What a Week: Ho Ho Whoa! An End to the Week Is the Best Gift for This Market

A bear turns bullish, a bull admits his errors, and Task gleans a golden lesson from this wild week.
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SAN FRANCISCO -- The ghost of Santa Claus rallies past emerged Friday, ending a week in which a far less welcome specter appeared as well.

The

Dow Jones Industrial Average

rose 1.4% Friday, while the

S&P 500

gained 2.4%, and the

Nasdaq Composite

jumped 7.6%, its fifth-best percentage gain ever. The advance was fueled by rising expectations that the

Federal Reserve

will ease interest rates prior to its Jan. 30-31 meeting and a sense that harsh selling, culminating Tuesday and Wednesday, had created irresistible bargains.

The Dow continued to outperform this week, rising 1.9%, while the S&P slid 0.5% and the Comp shed 5.1%.

The market's abrupt mood swing was embodied by Don Hays of

Hays Advisory Group

in Nashville, Tenn.

On Wednesday, Hays

reiterated a long-held belief that the Nasdaq could fall to as low as 1800 by mid-January, in the "final plunge" of its bear market.

Hays' call came on a day when the Nasdaq tumbled 7.1% to 2332.77, its lowest close since March 1999, while the S&P lost 3.1% to 1264.74, its lowest close since October 1999. The

Wilshire 5000 Total Market Index

also hit a 52-week low Wednesday.

The precipitous declines evinced Wall Street's disappointment that the Fed didn't lower interest rates Tuesday. The Fed did

shift its bias to one focused on the risk of economic slowing. But that 180-degree turn proved insufficient to investors anxious for an actual rate cut. Major market proxies all closed lower Tuesday, after a midday rally evaporated following the Fed's announcement.

Midweek, Hays was saying the market's weakness would intensify. But Friday, he announced that his asset-allocation model had turned bullish, recommending clients increase their equity allocation from 55% to 77% for aggressive accounts and 65% for those less risk tolerant.

The change of view was spurred, first, by investor sentiment -- a contrarian indicator. The

American Association of Individual Investors

survey showed bullishness fell to 31% this week from 60%, while bearishness rose to 51%.

Second, the S&P 500's earnings yield had gone from 70% overvalued nine months ago, according to Hays' model, to just 4.5% overvalued today following the steep drop in Treasury bond yields.

Even the strategist was surprised by the speed of the reversal, which he previously forecast would occur (albeit from lower levels). Still, it does "not change my long-term caution," he wrote. "I still expect the third phase of the bear market, this time including all stocks -- new and old era -- to begin" as early as April 2001.

For the immediate future, Hays forecast "a few more weeks of scares, fits and starts," but ultimately a "trading rally with good upside potential."

An expectation that the Fed could cut interest rates "in the next two weeks" was also a factor in Hays' change of outlook.

Such speculation helped market averages rally sharply early Thursday. But the advance subsided after the Fed issued a statement that dampened such expectations, albeit temporarily.

Intermeeting rate cut musings were back in vogue on Friday, as was the market's upward bias.

Capitulation by Any Other Name

Several readers took exception to my contention that Wednesday didn't represent a classic "capitulation" session, and I'd like to review some of those comments, as

promised.

The most provocative of the responses was best expressed by one reader, who surmised: "Too many people are waiting for the theme to

Rocky

to sound off at the market bottom. My guess is it ain't gonna happen this time around."

Others pointed to recent columns by

Helene Meisler, who has argued that (in the words of another reader) "the slow grinding downward over the last nine months has in effect been an evolving capitulation and is replacing what normally would be a sudden and significant few days of selloff with high volume."

But there have been few days of significant selling on high volume -- most recently Wednesday, the second-busiest session in the Nasdaq history. (Friday's 2.2 billion shares in over-the-counter trading and 1.1 billion in Big Board activity didn't approach records, but were solid for a preholiday session. Financial markets are closed Monday in observance of Christmas.)

Different this time, perhaps, is that while individuals largely resisted the temptation to panic, mutual fund managers raced to the exits in a combination of tax-related selling and so-called window dressing.

Wednesday "smelled like capitulation and I hate that word," said Scott Bleier, chief strategist at

Prime Charter

. "But it wasn't the capitulation you'd normally think of: This was the money managers' capitulation. They were selling stocks at any price to get losses on the books to balance gains. Most of the public that's left standing are the ones who aren't going to sell their

Cisco

(CSCO) - Get Report

" or

Microsoft

(MSFT) - Get Report

, or any number of bellwethers that hit or approached 52-week lows this week.

This was an example of "money management at its worst," Bleier continued. "It's money managers that bring us to the extremes. They are the ones who panicked to get in

at the beginning of the year and panicked to get out" at the end.

Still, those who invest with fund managers by rote -- banks and insurance companies along with retail investors -- "ultimately give them the power to run amok," he conceded.

Bleier's mini-tirade came amid a longer conversation in which he defended some of his recent calls, including that

Alan Greenspan

had put a

concrete floor under the market, and that

last Friday marked a successful retest of the Comp's Nov. 30 low of 2523.

While conceding the error of those calls, Bleier reiterated a belief that the "earthquake" has past and this week marked the likely "end of the first great shakeout of the New Economy." The Nasdaq is now up about 120% for the past five years, while the Dow and S&P are up about 105% each, he noted, suggesting the market has returned to something resembling balance after the more recent bifurcated action.

Stocks will likely "bounce along" for a bit, and then "at some point you'll move away from the bottom and finally get something that sticks," he forecast. "But you probably have to wait for the first rate cut."

Bleier anticipates a "January effect" for the most beaten-down stocks, but he is not among those expecting the Fed to ease prior to Jan. 30-31.

And to All a Good Weekend

Which brings us to the philosophical portion of our program. Some readers, no doubt, will now dismiss Hays because his worst-case scenario didn't come to fruition. Others, perhaps, will dismiss Bleier because of his more recent predictions.

Bleier readily admitted his recent errors, but "I've always maintained it's as difficult to call the bottom as the top because things have gotten so extreme," he said (and he has always said that). "When you're trying to predict events without a crystal ball, it's very rare you get everything exactly right."

In other words, we're all human. Something to keep in mind as the holidays beckon and what has been a trying year for most investors comes to a close.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.