Stocks and the Economy, Singing Different Tunes "THE test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function," F. Scott Fitzgerald wrote in 1936. He might have been describing the difficulties faced by current analysts of the financial markets. The stock market roared through the first quarter of this year, yet most people believe that the economy isn't really healthy. That may not be a contradiction, but making sense of it may require some awkward mental gymnastics. Certainly, the market's recent rise has been spectacular. While stocks have dithered in April, the Standard & Poor's 500-stock index returned nearly 30 percent from its low of last Oct. 3 through March this year. Yet the economic picture has been mixed at best, with unemployment still above 8 percent and the gross domestic product growing at an estimated annualized rate of only 2.5 percent in the first quarter, according to the Wall Street consensus. The latest New York Times/CBS News poll last week found that unemployment and the economy remain the main concerns of most voters, 70 percent of whom said the economy is "very" or "fairly" bad. That was an improvement over October, when 86 percent said the economy was "very" or "fairly" bad, but it's hardly upbeat. This kind of dichotomy - market returns that may not accurately reflect the underlying economy - actually occurs rather often, and it poses a ticklish problem, both for professional money managers and for the rest of us. For example, if you focus on the economy and find that it's weak, you might think it wise to lighten the risk in your portfolio and concentrate on protecting your assets. On the other hand, if you focus on the market's momentum and believe stocks are likely to keep climbing, you might try to ride that wave until it crests. But if you look at both the economy and the market, and believe both that the economy is weak and that the market's momentum is upward, you may not be entirely comfortable with any course of action. Yet if you're fortunate enough to have money to invest, you must do something. In a report last week, Ned Davis, founder of Ned Davis Research, an investment research firm in Venice, Fla., put the problem this way: What's more important, he asked, "being right or making money?" He lands squarely on the side of making money, and says stocks are likely to rise over the next six months or so. But he acknowledged that he must balance his short-term views against his longer-term convictions about the state of the economy. As a "secular bear," he says he is convinced that the economy is plagued by deep-seated maladies that will take years to clear up and that, at some point, the stock market will resume a long-term downward trend. But as a close analyst of technical market indicators, he is advising clients that by year-end the market is likely to rise, though with some caveats. There may well be a correction - a relatively modest decline - in the next few months, his firm has concluded. But it is telling clients that a cyclical bull market is in place - a strong upturn within the longer downward trend. This may well seem confusing. Mr. Davis said as much, reassuring clients: "I remain a secular bear. I am concerned about the long-term consequences of the Fed's zero interest rate and easy credit policies and exploding government deficits. Despite these worries, he also said that it didn't make sense, at least right now, to "fight the Fed and fight the tape." In a telephone conversation, Ed Clissold, United States market strategist for Ned Davis Research, explained the firm's analysis, which has a wide following among money managers. Much of the apparent paradox is a question of timing, he said. "Four years from now, you may find that the stock market is trading in the same range as it is today," he said. But, he added, it is likely to cycle up and down in the interim. And over a much longer time frame, "global deleveraging still needs to be completed, and that will have negative effects for the stock market." While the market may consolidate in the weeks ahead, two main factors argue in favor of a continuing upward trend this year, the firm has concluded. The first of these is "the Fed" - meaning the Federal Reserve and other central banks around the world, which have adopted extraordinarily accommodative monetary policies and committed to redoubling their efforts if economic growth falters. The stock market generally responds favorably to loose money. The second is "the tape," the momentum of the market and its individual sectors, which continue to show favorable patterns. In essence, what goes up tends to keep going up - until it no longer does. And there are certainly many factors weighing on the market, both technical and economic. A short-term consolidation might be in order after a stock market rise as sharp as the recent one; in a benign forecast, a modest decline would prepare the way for a bigger run upward for several months, which Ned Davis Research sees as the likeliest outcome. Stock valuations are already elevated, the firm says, and while that may not be an immediate problem, it implies that some excesses will need to be wrung out of the market down the road. ENORMOUS problems remain for the global economy. The European financial crisis has been contained but not solved; further flare-ups are quite possible and could derail the market. Longer term, Mr. Clissold said, reversing the credit expansion and reducing debt loads are likely to have negative effects on riskier assets. Buy-and-hold investors who maintain diversified portfolios and rigorously reinvest dividends and interest can try to ride out these cycles, Mr. Clissold said, and "have what will probably be modest returns" in the years ahead. Market professionals who try to do better than that will need to be nimble indeed.