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Stocks Sizzled in Third Quarter, but Will it Last?

Friday, 01 Oct 2010 09:48 AM

 

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When you open your quarterly financial statements in the next few weeks, you might be both pleased and puzzled.

Despite the economic doldrums, the stock market put together a sizzling 11 percent return over the past three months, including its best September since 1939. For a time Thursday, the Dow Jones industrial average for a time appeared headed for 11,000.

But the gains are deceptive, market analysts say. While news about the economy has improved, there's no reason to believe it's roaring back. And the big advance was driven by a relatively small number of traders playing with a lot of money.

"I think a lot of this is just misguided optimism," says Rob Arnott, chairman of Research Affiliates, an investment firm in Newport Beach, Calif. "The headwinds we face are pretty daunting."

In other words, few are calling it the beginning of the next bull market — not with unemployment still near 10 percent and stocks bound in what market technicians call a trading range.

Still, the gains were impressive. In September alone, the Standard & Poor's 500 index rose 9 percent, the Dow almost 8 percent and the Nasdaq composite index 12 percent. Every sector of the market was up.

September is usually the market's worst month. This time, it was the third-best month of any kind in 10 years, narrowly trailing only March 2003 and April 2009, when stocks were bouncing back from meltdowns.

So why the rally? Economic news, while not great, was at least enough to dispel fears of a so-called double-dip recession. The Federal Reserve indicated it was closer to taking new action to help the economic recovery along.

And investors started looking past the November midterm elections and concluding that likely Republican pickups in Congress mean that tax increases are less likely.

The quarter got off to an inauspicious start. On the very first day of July, stocks dipped to what remains their low point of 2010: 1,011 for the S&P 500 index and 9,596 for the Dow in intraday trading.

After rebounding to finish July up 7 percent, the market limped through August. The S&P 500 fell nearly 5 percent, and the major indexes wiped out any gains for the year. Besides the tough job market, home sales were miserable and Americans were being cautious with their spending.

What first changed the tone of the market and started soothing double-dip worries was the Sept. 1 release of figures that showed surprisingly strong growth in the U.S. and Chinese manufacturing sectors.

More news trickled in throughout September that, if not terrific, was at least not bad. Payrolls and orders for durable goods improved, and there was a flurry of corporate deals, plus the hints from the Fed about further help. The rally was on.

"It's a huge relief and it was absolutely unexpected," says financial adviser Jon Stein, CEO of an online brokerage called Betterment.com.

While the gains did a lot for millions of 401(k) accounts and other investment holdings, the rally was rather thin, and some market observers say that's a sign it won't last.

Volume on the New York Stock Exchange has been unusually low for the last several weeks. And two important sectors — financial and health care stocks — have been lagging the others, showing signs of weakness that mirror the economy.

"In order for this rally to really steam higher, financials have to participate, and we really haven't seen that yet," says King Lip, chief investment officer for Baker Avenue Asset Management in San Francisco.

Investors took far more money out of stock funds than they put in — more than $42 billion for the quarter and more than $15 billion in September. Meanwhile, cash has moved into bonds for 21 months in a row, according to the Investment Company Institute.

"People are not swarming back into the market," says Morris Mark, president of New York investment firm Mark Asset Management. "There's a lot of money that could be invested, but it's not happening yet."

Everyday investors are still scarred from 2008, when some had more than half of their holdings wiped out during the meltdown. About half of American households own stocks, directly or indirectly, and many remain skittish because of the "flash crash" this May, when the Dow plunged nearly 1,000 points in minutes. Regulators are still investigating the sudden nose dive, which may have been triggered by computerized trading.

On top of that, the market is more volatile than usual. An Associated Press-CNBC poll taken in August and September found about three in five investors less confident about buying and selling individual stocks because of the volatility.

Financial professionals, too, are mixed in their outlooks.

Interviews this week with more than two dozen money managers, investment strategists and other experts turned up forecasts that the S&P 500 will be anywhere from 14 percent higher to 25 percent lower by the end of this year.

A government extension of income tax cuts from the past decade could lift stocks further, even though most think the market has already factored in the assumption that it will happen.

The S&P, now up 2 percent in 2010, has been trading largely in a range between 1,040 and 1,230 since mid-May. Analysts say the real test of whether the rally can continue its run will be if investors have enough conviction in the rally to push it through the 1,230 level, up nearly 8 percent from where it is now.

If they don't, there could be a sell-off.

Everyday investors, many of them leery of stocks, simply want to know whether it's safe to get back into the market for the long haul. And that may take more than one very nice quarterly financial statement.

"Clients want to know if they're going to be able to make it in retirement," says Larry Rosenthal, a financial planner in Manassas, Va. "They want simplicity and they want to know that they have dependable streams of income. What I hear a lot of is 'Are we going to be OK?'"

© Copyright 2014 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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