Q&A: Paul Desmond of Lowry's, Part II

Even on a plus-140 point day, you still see, based on the trends of the majority of the Dow, that they are not really looking particularly healthy?

No, they are not looking healthy at all.

Now, I know you don't do forecasting or make predictions. You think that sort of stuff is folly. But the question that I know people are going to ask me is, 'Well if Paul Desmond thinks we are in the process of topping, how much further is this going to go?' How much more time do we have to start culling individual names? Can this process take another year, or are we looking for significant trouble sometime in 2006?

Our expectation is for a sharp decline throughout most of 2006 that may well reach its low sometime around September of October.

The traditional months for those sorts of things.

Yes, those are just the most common months historically, more bottoms occur in the September-October period than at any other time.

I have Jeff Hirsch's Stock Trader's Almanac right on my desk, and they've looked at that data on a calendar basis, nine ways from Sunday, and most people think it is October. September seems to be pretty bad also. So, in terms of positioning, you would continue to stay with mid-caps until they show signs of rolling over.

Well, I think it is entirely possible that we are seeing the start of the rolling-over period now. In other words, this rally that's beginning here in the last two days, will be an important test of strength of this bull market. If the majority of mid-cap stocks do not get back to their highs along with the market averages, then that would be a sign that the mid-caps have started to rollover, and I would be anxious to cut back on my holdings of mid-caps at that point.

So is it safe to say, to go back to your ... New England metaphor: The leaves have already changed colors, we are starting to see leaves drop and it is a matter of time before they all hit the ground. Is that a fair way to describe where you are?

Yes, the important things for investors to realize is that market declines start out with complacency as being the most dominant emotion at that time. And the means that most people are half asleep, and they are just not paying attention. They don't think the markets can go down, so they don't think there is any need be watchful, but that is exactly when an investor needs to be particularly alert. The last stages of a decline, the very last couple of months of a market decline are the most intense, because that is when the panic sets in, and that is when it is absolutely essential that you are already out of the market. You surely don't want to go through that final stage.

So, I am trying to pin you down a little more as to where you think we are in this process. It is apparent that you are concerned and you are cautious and that you think the technicals and the market internals are implying that -- I don't want to say that we are in the ninth inning -- but is it safe to say that we are late in the cyclical bull market within a broader secular bear market, or do you not make that distinction?

I don't make that distinction. I think that those terms tend to block an investor from really clearly seeing what is going on.

I prefer to just concentrate on the idea that about every four years on average we have a setback in the market that typically last for anywhere from nine to 11 months, and prices typically drop in excess of 20% on average. I think that is the major thing to concentrate on. Investors simply have to go back through history and realize there is a very consistent pattern of market bottoms about every four years. You can go back and see, for example, there was a major bottom in '49, '53, '57, '62, '66, '70, '74, '78, '82, '87...