Get ready for a bouncy stock market

By Jim Jubak

What will it be for the second half of 2007? Will economic growth come in stronger than expected and push stock prices to new highs? Or will bond market turmoil send interest rates higher, taking a bite out of stock prices?

Over the next six months, I think better-than-expected economic growth will outweigh slowly climbing interest rates and that stocks will finish slightly above current levels.

But buckle your seat belts: Rising volatility will make that modest gain a very bumpy ride. If you're going to stay in stocks for the remainder of 2007, you'd better be prepared for a roller coaster's worth of thrills and chills.

Investors who don't know what's coming could wind up whipsawed by emotion into buying high and selling low -- repeatedly. That's a sure recipe for losing money even as stocks in general climb higher.

What we've seen, what's likely

Here's what I expect and how to cope with it.

In my June 22 column, "Why stocks are safer than bonds now," I projected a 12% to 15% return on the major indexes for all of 2007. I don't see any reason to change that prediction. The indexes haven't moved appreciably since then, so as of July 5 that would mean a 3% to 6% climb in the Dow Jones Industrial Average ($INDU) for the remainder of 2007, a 2% to 5% increase in the Nasdaq Composite Index ($COMPX) and a 4% to 7% rise in the Standard & Poor's 500 Index ($INX). Not great but better than a poke in the eye with a sharp stick, as I wrote then.

In recent weeks, volatility has picked up. In June, the Dow Jones industrials moved up or down by more than 100 points on seven of the month's 21 trading days. That's a remarkable 33% -- and up from the four 100-point up or down days in April and the four in May.

You can see how this would whipsaw investors if you look at a chart of the S&P 500 Index and a popular method for generating buy and sell signals using the Moving Average Convergence/Divergence (MACD) tool invented by Gerald Appel, one of the deans of technical analysis.

You can set this up for yourself on MSN Money's charting tool. Pull up a historical price chart for the S&P 500 for the past three months. Under "Analysis" in the chart's tool bar, go down the menu and click on MACD. That will pull up a MACD chart in the bottom pane of the page. In the same Analysis menu, click on "Settings" and set the periods for the MACD tool at the commonly used 12, 26 and 9 settings. Now, according to this system, every time the black line crosses the red line on the MACD chart, you've got a buy or sell signal: Buy when the black line crosses over the red and sell when the black line crosses under the red.

You'll see that this technical indicator produced a buy signal on June 1, a sell signal on June 5, a buy signal on June 18, a sell signal on June 19 and a buy signal on July 3.

Whew. That's some volatile market. Volatility is likely to get worse, too, over the next few months too.

How to beat the jitters

The worries about the bond market and the meltdown in the subprime-mortgage market that have driven bond and stock volatility for the past few months certainly aren't over. Everyone on Wall Street is on tenterhooks because no one really knows whose portfolio of mortgage and loan-backed assets is going to blow up next. That nervousness exaggerates every reaction to every rumor. And it turns relatively predictable events -- such as the next, clearly telegraphed interest-rate increase from the European Central Bank -- into an excuse for overreaction.

The volatility generated by these bond market jitters will, unfortunately, play out during some of the most volatile months of the year for stocks -- if history is any guide. July is one of the stock market's better months because the start of the third quarter brings a big increase in retirement money into the market. For the S&P 500, for, instance, July is tied for the sixth-best month on average -- up 0.9% -- from 1950 to 2006, according to the Stock Trader's Almanac.

But all three indexes, on average, follow a positive July with a weak or even miserable August and September. From 1950 through 2006, the Dow industrials have been down an average 0.1% in August and 1% in September, and the S&P 500 down 0.001% in August and 0.7% in September. From 1971 through 2006, the Nasdaq Composite has been down an average of 0.2% in August and 1.5% in September. August and September are the only two months of the year that are down on average for all three indexes.

Continued: Use the volatility

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