NEW YORK (CNN/Money) - The last week of December and the first week of January are always an important time for investors to size up the stock market.

If the outlook is encouraging, depressed stocks usually rally near year-end and continue their gains into mid-January. In addition, it's Wall Street lore that the market's overall behavior for the first week of January sets the tone for the year.

I expect that both these bellwethers will signal a strong 2004. The effects of the Bush tax cuts are still rippling through the economy. Inflation is extremely low. The Federal Reserve has made clear that it's in no hurry to raise interest rates. And after a recession and a long bear market, the economy is due for a substantial upturn.

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If you want to play the year-end bounce, your best bet is to pick stocks that have lagged over the past year and are selling way below their all-time highs.

There's a sound basis for the strategy. Investors typically reshuffle their portfolios at the end of each year. And since that's when the tax year ends for most individuals, they're likely to sell stocks that are deeply depressed to generate capital losses for tax deductions. That selling depresses those stocks even more.

Once tax selling is done, those stocks typically rebound and continue to rally into early January, as long as investors feel positive about the outlook for the coming year, as they clearly do now.

My top choice for comeback kid is Merck (MRK: Research, Estimates).

The pharmaceutical industry in general is suffering from an unimpressive new-product pipeline. The blockbuster drugs that fueled big pharma gains in the 1990s are coming off patent. Many drug giants don't have enough new products to replace the blockbusters that are winding down -- and Merck's lineup looks particularly skimpy.

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The expectations for Merck are now so low, however, that even mediocre performance would probably boost the share price. Projections for industry profit growth have fallen from double-digit annual rates to less than 10 percent. But Merck's earnings growth is projected to average less than 6 percent over the next five years.

Still, the company gets a triple-A rating for financial strength and the shares yield more than 3.2 percent. And at a current $46, the stock trades at less than 15 times estimated 2004 earnings. But it wouldn't take that much good news on the new product front to convince investors that Merck deserves a significantly higher valuation. And Merck invests about 13 percent of sales -- some $3 billion a year -- in research and development.

In a recent column, I asked rhetorically whether over the past decade an investor would have preferred owning shares in Oracle or my low-volatility picks, which offer more moderate -- and sustainable -- growth.

The implication was that Oracle's losses in the recent bear market made it the less-attractive choice.

One astute reader responded that he would have preferred Oracle to my safer picks. He argued that if you bought Oracle and held on throughout the past decade, ignoring the stock's setbacks and volatility, you would have made more over the entire decade than you would have earned on safer stocks.

That argument is literally true, but is unpersuasive in real-world investing. You can't just ignore volatility. No matter what investors say, few of them will actually hold on through scary ups and downs. And shareholders inevitably trim their holdings or bail out altogether at exactly the wrong time. That's why most investment strategists focus on risk-adjusted returns.

There's a place, of course, for aggressive-growth stocks in your portfolio. If you're well enough diversified, one or two aggressive-growth stocks will likely increase your total return without boosting your risk too much.

But in general, remember that moderate-growth stocks usually provide the best risk-adjusted returns. Moreover, since these stocks are typically underappreciated, there are stretches of time when they outperform aggressive growth stocks even on an unadjusted basis.

Michael Sivy is an editor-at-large for Money magazine. Sign up for free e-mail delivery of Sivy on Stocks every Tuesday and Thursday.