Bounce Beckons but Long-Term Challenges Remain

Two weeks ago, the S&P 500 and Dow Jones Industrial Average had reached the top of their trading ranges and I surmised that, at the very least, a retracement of the Aug. 13 to Sept. 15 rally was likely. Furthermore, I suggested any break of S&P 1123 would project a pullback toward 1100-1105.

These levels have been reached -- the S&P traded as low as 1101.29 Tuesday morning -- and the markets have become slightly oversold, at least on a short-term basis. That suggests to me that a small, relatively insignificant, bounce is due. After that, we should resume moving downward toward an intermediate-term low sometime in October.

As that progression unfolds, investors may wish to ponder this philosophical query: What is the meaning of the lower highs and lower lows of 2004? Are we in a bear market? Or, as some have argued, are we merely digesting outsized gains from 2003?

With the third quarter ending Thursday, and the indices flat to down for the year, one can hardly claim this is a powerful bull market. Yet the range-bound environment hardly proves the bear's case.

My conclusion? We are working our way through a post-bubble, post-stimulus economy. We continue to suffer the hangover from the bubble's aftermath: The Nasdaq Composite remains more than 60% off from its all-time high. Capacity utilization is lingering in the 75% area, thanks to all the overbuilding and over-investment from the 1990s. End-user demand remains anemic, and manufacturers find themselves unable to pass along price increases, despite the rising prices of many commodities.

All this suggests that economic growth will remain modest -- in the 2.75% to 3.5% range. Inflation will be found primarily in commodities, as opposed to the typical economic expansion where wage pressures predominate the inflation chatter. Job growth will continue to be mostly mediocre. Investors should expect sub-par returns from the indices as they revert to their historical mean.

---

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].