Investment adviser Jim Stack’s recent calls have been on the money. Here’s why he thinks stocks will continue to rise. By Steven Goldberg, Contributing Columnist November 2, 2010 Unemployment remains stubbornly high. Consumer debt and government debt -- local, state and federal -- are at or near record levels. The housing crisis refuses to go away. The dollar is falling. Gold, a refuge for investors during uncertain times, is soaring.Amid all this gloom, the stock market has continued to climb since bottoming on March 9, 2009, albeit with occasional stumbles along the way. In fact, through November 1, Standard & Poor’s 500-stock index has zoomed 81.1% since hitting its nadir. James Stack, president of InvesTech Research, a money-management and advisory firm in Whitefish, Mont., says the market’s rise makes perfect sense -- and will continue. Why should you listen to Stack? Because he called the onset of the 2007-2009 bear market almost to the day and timed the start of the current bull market nearly as well. Like any good market timer with contrarian instincts, Stack takes comfort from widespread bearishness among investors. That’s usually a bullish sign. But Stack admits that he’s more nervous than usual about the market’s prospects. “Every bull market climbs a wall of worry,” he says, “but this one has had to climb a mountain range of impending doom.” Advertisement Stack, publisher of the InvesTech Market Analyst newsletter (www.investech.com), isn’t the only bullish timer with some gray in his hair. Steve Leuthold, who hasn’t done so well in calling market turns the past couple of years, recently turned bullish again. Both Stack and Leuthold, chief investment officer of Leuthold Weeden Capital Management, in Minneapolis, cite the market’s healthy technical condition for their bullish stances. Technical analysis gets about as much respect in many corners of Wall Street as fortune telling does. But while no one should rely on technical analysis exclusively, you shouldn’t automatically dismiss what technicians have to tell us. Essentially, they look to the market itself to gauge where it will head next. The chief reason Stack remains bullish is a proprietary model he developed called the Negative Leadership Composite. In a nutshell, this model takes its lead from the number of stocks hitting new 52-week lows. The fewer stocks at new lows, the better the outlook for the market. Why is that bullish? Stack, once an IBM engineer, cites research from psychologists who have studied investor behavior: “Suppose you have two stocks you buy at $20. One rises to $25, the other falls to $15. Which would you sell?” Stack says, and studies confirm, that the overwhelming majority of investors would sell the stock that has risen to $25. It’s psychologically easier to sell a stock that has risen than to dump one that has dropped. Most investors hold on to their losers much too long, hoping to break even. Advertisement So by the time investors unload their losers -- often stocks that are reaching new 52-week lows -- they’ve already sold their winners. Explains Stack: “You’re either throwing in the towel, or you’re saying, ‘I’m so afraid of this market that I don’t care what price I’m selling at. I’m getting out.’ ” Stack’s Negative Leadership Composite remained solidly in bullish territory last summer -- even amid fears that the economy would slip back into recession. And the model continues to be bullish today, with few stocks hitting new lows. Stack also looks at a rally’s breadth -- how broad-based the rally is -- to determine the market’s direction. So far, the small-company Russell 2000 index, the economically sensitive transportation indexes and the income-oriented utility indexes have continued to rise along with the Dow Jones industrial average and other blue-chip-dominated indexes, such as the S&P 500. Markets that become increasingly narrow -- with investors typically clustering into a small number of large-company stocks -- are usually cruisin’ for a bruisin’. Sell your gold stocks and precious-metals funds Advertisement What about gold? Sell now, says Stack. Gold has risen faster than the major stock indexes this year as investors have sought to insulate themselves from a falling dollar and the possible revival of inflation. “Gold right now is running 70% on psychology and 30% on fundamentals,” Stack says. “Psychology can reverse, and when it does, there’s no time to get out,” he says. Although he’s a technician, Stack pays close attention to the economy. He believes the U.S. economy will grow slowly as consumers, businesses, and state and local governments struggle to pare debt. (Because of his expectation for slow growth, Stack says investors should lighten up on commodities in general, not just gold.) But he’s not a long-term pessimist. “The U.S. economy is amazingly adaptive,” he says. He scoffs at those who foresee the U.S. undergoing the sort of “lost decade” that Japan has experienced. Stack, calling himself “cautiously bullish, not wildly bullish,” won’t guess how long the bull market will last. “But we could see double-digit returns over the next 12 months. With so much pessimism, the surprise might be on the upside.” Steven T. Goldberg (bio) is an investment adviser.