I come back from a month out of the country and what do I find? A market that looks shockingly similar to the one I left behind -- and to the one investors have been struggling with for the past 18 months.

Once again, as they did in April 2001 and August 2000, the indices have staged an impressive rally off a bottom in anticipation of a recovery.

For instance, the


climbed from 1639 last April to 2314 on May 22 -- a 41% jump -- as investors bid up stocks in anticipation of a 2001 recovery. The

Dow Jones Industrial Average

rose 21% from March 22 through May 21.

This time the Nasdaq soared 44% from its Sept. 21 bottom and the Dow climbed 23%.

Again, stocks have started to give back some of those gains on fears that prices have climbed too far, too fast. A newly conservative Wall Street began to warn that stocks were too expensive as the Nasdaq approached 2000. Morgan Stanley market strategist Steve Galbraith, for example, pointed out in a report titled "Tech Pyrotechnics -- D¿j¿ Vu All Over Again" that the technology sector was now trading at 48 times expected 2002 earnings -- about the same multiple as just before the technology bubble burst in March 2000.

In the past few days, investors have started taking profits in some of the stocks that have increased the most, recalling that the April rally in the Nasdaq market was followed by a decline that took the index back to 1695 on Sept. 10 -- the day before the terrorist attacks on New York and Washington -- on the way to a postdisaster low of 1423 on Sept. 21.

Just Another Sucker Rally?

So once again investors have to ask the questions that they must be tired of asking by now: Is this just another sucker rally (in a bear market) that has driven stocks to unsustainably high valuations? Or is the stock market rally a reliable leading indicator of a turn in the economy that will take stocks higher from here? Depending on how you answer those questions, this is a good time to sell and take some profits, or a good time to buy.

Here's how I'd answer those questions.

First, let's separate the short-term and the long-term trend in the market as much as we can.

In the short term -- and by that I mean the days until the end of the year -- the trend is lower for reasons that have nothing to do with the fundamental questions I've raised about this market.

Most professional investment managers are solidly in the black for the fourth quarter of 2001. For example, according to Morningstar, as of Dec. 14, the average large-company growth fund is ahead by 6% over the past three months and the average small-company growth fund is up 9%. Technology funds have soared 16%.

It has been a long time since fund managers have seen positive numbers like those. Year to date, large-company growth funds are down 25% and tech funds are off a whopping 38%. That gives you a sense of just how welcome the current black ink is.

And it's a sure bet that professional money managers are reluctant to do anything that might turn that black ink to red in the last days of the year. This is a time for protecting gains and not for taking new risks. The slow downward drift of the general market in the sessions of last week is a good indicator that professionals are in a defensive mode. There's simply not a good reason to buy anything at this point in the year.

At the same time managers were disposed to quickly sell anything that might be dangerous to their portfolios -- hence the dumping of



shares on fears that the wholesale energy producer will become the next



. Calpine fell 34% for the week.

The beginning of earnings warnings season only reinforced that reluctance to buy and the predisposition to sell. With companies such as


(CIEN) - Get Report

issuing December warnings that 2002 revenue would drop by 40%, prudent managers had incentive to steer away from any stock that even smelled risky, and little incentive to buy the issues that had climbed in price so recently.

But it's important to note that this short-term trend, which I believe points modestly downward, doesn't tell investors much of anything about the fundamental direction of the stock market. Those investors who believe that the rally will continue, or that it will turn into another downward leg in a continuing bear market, are basing their calls on longer-term trends in the economy and in the money supply.

The Bullish Scenario

The bullish case rests on two factors. First, optimistic investors believe they've seen signs that the economy has bottomed. The concrete evidence seems thin to me. For instance, the recent huge drop in the number of people filing new claims for unemployment -- down 86,000 for the week -- could be a sign that the worst of the wave of layoffs is behind us. But it could also be just a reflection of the unseasonably mild weather across the country that has kept more construction workers on the job than usual at this time of year.

The "anticipatory economic evidence" from past recessions is stronger, I think. In past recessions, interest rate cuts of this magnitude have almost always jump-started the economy after a lag of six months or longer.

Given that the lag is now edging toward a year -- measuring from the

Federal Reserve's

first move in January 2001 -- there is no doubt that lower interest rates have led to a boom in mortgage refinancings. That's put extra spending power in the hands of consumers, who in turn have propped up the sales of big-ticket items like cars. Add those factors to the economic boost provided by lower energy prices, and it is reasonable to believe, based on the record of past recessions, that this one is near a bottom.

Second, the bulls argue, any indication that the recovery is for real will send a torrent of cash rushing into the stock market from the sidelines. U.S. households are sitting on $4.29 trillion in money market and savings deposits. That balance is up $700 billion, or about 20%, since the beginning of 2000.

Each Federal Reserve interest rate cut has made stocks a more attractive alternative -- some of that cash is now earning just 2%. Fear has kept most of that money on the sidelines, but that pile of dollars will eventually start to flow back into the stock market and drive stocks higher from here.

The Bears' Case

The bearish case rests on two factors. Bears see no signs that the collapse in business investment that has led the economy lower is over. For example, a recent survey of 291 chief financial officers found that fully 47% expect to cut capital spending in 2002. Reports from individual companies seem to support the case that the economy still hasn't hit bottom.



announced that it would cut capital spending in 2002 to $4.3 billion from the $8.5 billion that the company spent in 2001. That's significantly lower than the $5.5 billion in capital spending that Qwest was projecting as recently as September.

And it's not just the capital spending side of the economy that's showing new weakness. Consumer spending is finally showing signs of giving out. November auto sales, for example, fell 12% from October's levels as auto companies cut back on their use of zero-percent financing incentives. Consumer spending on retail and food services fell 3.7% in November, the Commerce Department reported, in yet another sign of slowing consumer demand.

The bears don't deny that there's a mountain of cash on the sidelines that could flow into stocks. They just argue that it isn't inevitable that it will. Investors burned by the tech crash of 2000 and scared by disasters such as Enron that have wiped out the retirement savings of thousands of individuals may have significantly reduced their appetite for stocks as an asset class. Stocks as a class could simply fall out of favor with investors, who would then build portfolios with much lower levels of equity exposure.

It doesn't have to be one or the other of these scenarios, of course. And in fact, the evidence points to an economic recovery and a course for the stock market that's much more a portrait in gray than a simple bull/bear dichotomy.

Like the bulls and the bears, I have two reasons to believe in my in-between market and economy. First, this isn't your "normal" recession. Most recessions are led by a drop in consumer spending at the front end and a surge in consumer spending at the back end. In other words, consumers stop spending to create the recession and consumers start spending again to end it.

Strange Recession

In the standard recession, the collapse in business capital spending follows on the collapse in consumer spending. Companies stop spending on new machines and bigger plants because, with consumer demand falling, they don't have enough business to keep current equipment busy.

The typical recession ends when all that pent-up demand ends in a surge of renewed buying. Economists can't do more than take a stab at the psychology that suddenly shifts in favor of renewed spending, but once the shift is in place, rising consumer demand leads to a renewal of capital spending as businesses rush to catch up.

This recession hasn't worked like that. The collapse of capital spending on the business side of the economy led the way into the downturn, and consumer spending has held up relatively well -- so far. Car sales may have fallen by 12% in November, but consumers still snapped up cars at an annual rate of 18 million vehicles that month -- 50% above the rate of sales that marked the 1991 recession.

Wireless-phone sales may have disappointed CEOs and investors who were counting on 500 million units in 2001, but the final numbers are likely to show sales of better than 380 million phones. That's not that far below the 400 million phones sold in 2000. The current estimates of 420 million in sales for 2002 don't seem to suggest a huge pent-up demand for phones either.

Looking around, I don't see the setup for the surge in pent-up demand that marks the end of the typical recession. Sales of wireless phones and PCs and cars and washing machines are likely to pick up with the end of the recession but at relatively modest rates.

And those modest rates of growth won't be sufficient to fuel a robust recovery of capital spending on the business side. Growth in demand is likely to be such that, for some time, companies can meet orders by putting idled capacity back to work or making modest productivity improvements.

Saying Goodbye to the V

Under this scenario, the recession ends, contrary to the expectations of bears. But it ends with very modest growth, contrary to the expectations of bulls.

My second reason for favoring this gray scenario over either the bull or bear views is the convincing nature of both those calls on the economy. There are good arguments to be made each way, and adherents of each view will continue to slug it out with their dollars in the market. Neither side is going to have conclusive proof for their case for some time. Remember, even the most bullish don't expect to see an economic recovery until midyear.

In this situation I expect that the market will surge and retreat, as each side gains temporary advantages based on the most recent news and data. The overall course of that vacillation will be upward, I believe, because the economy is headed for some kind of recovery, even if it's the exceedingly anemic one that I've described. But the overall feel of the market won't be so much upward as back and forth.

What kind of investing strategy works best in such a market? One that buys out-of-favor stocks or groups when prices are low because the vast majority of investors scorn the shares. One that watches valuation and sells at the temporary top created when the stock or group moves back into favor, then is keen to look for the chance to rebuy when prices have fallen.

Such strategies are generally called contrarian, and I'll spend my next column outlining a contrarian approach to 2002 and listing a few new buys and a few current sells that fit this approach.

Jim Jubak appears Wednesdays on CNBC's "Business Center" at 6 p.m. EST. At the time of publication, he owned or controlled shares in the following equities mentioned in this column: Taiwan Semiconductor Manufacturing.