updated 12/23/2008 6:24:46 PM ET 2008-12-23T23:24:46

After a year of devastating losses, the stock market has the makings of a recovery in 2009: Nearly $9 trillion in cash on the sidelines, waiting to be invested.

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But before investors can feel comfortable diving back in, they'll need to overcome the chilling effects of a recession and their distrust of how Wall Street operates.

"So many people have been so badly damaged," said Alfred E. Goldman, chief market strategist at Wachovia Securities, who has spent nearly 49 years monitoring the market.

Goldman said he's never seen despair worse than it was in late November. Indeed, that's a sign the market has hit bottom. And as mood improves, he said, some of December's record $8.9 trillion in money supply, as measured by the St. Louis Federal Reserve, could be funneled back into stocks, bonds and other investments.

Fear on the part of investors and consumers alike could make the process slow and choppy next year.

Gavin Rampersaud, who lives in New York with his wife, bought land in Florida in 2005 as an investment property, and it has fallen in value from about $80,000 to $20,000. And he still has his New York mortgage to pay.

"We've already cut back a lot. We don't go out as much," Rampersaud said. "Investing? We're tight as it is.

Decades from now, economic professors may well point to 2008 as the year capitalism went on life support. Home prices sank further than any mortgage lender could have imagined. Banks including Lehman Brothers Holdings Inc. and Washington Mutual Inc. failed, and many others received government funding or were bought up in desperate shotgun deals.

As investors recoiled and cashed out even their safe assets to build up reserves, the Dow Jones industrial average tumbled by as much as 47 percent from its October 2007 record. The stock market's drop between October 2007 and November 2008 wiped out more than $10 trillion in stockholder wealth.

In 2008, governments around the world have shoved trillions of dollars into the financial system, primarily by offering and guaranteeing various types of loans and investing in troubled companies. Signs are emerging that these rescue plans are beginning to stick.

But getting U.S. stocks moving higher again — let alone back to their 2007 levels — is going to be a long haul.

The credit crunch is forcing large investors from the super-rich to hedge funds to pension funds to governments to take on less risk. And after the news came out that investment adviser and former Nasdaq stock market chairman Bernard Madoff allegedly bilked clients out of $50 billion through a fraudulent fund, investors have even more reason to adhere to safer, tried-and-true strategies.

"Bernie Madoff has created a real issue for high net worth individuals, and it reaches around the world," said Robert Howell, a finance professor at Dartmouth College's Tuck School of Business. "We're not going to have people handing over millions and millions of dollars to hedge fund managers with no accountability."

And because there will be less money invested, it's likely there will be less market activity.

"I think the markets will have changed significantly," Howell said. "When you have reduced activity, you don't have as much pressure upward. It's frenzied buying that pushes the market upward."

Already, the assets of the large, unregulated hedge fund industry dropped this year by about a fifth to $1.55 trillion in November, according to Singapore-based hedge fund research firm Eurekahedge. About $125 billion of the losses were from redemptions, or when a hedge fund is forced to sell assets to meet clients' requests for their money back.

The deleveraging, or cashing out, process appears to be more than halfway done, said Eric Brandhorst, senior managing director at State Street Global Advisors, pointing to hedge funds' leverage ratios. However, as the Madoff scandal reminded us, more losses are always possible — particularly when one considers the complexity and lack of regulation in large swaths of the financial industry that poured money into exotic instruments little understood by most of the investing public.

"The losses are so opaque and so esoteric. They involve hedge funds, and they involve derivatives. We don't fully understand the extent of damage that's out there," said RBC Capital Markets fixed-income analyst T.J. Marta. Derivatives are financial contracts, such as options or swaps, that are based on the value of another asset. Swaps, for example, were the downfall of the world's largest insurer, American International Group Inc., which the U.S. government took over in September.

Another factor that could limit a stock market rebound is a weak consumer. Personal consumption — which dropped 3.8 percent during the third quarter, according to the Commerce Department — accounts for more than two-thirds of economic activity.

It would take a pretty horrific economic downturn to instill the same frugal mindset of those who grew up during the Great Depression. But it's a pretty safe bet that when it comes to consumer behavior, the coming years will be different from the era spanning the early '90s until now — when the Hummer, "bling" and $200 blue jeans entered our collective conscience, and consumer credit more than tripled to nearly $26 trillion.

Veronica Mathieson, said she's saving money these days by paying more attention to how much she's spending on gifts, and "brown-bagging it. The little things." She works in marketing in New York, "where you spend $12 on a salad if you don't bring it."

Cutbacks will be more drastic for the millions of Americans who have lost their jobs. U.S. unemployment is at 6.7 percent, the highest in 15 years, and some economists forecast a rise into the double-digits next year — a level not seen since the early 1980s.

Another reason companies should probably expect slower consumption growth is that there's less credit available. The nation's largest banks — from the weaker Citigroup Inc. to the stronger JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. — have learned a harsh lesson from their missteps in mortgage lending and gotten more conservative.

If Americans do end up spending significantly less in the coming years, corporate profits may not return to their pre-2008 strength. That means that many of those seemingly cheap stocks out there might actually be correctly valued.

Of course, the future always looks bleak when conditions are bad. The positives include the fact that stock volatility in December has been much lower than in November. The government's bailout efforts might weaken the U.S. dollar, but other major currencies probably won't be very strong, either. And in the history of capitalism, risk-taking has always bounced back.

Many market watchers are taking a Darwinian view, saying that when the crisis is all said and done, only the strongest companies will have survived, and the world will be better for it.

"Capitalism has to burn down once a lifetime," RBC's Marta said. "That's how it lives."

Main Street just might be a bit more shrewd when it comes to Wall Street in 2009.

"There has to be some distrust. But we're a lot smarter than we were 12 months ago," said Sam Boosak, who works at Benedetti Custom Shoes in Manhattan. "I'm not going to just stash my money under a mattress."

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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