Don't trust this market rally

By Jim Jubak

We're still in a bear market.

How, you ask, can that be when the stock market has rallied so strongly from its March 10 closing low? As of the April 23 close, the Standard & Poor's 500 Index ($INX) was up 8% from its 1,273 close of March 10. Hey, stocks even climbed above the Jan. 22 low of 1,311 in this rally.

Because, as reassuring as this rally may have been, and as profitable as it was for investors who were on board, it hasn't been strong enough to reverse the downward momentum that's been in charge since the S&P 500 topped out at 1,563 on Oct. 9.

This rally has failed to break through resistance at 1,400 on the S&P 500 several times this year: on Feb. 1, Feb. 26, April 7 and April 18. The same thing happened Thursday, April 24, as the S&P hit 1,397 at 3:05 p.m. ET, then pulled back to close at 1,389.

That's not what happens in a trend reversal from a bear-market decline to a bull-market upswing. Until we see a move strong enough to take the market decisively above that level on the S&P 500 -- and through comparable levels on the other major indexes -- all we have is a rally in a longer bear-market trend.

Signs the market will decline

For a good part of the past three months, stocks have been stuck in a trading range, with rallies failing at 1,400 on the S&P 500 and declines bouncing off 1,275 or so. A trading range like this either turns into a real rally that reverses a bear market or into another leg down in a continuing market decline.

Odds are good that this trading range will turn into another drop in the market because:

• Even in good years, the period from May through October is the weakest part of the year.

• The economy is showing signs that it will be weaker for longer than Wall Street had expected back in January.

A history of seasonal weakness for the period that begins in May isn't a guarantee that stocks will slump in 2008, but it's not good news either, because the seasonal ebb and flow of the stock market is a result of real cash flows. The superior performance in January through April is probably a result of money that flowed into investment accounts in December to beat year-end deadlines and in April to beat tax deadlines for individual retirement accounts and the like.

• Talk back: Do you trust this market rally?

Since 1950, according to the Stock Trader's Almanac, January has shown an average 1.4% gain, March an average 1% gain and April an average 1.3% gain. (February is, on average, a down month, but by just 0.02% annually.)

Why this year is different

The returns for May and June are much less positive, with stocks showing just a 0.2% average annual gain. August and September actually show a small average annual decline. (July, the home of the summer rally, has a 0.9% average annual gain.)

The most likely explanation of this pattern is the decline in cash positions that follows the April 15 tax deadline and a general drop-off in trading activity as Wall Street goes on vacation.

This year, though, the direction of the economy, rather than the seasonal background, will decide how the February-through-April trading range gets resolved.

Right now, economists and Wall Street are counting on a relatively shallow and short-lived slowdown. According to the most recent Wall Street Journal survey of 55 economists, growth in the first quarter of 2008 will show a slowdown to 0.2% -- just barely positive -- from the already weak 0.6% recorded in the fourth quarter.

The economy is expected to grow by an even weaker 0.1% in the second quarter, then rebound with 2.1% growth in the third quarter.

The view from Wall Street

That's pretty much what Wall Street expects, too. Right now the bottom-up estimate for reported earnings on the stocks in the S&P 500 shows a 28% drop in the first quarter and a 27% drop in the second quarter. That's followed, however, by a 14% gain in reported earnings in the third quarter and a 93% gain in the fourth quarter.

I don't think there's any doubt that economists and Wall Street will get the weak growth in the economy and in earnings that they're counting on for the first two quarters of 2008. Lousy results that are as lousy as expected won't move the market out of its trading range.

So the big question for the economy and for the stock market is this: Will the market get the quick recovery it's counting on for the second half of 2008? If not, I'd expect to see the current trading range turn into another leg down in the bear market. That down leg would set in, then gain momentum as more and more investors came to believe the economy would stay slow longer than they had expected earlier.

Continued: What could wreck expectations

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