The Coming Week: Going Nowhere Fast

Having to deal with far-flung hackers breaking into his company's network and attempting to steal source code, Microsoft (MSFT Quote) CEO Steve Ballmer was probably a pretty frustrated fellow by the end of last week, not knowing whether he was dealing with a harmless situation or a full-bore disaster.

At least he can be happy about one thing -- his stock did move sharply higher.

After rebounding from a near-term bottom, the Nasdaq Composite Index and S&P 500 probably had the Microsoft tagline in mind: Were do you want to go today? Or rather: Where do you want to go this week? Despite the buying witnessed late in the week, the answer for October has been "nowhere."

Bear, Bull, Bull, Bear -- Let's Call the Whole Thing Off

There are a number of good reasons why the stock market isn't likely to drop sharply in the coming week -- but that doesn't mean it's going to rally sharply, either.

Equities have been a hard place to make money this month. With more than 80% of the S&P 500 done reporting earnings, the outlook, if anything, has grown more pessimistic.

There's some relief among market observers that the most speculative technology stocks were knocked down this week, reducing high valuations among those stocks. That's the fiber-optics, networking and software storage names. The selling was prompted by the market's mixed assessment of earnings from Nortel Networks (NT Quote). Nortel ended the week losing 38% of its value, Ciena (CIEN Quote) dropped 30% and Corning (GLW Quote) fell 28%.

And investors are happy October is coming to a close -- tax-loss selling by mutual funds, which involves getting rid of losing stocks, will end, removing one source of pressure on the market.

Observers tend to believe that the market has hit a near-term bottom, because the economy appears reasonably strong and the financial system doesn't seem to be at risk. But now that valuations have been harshly judged and the market is lower, it's hard to build a scenario in which stocks appreciate dramatically during the next month or so.

"Technology still looks pretty weak," says William Rhodes, chief investment strategist at Williams Capital. "It looks like it bounced off a deeply oversold condition. If that's what's supporting the rally, it means these stocks will drop back in relative price, and they may or may not pull the rest of the market with them."

Some investors are trying to wring a bullish case out of the technology drop; that extensive weakness in stocks would point to economic weakness, which would prompt the Federal Reserve to step in and lower interest rates. But the market isn't collapsing. The Wilshire 5000 Total Market Index is still just 14% off its all-time high, indicating modest slowing in the economy.

"If the Wilshire is telling you the truth, we're having a little bear market here, nothing bad," Rhodes said.

That means technology stocks, especially the most speculative New Technology issues, as well as areas like semiconductors, were still overvalued up to Labor Day.

Now What? Eat Worms?

Now that the stocks have come back to this equilibrium, investors are having a hard time envisioning them running back to earlier levels. Brian Gilmartin, portfolio manager at Trinity Asset Management, calls it constructive that investors were buying Microsoft and Intel (INTC Quote) Thursday and Friday in the face of weakness in other Nasdaq stocks.

Value-oriented investors have become more optimistic in the last week, so Gilmartin feels big-cap tech stocks were hammered down to a point where they reached a good value. Still, that doesn't mean he knows what to buy.

"The thing is, there's nowhere to hide," says Gilmartin, a growth-oriented manager. "Utilities and energy stocks have already started to degrade; I'm buying Tyco (TYC Quote) and Fannie Mae (FNM Quote)."

Similarly, other groups don't look quite as attractive either, whether in or out of technology. Aerospace and defense stocks are in a similar situation as energy stocks; they've rallied strongly but aren't looking as attractive to managers. Chemicals and paper stocks, among the few sectors that are trading near their recent lows, are having a hard time with heavy international competition.

One reason for the pessimism grows from the economic figures. Third-quarter GDP grew at a rate of 2.7% -- slower than the anticipated 3.4% rate -- and a survey released Friday by the National Association of Business Economists warns of a sharp profit squeeze and a slower rate of capital spending. It may very well be that the Fed, in a number of months, does end up cutting rates and spurring additional investment.

But until then, a decline in business investment doesn't bode well for the market. The increasing defensiveness among businesses may engender a similar reaction among investors, who might look (gasp!) to food, tobacco and beverage stocks if this persists.

If this is a bear market, it hasn't shouted it out. But the bull market hasn't exactly reasserted itself either. The market's stuck in the middle -- frustrated.

Just like Ballmer.