Everybody is groping for answers about where the market is heading in the fourth quarter.

Enter the

Disparity Index

.

Q4: Boom or Bust?
Every day this week, TheStreet.com chats with
a top money manager to hear
his forecast for how this volatile year is going to end.
The lineup:

Monday: Kurt Schansinger,
manager of the Merrill Lynch Balanced Capital Fund

Tuesday: Paul Meeks,
skipper of Merrill Lynch Internet Strategies and Merrill Lynch Global Technology

Wednesday: John Maack,
director of equities at Crabbe Huson

Thursday: John Bollinger
of Bollinger Capital Management and EquityTrader.com

Friday: Kevin Landis
of Firsthand Funds

Weekend: Bob Turner
of Turner Funds

The index is the brainchild of

John Bollinger

and his team at

EquityTrader.com and

Bollinger Capital Management

.

When Justin Lahart huddled with Bollinger as part of

TheStreet.com's

weeklong series on what the pros see for the fourth quarter, he talked about the investor psychology in the wake of the swift, stunning bear market of 2000 and, of course, the index.

We'll leave the explanation of the Disparity Index to him, but what it tells him is that the market will favor stock pickers over momentum traders. Hint to stock pickers: Think health care and energy.

Lahart

: To begin with, how did we get here and where are we going?

Bollinger

: The how we got into this mess is pretty easy. We had an extraordinary speculative bubble in the

Nasdaq Composite Index

-- specifically in the technology stocks and more specifically in the Internet stocks that peaked out this spring. From there we got the fastest bear market ever seen. We lost 40% in the Nasdaq in a period of six weeks. That really provides the background against which events since then need to be measured.

If you examine history, you'll find that 40% is pretty typical for a bear market. It's within a few percentage points of the median bear market that we would expect. But six weeks is extraordinary -- the shortest bear market on record. The analogy I like to use is to a death in the family. The decline in the Nasdaq was essentially an event that destroyed many portfolios and caused a tremendous amount of damage -- financial and emotional.

Normally a bear market takes 18 months or so, and across that span the emotional damage is done slowly, and there is ample time for the individuals involved to adjust to the new environment.

Viewing the lightning bear market earlier this year as a death in the family, one would expect the family members to grieve and that grieving process should probably take a year or more. My theory is that we are six months or so into that grieving process.

We are in a massive trading range. Probably, in a long-term sense, from 3200 to 5200 for the Nasdaq. But more practically, from 3200 to 4200. I expect this trading range will prevail well into next year, and that really only after individuals have had time to complete the emotional adjustment to the new, post-Internet bubble world will we break out of that trading range.

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In a similar vein, I believe that the

S&P 500

is delineated by similar points in time but that we will trade in the upper half of the

S&P's

trading range vs. the lower half of the Nasdaq's trading range.

There seems to be one major beacon of light here, and that is mid-cap stocks. I believe we are in the process of making a long-term transition from an emphasis on large-cap stocks to an emphasis on small-cap stocks. And mid-cap stocks are the immediate beneficiaries, as they are the first place that large-cap managers turn to when they want to move down the ladder in corporate size.

Lahart

: And that's a liquidity issue?

Bollinger

: Exactly.

Lahart

: So, from big to small, a better performance on the S&P than on the Nasdaq. What about on a sector basis? Are there any sectors that are doing well here?

Bollinger

: I actually think we are emerging into a stock picker's market rather than a market timer's market. There are certain phases of market activity where it's most important to hone and use your market-timing skills, and there are certain phases of market activity where it's more important to be a really good stock picker.

One of the indicators that we keep is called the Disparity Index. Essentially, it is an evaluation of whether the markets are trading in a consistent manner. In order to calculate the disparity index, we look at the sign of the change of the

New York Stock Exchange Composite

and compare it to the sign of the change of the Nasdaq.

When the sines are different, we award a

percentage point. Under normal circumstances, over the past 15 years or so, the disparity index runs in a fairly narrow range -- between 20% and 30%. Recently it has traded at levels as high as 65%. This is an indication of the extreme rotation from sector to sector and market to market that has marked the stock market recently.

This suggests not only that stock picking be a superior strategy to market timing but that industry group and economic sector will be more volatile than we would expect from history, and therefore we'll have to focus on shorter-term movements than we would normally.

To answer your question, when one looks at the intermediate trend of the major economic sectors, we find five sectors supporting positive intermediate momentum at present. Health care, energy, consumer noncyclical finance, and a sector we call "yield" that consists of utilities and other stocks that are traded primarily for their yield.

All other sectors support negative momentum at present. However, we think that there are substantial opportunities within those sectors, both at the group and stock level. Stock picking and group selection skills are going to be the key to successful performance over the next year.

For more on Bollinger's views of the market, read

TSC's

Streetside Chat from June 17.