Model Behaviorist's 5/31/2006 Journal-- Strategy Lab - MSN Money

Model Behaviorist's 5/31/2006 Journal-- Strategy Lab - MSN MoneyBut there are times when a lot of stuff can be going wrong in the world, and the market does not climb the wall of worry. Sometimes, investors do get into a dark mood and sell into bad news. And, they appear to get into that mood about once every four years -- or actually about every 52 months.

Starting in mid-May, I grew bearish about the prospects for stocks this summer and encouraged subscribers to likewise become much more cautious. Set stops to get you out of stocks at definitive breakdown points (under significant past support) and either replace them with “defensive” names or just go to cash, as I did in Strategy Lab.

Preparing for the worst
If you're like most investors, you have made a lot of money in the past four years. We all made a killing in housing stocks, small-caps, mid-caps, energy and metals. And we want it to go on forever. But there are cycles to all things, whether it's the seasons of the year, or sports or stocks. Learn the lesson of Scott McNealy's enthusiasm in October 2000. The cycle is really turning hard against stocks right now, and it's time to prepare for the worst.

To be totally blunt, I think there is real potential for a 10% to 25% decline over the next six months -- with the harsher end of the spectrum the more likely. As much as I wish that weren't the case, it seems unavoidable. What's worse, a lot of the stocks that smaller investors are the most heavily invested in -- the small-caps and mid-caps -- could get hurt even worse.

I'm not forecasting a "secular" bear market, where stocks might go down for years. So if you are tough as nails and want to just hang tight to your long-term holdings, go ahead. But for the rest of you, I'm just suggesting that the potential for a decline over the next six months now is greater than you may be willing to bear. And if the market firms up and doesn't go down, at the very worst, you will lose some opportunity -- not money.

There are a couple of issues that have driven me in this direction. The most important is the historical tendency of the market to suffer a serious bearish phase every 52 months, or roughly four years. They occur with great consistency. Just looking at the postwar period, we had bear markets in 1949, 1953, 1962, 1966, 1970, 1974, 1978, 1982, 1987, 1990, 1994, 1998 and 2002. This is sort of like one of those easy math tests that schools give fifth-graders. What is the next likely number in this series?

Should reach a bottom late in 2006
The last bear-market bottom occurred in October 2002. So, using history as a measuring stick, we would expect another bottom in August to December of this year.