The hope of a promising resolution to the war in Iraq jerked the market out of the doldrums, prompting the question of whether the bear market is over. There are compelling arguments from those who believe stocks are in for more pain and from those who believe the worst days are behind us.

The bearish case rests on the continuing weak economy, while the bulls feel that the bubble speculation has been purged, and that corporate America is running lean and is poised to see a ramp in profits in the near future. I'm sure both camps will have days of glee and doubt over the next few months. The best approach is probably one of flexibility. That is, don't make a committment that the market must or should necessarily do anything one way or the other over the next few years.

One man who has taken an objective long-term view is Jonathan Lin, a market analyst with Salomon Smith Barney. Lin thinks we're still in a structural bear market and will remain so for four to five years. "There will be some secular bull rallies, but basically the statistics are saying that investing right now is a waste of time," he says.

Neutrality Possible

Lin's opinion is drawn from his analysis of stock market performance over the last 100 years and is based on the premise that returns over time revert to the mean. When Lin first published his

Reversion to the Mean

study in September 2000, he projected that the

S&P 500

, on the basis of normalized annualized gains over 50 years, should bottom at 776 by the end of 2001. The timing was about a year off, but the price was right: The index hit 768 in October 2002.

"If you look at returns over the past 10 or 15 years, it encompasses the greatest structural bull market of this century and produces average returns of 15% per annum," he says. "I think a 50-year period, which at least includes one bear market and the current one, we get normalized returns of 9.3%."

The table below shows expected price levels for the S&P 500 index as a function of the normalized annualized gain for various time periods.

"While the resolution and removal of the excesses of the bubble has occurred, the data says we will now remain in a neutral market until 2010," says Lin. As to whether achieving a certain price level over the next year would alter his view, Lin remained steadfast but added a caveat.

TheStreet Recommends

"Markets tend to overshoot on both sides," he says. "So while I think it's unlikely, we could see 600 on the S&P and 4600 on the


. And we could trade much higher in the next six months to a year. Neither will change my long-term view that average annual returns over the next four years should be neutral."

His point is that any extreme price points over the next year won't change the fact that stocks have a historic return of 8% a year. We might have hit Lin's absolute price resolution, but we'll need a few years of zero gains before the reversion to the mean is achieved.

The Takeaway

Having no reason to argue with his data, the conclusion I draw from Lin's research is that the next few years will treat nimble traders much more kindly than they will buy-and-hold investors. That means not confusing short- and intermediate-moves in the market with long-term trends.

In order to generate positive returns, one will need to catch cyclical market moves. And it should be noted that Lin's study, being statistical in nature, makes no predictions other than that returns should normalize over time. It by no means rules out the possibility of double-digit percentage gains or losses over the next few years.

As always, options can offer a flexible low-risk means to capturing profits. As most experienced traders know, the market typically overshoots expected price objectives on both the upside and the downside. Placing that notion against the backdrop of a range-bound market leads me to believe that a good general strategy will be to establish contra-spread positions as the market hits overbought and oversold conditions in the short term.

Given the premise that the market will stay in a defined range, I'll also assume that volatilty levels will slowly drift down from the current mid-30s level to a more normalized low-20s range. This means it might be wise to use strategies that sell premium, such as selling spreads for a net credit.

For example, in the very short term the S&P might face resistance near 910. If the index should climb above 900, one might look to sell the May 925/950 for a net credit of $11. This would give a you break-even of 936, a sufficient cushion for an overshoot in the short term. Or if volalilty falls below 30, it might make sense to purchase some puts in anticipation of a pullback.

Steven Smith writes regularly for In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to

Steve Smith.