FIRST, THE GOOD NEWS.

According to Barry Ritholtz, chief market strategist at Maxim Group, an investment management firm in New York, stocks are about to experience the biggest rally of the current bull market.

"If my timing is correct, and if my macroeconomic assessment is correct," says Ritholtz, "there will be a rally from June through November. That period that five-month period will encompass a significant rally. Historically, the last rally of a bull market tends to be the strongest within the cycle."

Ritholtz bases his assessment on a number of factors including trends in inflation and long-term Treasury yields, investor sentiment and the limits of the federal government's ability to stimulate the economy. As for the latter, following aggressive campaigns to cut taxes and hike rates, he feels the White House and the Federal Reserve have all but exhausted their options for sparking economic growth.

Which leads us to the bad news. If Ritholtz is right and this is, indeed, the last leg of this bull market, then next year is shaping up to be an ugly period for equities.

"I suspect the present rally will run longer and further than many expect," he says, "but I also think that the potential downside into 2006 is quite substantial. I don't want to put a number on it, but it could surprise people a great deal."

SmartMoney.com asked Ritholtz how individual investors can profit from the current bull market. While he wouldn't commit to long-term picks, considering his bearish view for 2006 and 2007, he did suggest three exchange-traded funds that would fit nicely into a short-term trading strategy.

SmartMoney.com: You turned bearish at the end of March, and then shifted bullish about two weeks ago. Why did you change your position?

Barry Ritholtz: Around March 29-30 we had a bear call. The internals of the market decayed and the money supply had dropped off enough that we thought it made sense to sell stocks, and look for a better entry lower. We didn't go as low as I had hoped. We saw the market drop from 10800 to 10000. The Nasdaq gave up 100-plus points, the S&P pulled back. I would still like to see a firmer bottom being made. That said, at some point over the next month or so, I think we'll see our most tradable low in the major indexes, which will signal the start of one of the strongest rallies of this post-bubble period. If my timing is correct, and if my macroeconomic assessment is correct...there will be a rally from June through November. That period that five-month period will encompass a significant rally. Historically, the last rally of a bull market tends to be the strongest within the cycle.

SM: What indicators are telling you that a market top is coming?

BR: I have a philosophical approach. I believe in something called variant perception. I don't believe the market is perfectly efficient. It's not nearly as efficient as people think it is. If you could figure out where the masses of investors are getting it wrong, there's money to be made in those circumstances. What makes it so challenging to do well is that being right is not much to do with making money. You have to not only find out where the crowd is wrong and where their perception is varying from reality, but figure out how long it will take to come back into focus, to come back to reality.

The housing bubble is a good example of this. The whole world is insisting there's a housing bubble. If you forget everything you've heard, and think about the classic definition of a bubble, the factors don't really exist. In 1999, 90% of stocks purchased were held for less than a year. The National Association of Realtors just did a study that said that less than 3% of houses were sold within a year.... I think we have a bubble in bubbles. That's what I assume is going on now. People who missed the bubble in dot com, in tech, all of a sudden, don't want to get embarrassed. They're seeing bubbles everywhere they look. We're all guilty of it.

SM: How does inflation play into your outlook?

BR: No matter what measure you use for inflation commodities, wood pulp, cement, when you look at the price of food and health care there has been a big increase in prices. Automobile prices have gone up significantly.... Yet I continue to hear people look at various data points, and look at it like Candide, and say that everything is the best of all possible worlds.

On the inflation side, the 30-year bond "conundrum," as Greenspan called it, has nothing to do with inflation the Fed can do something about. It's too few dollars chasing too many goods. We clearly don't have wage inflation. The Fed is relatively powerless to do anything about inflation. They're trying to do something about the housing bubble. If anyone thinks that housing will pull back 80% like the Nasdaq did, then we'll be living in a hefty recession. I don't think that's going to happen. Inflation looks low, but really isn't low.

SM: So what do you think this increasing level of inflation portends for the economy?

BR: Would the 10-year [Treasury] note drop below 4% if everybody is really anticipating robust growth? My theory is that the 10-year is below 4% because (a) Asia is exporting deflation. We have inflationary issues on the commodities side; and (b) there's a lack of supply of the 30-year bond... I read this as anticipation by the bond market of a slowdown. Call it a flight to quality. The bond market is actually looking for a weakening. Also China and Japan the trade deficit is so huge, they're buying tons of securities. How can people say there's no inflation? Everything we buy costs more than it used to.

Growth is more anemic and inflation is worse than people realize. The way that that will become an investing thesis is when it dawns on people that this economy isn't that hot. The variant perception is to see what people believe. The market goes down when there are more sellers than buyers. Anticipating the reversal of that when there are more buyers than sellers is the key to making money.

SM: You've said you anticipate an economic withdrawal of stimulus. What do you mean by that?

BR: In the history of market crashes, there's been anemic to low job creation, low capital spending. The government decided that wasn't acceptable. They basically cranked up stimulus as strongly as they could: a trillion dollar tax cut, cutting capital-gains taxes, dividend tax cut, the Fed cut interest rates, the Fed cranked up money supply, wartime spending. That's pretty much every lever the government has at their disposal. It's a way to have an economic recovery without having to pay for excess of the '90s. It takes about a decade to work all that out after a downturn. Here we have a situation where we've thrown everything we have at the economy. The stimulus is like trying to temporarily revive the Frankenstein body off the slab. But once the electricity is turned off the Frankenstein monster falls back on the slab. That's been the Frankenstein economy. The stimulus is failing.

[The question is] are the masses of investors interpreting the data right? And if they're not, when will they figure it out? In the market, it doesn't matter what you believe to be true because you're one vote, even if you run a billion-dollar fund. It matters anticipating what everybody else is going to do. And that creates anomalies; you end up selling stuff you like and buying stuff you think will end up in the crapper... In the market, you don't want to be right, you want to make money.

SM: Has this principle ever steered you wrong?

BR: Here's an example of variant perception where I was wrong. Tyco International got bad it went down to single digits. I thought, it's such a debacle, I don't want anything to do with it. One of my rules is if you haven't done in-depth research into a company, go back and start from scratch. From July 2001 to 2002, Tyco underwent major change.... But I was just so unhappy with Tyco previously. I still violated that rule. It went up significantly from single digits, to mid-30s, back to high-20s. You can't marry a prediction.

One of my best picks last year was Apple Computer. I got one of the very first iPods out there. I thought it was going to be a home run. Every person I spoke to thought Apple's a dead company. I bought it sometime in 2002, 2003, when the first iPod came out. For the longest time Apple was trading at $13 to $18. People have a conception in their minds it's people being intellectually lazy. They get thoughts in their minds and they get cemented. It's very challenging to remain open minded and flexible. If you don't do that, you're going to miss opportunities. I urge investors to have a prenuptial agreement with a stock; if the following things happen, I will divorce the stock.

SM: Are there other stocks you like right now?

BR: Understand that any picks here are for trading, and not investing. I fully expect to seriously reconfigure my portfolio of holdings by year's end.

I would look to get long the Semiconductor HOLDRs Trust, Nasdaq 100 Trust and S&P 500 Depositary Receipts over the next few weeks, with the intention of selling them toward the November/December time frame. About the same time, depending upon conditions, I would be looking for an opportunity to get short very short. I suspect the present rally will run longer and further than many expect, but I also think that the potential downside into 2006 is quite substantial. I don't want to put a number on it, but it could surprise people a great deal.

SM: Your forecast for next year sounds pretty ominous. What's convincing you it might be a dismal year for the stock market?

BR: I looked at a century-long history of market rallies and crashes. I found that after each major crash, it tends to be followed by a war, sometime over the next decade. And you tend to have a sideways period in the market for a long time. After 1929, we had World War II. Then there was a global depression going on. Then at the same time it took from 1929 to 1954 for the market to break even. In 1966, the Dow hit 1000. We had the Vietnam War. It took from 1966 to 1982 for the Dow to finally get through 1000 on a permanent basis. The third time, in 1999-2000, we had a huge collapse, 80% on the Nasdaq. Iraq is a significant war. It wouldn't be unprecedented to see the market pretty much sideways or be range-bound from 2500 down to 1000 for the Nasdaq.

Post-bubble, historically, the market collapses, reinflates about 50%, then pops a second time. It makes the second collapse worse than the first. That happened in 1989 in Japan, it happened in 1929, and the "nifty fifties." If it happens in 2006-07, everyone will be stunned by it. My anticipation is that I'd love to see the Nasdaq make its way up to 2500. That would be the peak of this post-bubble rally. Then it would get ugly for 2006-07.