Analysts divided on whether bulls have run course

NEW YORK -- Rising interest rates, inflation, Iraq and uncertainty about this year's presidential race have set the bears growling on Wall Street.

Some analysts say the bull cycle that investors have enjoyed for much of the past year was just a short reprieve in a larger bear market. Others say the current uncertainty is only a hiccup in a prevailing upward trend. Either way, things sure have been confusing lately.

"The risks have risen; things aren't as bullish as they were a few months ago," said Sam Burns, an analyst with Ned Davis Research, which advises institutional investors on market trends. "It's a mixed picture. We're going from a green light to a yellow light, but we're not at a red light yet."

Burns and many others on Wall Street believe we're in the midst of a "secular bear market," which is financial-speak for a long-term downward trend. Secular phases, which may last 15 years or more, can encompass multiple bull and bear cycles. Under this theory, the most recent "cyclical bull market" began in March 2003, and started flagging earlier this year.

But while the market is moving sideways and looking weaker, few observers are willing to say the bulls have run their course.

"We haven't gone so far as to declare a cyclical bear market, but we are watching all our indicators to see if the weight of the evidence falls in that direction," Burns said. "If inflation gets out of hand, if rates get jacked up a lot, or if things in Iraq come off the rails, that could change things."

Other analysts remain more optimistic. Even though the market seems to be selling off on the current uncertainty, there are a number of signals pointing to a strong, lasting recovery for Wall Street and the economy, said Kenneth McCarthy, chief economist with vFinance Investments Inc.

"I find it hard to see a longer-term bear trend in an economy with double-digit profit growth and strong economic growth," McCarthy said. "I think what we're seeing is more of a short-term correction caused by several things coming together, the key thing being the higher interest rates."

Many market watchers have looked to the past for guidance, comparing today's environment to the difficult period from 1994 to 1995, when the Federal Reserve last started to tighten its policy after a prolonged period of low rates. McCarthy said he's not convinced that's a good analogy, however, especially since Fed policy-makers have suggested they don't want to repeat that pattern, a series of sharp increases.

"If you're a long-term investor, you're looking at this and thinking 'OK, we're going to get over this hump,"' McCarthy said. "And even after '94 and '95, we had '96, '97 and '98, which were years with ... dramatic growth."

It might sound strange, but the very fact that so many investors are wary about the market's potential for a further rise is a bullish sign, said Ken Tower, chief strategist for Schwab's CyberTrader.

"Worry ... is totally the normal backdrop for a bull market," Tower said. "When no one is worried anymore, that's the top. Having people nervous, having people on the sidelines, having that money gradually committed to the market, is what will drive the market higher."

Better-than-expected earnings have helped support the market during its recent slump, but investors are braced for a turbulent summer as the presidential race heats up. Financial markets typically fare better when incumbents win, because investors prefer the continuity of current policies over the unpredictability of a new administration.

The market may remain volatile through the election and then turn up again in November, regardless of the outcome, simply because the uncertainty has passed, said Burns, of Ned Davis Research.

In the meantime, investors seem to be favoring cautious positions, which would be prudent given the interest rate environment, alone. Higher rates don't automatically lead to lower share prices if the economy is strong, but the best gains come when rates are stable or declining, said Sung Won Sohn, economist with Wells Fargo & Co. in Minneapolis.

"Another up-leg in the stock market is possible, but once the market realizes the true intentions of the Federal Reserve, a risk-averse and conservative investment policy is in order," Sohn wrote in a research note to clients. "High quality, dividend-paying stocks with solid balance sheets are coming into vogue."