This Is an Efficient Market?

A key element of human nature, and financial journalism, is the desire to make sense of what belies easy explanation. For example, today's modest rally seemed rational given the growing sense stocks had become oversold after recent declines.

But underlying (or overlying) the market's recent machinations is a "paradigm shift" brought about by the disproving of, or, at least, discrediting of so-called efficient market theories, according to Woody Dorsey, president of Market Semiotics in Castleton, Vt.

The "dot-com" bubble, Long Term Capital Management's unraveling and, more recently, Enron's (ENRNQ) bankruptcy, all suggest the market is not efficient, but constantly facing irrationality, Dorsey explained. Irrationality "doesn't always get extreme but is part of the way the market operates. It's happening right this minute."

Right this minute, the market is still operating under the consensus opinion that a new bull market began in late September, recent weakness notwithstanding. But Dorsey believes otherwise, predicting the post-September rally is over and that the market will be "quite negative" for the next four months.

Enron has become emblematic of "bull market accounting," he said, and its downfall has investors fretting that other firms' profitability may prove similarly ethereal. Such concerns have weighed on shares of Tyco (TYC), IBM (IBM), GE (GE) and Coca-Cola (KO), among others, as The Wall Street Journal detailed. (Each fell today even as the Dow rose 0.2%, the S&P 500 gained 0.8% and the Nasdaq Composite rose 2.1%.)

Short term, Dorsey agrees the market is oversold with the potential for a "sharp recovery pop" into month's end. "But there is no reason to force a long-side bias," he commented yesterday. "The question remains how best to sell into pops and/or, to actualize a structural short bias."

Without providing downside targets, Dorsey suggested the September lows won't necessarily hold in the coming downturn he foresees. For the record, on Sept. 28 Dorsey predicted the market had "bottomed temporarily" and would enjoy a multi-month rally thereafter.

GuruVision: Another Party Heard From

One of the "other gurus" recommended by readers, Dorsey debuts in GuruVision today. As always, GuruVision strives to provide an outlet for alternative voices, but does not claim to be a substitute for firsthand access to any pundit's offerings.

Dorsey certainly fits the "alternative" category and readily admits "looking at the market in a different way than most people do."

Specifically, Market Semiotics is an "interpretive reading of how the market operates according to a set of behavioral market principles," he explained.

But unlike Elliott Wave theory, which deals primarily with long-term price patterns based on repetitive crowd actions, Market Semiotics does not deal in absolutes.

"I don't talk about price, what I talk about is psychology, confidence and the timing of the market," he said, echoing elements of George Soros' Theory of Reflexivity.

Instead of relying on commonly cited sentiment indicators such as the Chicago Board Options Exchange Volatility Index, put/call ratios, Arms Index, and Investor Intelligence survey, Market Semiotics uses a proprietary sentiment indicator. There's nothing magical about the system, which is compiled daily by polling of small cash and futures markets traders, Dorsey conceded. But the ability to correctly interpret the data is key. "You can go out and buy the best golf clubs, but that doesn't mean you can hit the ball off the tee," he said. "It's only a tool."

Edgar Peters, chief investment officer at PanAgora Asset Management in Boston, which manages more than $12 billion, has a similar approach. Like Dorsey, he focuses on behavioral issues, doesn't believe the market is efficient and generally eschews commonly cited sentiment indicators.

Peters also believes investors should be defensive, but has a less draconian view than Dorsey.

After becoming "very bullish" in the wake of Sept. 11 -- because of a view investors had overemphasized the negative economic implications of the attacks -- PanAgora became more bearish in late December as investor optimism grew, Peters recalled. "At this stage, things are starting to cycle back in the other direction," as accounting and asbestos concerns, as well as valuations weigh on stock prices and investor sentiment.

But it's too early to make a contrarian bet, he said, as sentiment is merely "in transition" from positive to negative. "You can be wrong for long periods of time" betting against the herd, "but there will be a point where people will be overly pessimistic again," Peters continued. "We might be getting close" to that juncture.

Notably, Sam Ginzburg, senior managing director of equity trading at Gruntal, expressed a similar view today.

With any kind of relief on the asbestos front, companies such as Dow Chemical (DOW) and Halliburton (HAL) are "going to the moon," he forecast. Similarly, Coca-Cola and GE "will be phenomenal buys" if and when accounting concerns fade.

Resolution of such "ancillary things," combined with some good news on the economy (maybe from Easy Al tomorrow?) and the end of earnings season and "I think you see a rally," the trader said. "When the turn comes, your head will spin at how fast things run."

That said, Ginzburg conceded it's best to hedge bets with puts because "a ton of land mines" remain. Similarly, Peters forecast 2002 is "not going to be a high return year" and is expecting only high single-digit returns from stocks.

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