The recent stock market rally from the March 9 low has provided investors with a promise that things may get better in the economy, markets and exchange traded funds (ETFs). However, there’s still a lot of grim economic news that could lead to a long basing period.

Quite often when stocks settle into a basing environment, they are taking a pause and perhaps preparing for a sustained rebound somewhere down the road. Many traders now appear to be buying stocks in anticipation of a recovery at least four to six months from now.

In a basing period, stocks are in a long-term trading range, which might be narrow or somewhat wide, and this usually occurs after a major correction. During these periods, rallies off the bottom tend to be quick and short-lived. As stocks spike, they reach a level of resistance that they cannot break through. Then they decline again, testing their previous lows.

The trading range of the basing period typically is a function of the magnitude of the prior correction. Palash R. Ghosh for Dow Jones Newswires spoke to us about the basing period.

We saw a decline of 50%-55% in the recent bear market decline. The rebound we just witnessed was about 20%-25% off the bottom, which represents a pretty tepid recovery.

Disappointing first quarter earnings – which many expect – could help the current rally peter out, leading the market to test new lows. On the bright side, equities will likely remain above those lows, buoyed by confidence in the government’s stimulus packages and expectations of an economic recovery later in 2009 or early 2010.

A basing period helps the market build up resistance. Even if we get worse news on the economic or earnings fronts, stocks may have the resilience to keep above recent lows because a firm bottom has already been established.

Thus, setting a base can be a welcome development. It can mean stability, even if fundamentals are not that encouraging, reflecting the fact that the market is taking things in stride with the anticipation of positive economic/market news several months down the road.

Tags: ETF 101, ETF Trends in the Press, S&P 500