks—has created many more 90% downside days than ever before, and also the historic level of deleveraging at hedge funds today may throw things off.

So the bottom line is that after a cluster of very intense declines, we are on high alert for a 90% upside day that would signal the start of a multi-week rally at minimum potentially on par with what we saw from mid-March to mid-May this year, or from mid-July to mid-August. If that happens, we could make a lot of money in a short period of time, while assessing the strength and breadth of the move in a way that will help us know when it is likely to end.

Short Sellers the Problem?

There’s been a lot of discussion lately about whether aggressive short-sellers are at fault for the intensity of the recent decline. John Mack, head of Morgan Stanley, says there is "no rational basis for the movements" in his stock. He told Treasury Secretary Henry Paulson and his own employees that his company’s shares have fallen 45% in the past week because we are "in the midst of a market controlled by fear and rumors, and short-sellers are driving our stock down.

Well, I don’t know about that. Blaming short-sellers for the decline in your stock is the financial equivalent of blaming the sun for a poor backswing in golf. I mean, it might make things uncomfortable for you, but it’s not the main problem.

To be sure, there are short-sellers attacking stocks for profit, don’t get me wrong. But it’s not illegal or even unethical. It’s a natural part of the market’s ebb and flow, and a way for people to take advantage of what they consider to be superior knowledge about the likelihood of a decline. It’s just as easy for short-sellers to be wrong as it is for them to be right. And the hypocrisy is rich, considering that Mack’s own hedge funds undoubtedly engage in heavy short-selling themselves.

The Real Problem: Shrinking Business

No, the real problem is two-fold in my opinion. The big New York investment banks depend on the confidence of their prime brokerage clients, and that confidence is evaporating.

You see, the big hedge funds and pension funds put their money at broker/dealers like Morgan Stanley (MS) and Goldman Sachs (GS) because they get low commission costs, cheap credit and good execution on their trades. In return, MS and GS earn their cash flow from those commissions and interest on their margin loans.

But where does MS and GS get the money to provide those loans? They get it largely by selling commercial paper, which is short-term paper that is bought mostly by money-market funds.

So here is where it gets scary. You may have heard that one of the oldest and largest money-maket funds in the country, Reserve Primary, "broke the buck" on Monday when they were forced to write down $750 million in Lehman Brothers (LEH) bonds. Reserve Primary’s NAV went from its usual $1.00 to 97 cents, and customers fled. Before Reserve put a seven-day hold on redemptions, they lost half their $60 billion, and you can bet a lot more will leave when the seven days are up.

Now companies and regular people are freaked out about money market funds losing money, so they are switching their funds out of them to short-term Treasuries. They might not provide as much yield, but at least they won’t lose anything. (See also: "Captial Destruction Paves Way for Further Losses.")

Commercial Paper Ripped

This is a terrifying scenario: If people en masse pull out of money market funds, the commercial paper market shuts down—and there goes the main short-term financing vehicle for thousands of medium-sized and large companies. If you want to talk about a potential Depression-type scenario, just shut off the CP market and see what happens.

Fearing that MS has lost its access to credit, and not wanting to have another Lehman on their hands, I’m hearing—but haven’t confirmed—that major hedge funds pulled 10% of their prime brokerage accounts out of Morgan earlier this week, and another 15% today. The brokers are said to be threatening that they will never take clients back if they leave, and they’ll be sorry. It’s hardball time on the Street.

So that is probably the main reason these brokers are getting pummeled. Forget about the great earnings MS just announced. Hedge fund and pension fund managers know that MS’ cash flow may be severely constricted now, and for the sake of their own fiduciary duties they feel they need to move their money to a safer spot.

Morgan is said to be engaged in talks with Wachovia (WB) tonight, and potentially other banks around the world as well. The reason that the brokers are running into the arms of banks is that unlike broker/dealers they get "real" money from depositors which they can then lend to their hedge-fund clients, and thus are not so reliant on commercial paper and other external financing vehicles.

So it’s clear now, after Lehman, that the government won’t bail out broker/dealers, but they are still expected to back up "trophy" banks which epitomize national pride. In the United States, that would include, among a few others, Citibank (C) and Bank of America (BAC), but not Washington Mutual (WM) or National City (NCC). In Great Britain that would include Barclays; up north, the Royal Bank of Canada; in Spain, it would be Santander (SPB), and in Germany, certainly Deutsche Bank (DB).

Where Have the Deals Gone?

One sure sign of a weak market is the lack of initial public offerings. For five straight weeks now, there have been no IPOs brought to market in the United States.

Registration statements for IPOs have been filed at a regular pace, though, so we can see that there are currently 140 in the pipeline that have an estimated value of $30.2 billion. Energy, power, materials and financials make up the bulk of coming IPOs. The leader in underwriting for these deals is JP Morgan, with 31 companies awaiting an IPO, followed by Credit Suisse (CS) with 28 and Goldman Sachs (GS), with 22.

Merger activity has picked up a bit, totaling $14.5 billion last week, but overall 2008 mergers have totaled just $844 billion, which is a 34% drop from last year at this time. The big deal this month, of course, was the Altria (MO) bid for our US Tobacco (UST), at $11.6 billion. That was the biggest deal wince July 21st, which Roche Holdings bought Genentech (DNA).

Corporate stock repurchases, which were a big support for the market in 2006 and 2007, have also plunged this year. In the past week, 12 new repurchase programs were announced, totaling $4.9 billion. Yet despite the lower prices in the market, buybacks are down 40% this year compared to last year. That’s not encouraging.

Retail Improving

One small bright spot: As crude oil and gasoline prices have fallen in the past month, retail sales have improved dramatically. The ThomsonReuters Same Store Sales Index for September so far is posting a 1.7% advance in September this year over last year, which is actually better than the 1.4% comp of 2007.
Wal-Mart is a big reason, as it is estimating growth of 2% to 3% in the month. Other big discounters are also looking great this month, led by BJ Wholesale (BJS), with a 9% growth estimate, and Costco (COST) with a 7% estimate.

However full-price department stores are lagging, as Sakes is expected to be down 1%, while Nordstrom (JWN) and Kohl’s (KSS) are expected to be down 5% and 3%. Most specialty apparel stores like Abercrombie and Fitch (ANF) are likewise estimated to see sales shrink by as much as 6%, though one positive standout is Aeropostale (ARO), which is on track for 2% growth, according to ThomsonReuters estimates. That’s presumably why ANF is down 39% from its 2007 high, while ARO is close to a new high.

Our own Dress Barn (DBRN) has been one of the strongest retailers this quarter, and has seen shares rise to a one-year high at $17.05. Shares are up 41% this year, though they’re still down 30% from their 2007 high. Other specialty retailers rising to the top of my StrataGem models are Aeropostale, Urban Outfitters (URBN) and Buckle (BKE), so I wouldn’t be surprised to see more of these kinds of companies show up as strong buys in October.

This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.