2005 DOESN'T LOOK LIKE A GOOD YEAR

2005 ANNUAL FORECAST MEETING... I'm heading into New York this afternoon to be a panelist for the 2005 Annual Forecast Meeting which is held each year by the Market Technicians Association. Some of the topics discussed will be: Where do we stand in the presidential cycle? Will 2005 be another bull year? Is there a secular bear market in force? Which sectors look most attractive? Although I've written my views on some of those subjects before, I thought this would be a good time to review some of them.

WHAT ABOUT THE PRESIDENTIAL CYCLE... The presidential cycle is broken down into four years. Usually, the worst of the four is the post-election year. That's this year. The first two years are weaker than the second two. The reason for that is because the government often takes harsh measures to get its economic house in order at the start of a new term. This year that could be in the form of a more aggressive tightening by the Fed -- or a willingness to let the dollar continue to depreciate. Whatever form it takes, the presidential cycle works against the market this year and next. The market has a strong history of bottoming every four years -- 1990, 1994, 1998, 2002, etc. Those bottoms occur midway through the presidential cycle. The next major bottom is due in the autumn of 2006. The period between now and then may not be that good.

Chart 1

WILL 2005 BE ANOTHER BULL YEAR? ... I doubt it. I believe that the "cyclical" bull market that started in October 2002 is peaking. I can't rule out another retest of the old high (especially by the blue chip averages), but, in my opinion, that would be part of a topping process. After that, I think there's more risk than reward. The weekly bars shown below put the trend into better perspective for the S&P 500. I believe that the upleg that started last August is the last one in the cyclical bull market. I can't say for sure that it's over. But if it isn't, it's very close. When it is, the downside expectation would be a drop back down to the lows of last summer (1060). That would represent a 38% retracement of the entire cyclical bull market. From its December peak, that would be a 13% decline in the S&P. The downside target for the Nasdaq Composite (shown in Chart 3) is 1750, which would be a decline of 20% from its recent high. That would also be a 38% retracement of its cyclical bull market.

Chart 2

Chart 3

WHAT ABOUT THE SECULAR BEAR MARKET?... In case you're not sure what that means, take a look at Chart 4. It shows a logarithmic chart of the S&P 500 since 1974. Notice in particular the rising trendline that started in 1982. That defined the secular bull market that lasted for nearly two decades. That long-term support line, however, has been broken. At the very least, that means that the secular bull market is over. At its current level, the S&P is 300 points (20%) beneath its year 2000 peak. If it starts to roll over in the first half of this year, that be the first example of "lower highs" in twenty years (see red circles). The worst case scenario is another plunge beneath its 2002 lows. A more moderate scenario (which I lean toward) is a flatter trend between its 2000 highs and its 2002 lows. That latter scenario calls for alternating bull and bear cyclical markets through the balance of the decade. That means that the buy and hold style of investing that worked so well during the 1980's and 1990's probably won't work as well in this decade. One of the arguments against a full blown secular bear market at this time is the fact that the current cyclical bull market has taken place in five waves. In Elliott Waves, that calls for a serious retracement of the bull market, but not a move to new lows.

Chart 4

SECTOR PLAYS ... My favorite sector play for this year is energy stocks -- and oil service stocks in particular. Stocks tied to commodities should continue to do well, especially when the dollar starts to weaken again. I also favor defensive groups like consumer staples and healthcare. I believe that large-cap stocks should do better than small caps. I also favor large cap value over growth. Dividend-paying stocks should do relatively well. And, as I suggested earlier this month, rising short-term rates will make money market funds an increasingly attractive alternative to stocks.