Investors are well aware of the significant rally off the October lows. But lately they've also been hearing from financial commentators that "the easy money has been made." Rarely has a statement been as incorrect as that one.

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If you followed my columns and posts and purchased stocks in October, money has been made -- very good money at that. However, buying stocks last October when the market was in a free fall was anything but easy. It required a boatload of courage and conviction. In a market like this, there is no easy money.

The explosive rally that began off the Oct. 9 low surprised even me. Although I had anticipated a tradable fourth-quarter rally, I expected a moderately lower bottom and a more gradual recovery. With such big gains under our belts in such a short period, what should investors do now?

Paring Back With Profits

My inclination is to trim some positions and to continue paring back positions into any further market strength. The stock market rarely collapses in the last month of the year. In fact, the two best months of the year on a seasonal basis are December and January. The market could easily work its way higher over the next 30 to 60 days, but the strong market recovery in the face of poor fundamentals such as disappointing profit growth and a weakening economy appears to be discounting some of the traditional seasonal strength.

With big upward moves behind them, most stocks have lost the attractive valuations they enjoyed just eight weeks ago. Also, sentiment has turned very bullish very quickly. In many respects, this fourth-quarter rally resembled last year's. The market may not roll over tomorrow, but sustainable and material progress from these levels is unlikely.

Which segments of the market appear most vulnerable? High-valuation sectors have the most downside risk, including most large-cap tech and media sectors, as well as many defensive sectors like staples and health care. Stocks with high price-to-earnings ratios are discounting growth rates that, for most companies, will not be achieved in a still-difficult profit environment.

Nor am I excited about some traditional large-cap value sectors, such as energy, cyclicals, utilities and consumer durables. Slowing consumption and low capacity utilization rates plague many consumer and capital goods industries.

Adding pressure to reported profits are tighter accounting standards for nonrecurring expenses and increased pension and options expenses. Simply stated, more of the bad stuff will pass through corporate America's income statement, depressing reported earnings.

So What Will Work?

Selected themes may continue to work, even in a difficult, rotational market. In

Barron's

a few weeks ago, I highlighted the investment theme of controversial stocks. Now, cheap stocks are controversial by definition. However, the valuation gaps between many "hairy" stocks and the general market is significantly larger than normal. Bond investors describe this situation as wide yield spreads. Stocks I have recently purchased or continue to own that fit this theme include:

Although these stocks remain very cheap, many seem to have found a bottom recently, and the gibberish from the short community seems to have lost its negative impact on them. Short tactics such as questioning a leading company's viability and categorizing each depressed stock as the next

Enron

or

WorldCom

or simply promoting a short idea with an asinine valuation target appears to have stopped working.

All of these "controversial" names may not work, of course, but many will -- and possibly in a big way. After all, how long would it take to double your money in the big, safe names like

Coke

(KO) - Get Report

,

ExxonMobil

(XOM) - Get Report

or

Intel

(INTC) - Get Report

?

Another theme I discussed in my

Oct. 1 column was speculating in small-cap biotech, computer tech and telecom shares. Two months ago, many small-caps in these sectors were simply being given away at fire-sale prices, and in the recent rally, many of them have been marked up to fair valuations.

The eight stocks I included as examples of good specs have appreciated an average of 75%. One stock,

Openwave

(OPWV)

, which was somehow left off the list but included in my disclosure, is up more than 300% in the past 60 days! (I've also mentioned it several times in

RealMoney's

Columnist Conversation.) I haven't yet sold anything here, but I wouldn't argue with investors who want to book some profits on these stocks. I do intend to pare back some of my "tech specs" as they continue to appreciate.

At the beginning of 2002,

I predicted a difficult, rotational market environment that would frustrate investors of all styles. I said that trading deep-value stocks after large price declines would offer an opportunity to make respectable returns, but that it wouldn't be easy. I criticized the perma-bulls as well as the perma-bears, because both lacked the flexibility necessary to successfully trade a highly volatile market.

In general, 2002 played out in line with my forecasts. Certainly, all of my ideas didn't work: Healthsouth and Tyco are two examples of "value mistakes." But for 2002, my value-oriented trading philosophy made money. It was, however, anything but easy!

A Housekeeping Note:

Many of you have been asking for more of my market insights. If you're not already a subscriber, I suggest you

sign up for

RealMoney

, where you can see my comments in Columnist Conversation just about every day.

Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin was long Tyco, EDS, Cigna, Cendant, Tenet Healthcare, Washington Mutual, Healthsouth and Openwave, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to

robert.marcin@thestreet.com.