Best Quarter in Years for Stocks
The stock market on Monday wrapped up its strongest quarter in years, boosting investors’ hopes that the long bear market has passed on.
But that may have been the easy part.
Now the economy will have to deliver a turnaround to back up the optimism that has lifted share prices.
Many Wall Street pros believe that the U.S.-Iraq conflict was the last obstacle in the way of a market recovery, after three years of deep gloom that wiped out trillions of dollars of stock wealth. Anticipating a quick end to at least the first phase of the war, the market took off in mid-March and has rarely looked back since.
The Dow Jones industrial average dipped 3.61 points Monday, but rose a net 993.31 points in the second quarter, or 12.4%, to finish Monday at 8,985.44. It was the Dow’s best quarterly percentage gain since the fourth period of 2001, when it rose 13.3%.
The broader Standard & Poor’s 500 index jumped 14.9% in the quarter, its biggest advance since the fourth quarter of 1998.
Since Jan. 1 the Dow is up 7.7% and the S&P; 500 has risen 10.8%.
Though stocks overall have pulled back somewhat in the last two weeks, nearly every category of stock mutual funds is in positive territory this year, according to fund-tracker Lipper Inc. in Denver. That should make mid-year financial statements much easier on the eyes of investors who have seen their accounts mostly dwindle since the market peaked in March 2000.
Indeed, it was tough to lose money in stock and bond markets worldwide in the first half. A plunge in bond yields -- driven first by safe-haven buying before the war, and later by the Federal Reserve’s suggestion that inflation might turn into deflation -- made older bonds appreciate in value. As for foreign stocks, they mostly followed U.S. shares higher in the second quarter.
But on Wall Street, at least, some may wonder whether they’re watching a rerun of the waning days of the late 1990s stock bubble: The highest-flying shares this year have been in sectors that arguably are filled with many highly speculative companies -- in particular, biotechnology and the Internet, both of which were preeminent symbols of the last bubble.
The Interactive Week index of 45 Net-related stocks, including EBay Inc., Yahoo Inc. and Broadcom Corp., is up 34.5% this year. The Nasdaq index of 75 biotech stocks, including Amgen Inc., Gilead Sciences Inc. and Human Genome Sciences Inc., is up 35.3%.
Strength in those sectors helped drive the Nasdaq composite index up 21% in the second quarter and 21.5% for the year, to 1,622.80 on Monday. Nasdaq’s quarterly gain was its biggest since the fourth quarter of 2001.
Likewise, shares of smaller companies in general have performed better this year than those of blue-chip giants. The Russell 2,000 index of smaller stocks jumped 23% in the second quarter, its best rally since the first quarter of 1991.
The surge in more speculative stocks -- especially those that have yet to earn a dime, such as Human Genome Sciences -- has been held up as a symbol that the 2003 rally is mostly the work of short-term traders who are just trying to make a quick buck.
“This is just a typical bear-market rally,” said Steve Hochberg, chief analyst at research firm Elliott Wave International in Gainesville, Ga. He expects prices to tumble anew this summer. The trend has been going his way over the last two weeks: The Dow has fallen 3.6% from its spring peak of 9,323.02 on June 17.
Market optimists, however, insist that the tide has turned in their favor, and that the spring rally was the start of a substantial move up, albeit one with periodic pullbacks.
“I think there is a window of a couple of years when we’ll be looking at significant outperformance by stocks,” said Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. “The upside is still pretty exciting.”
Like most market bulls, Paulsen figures the economy will improve in the second half of this year and into 2004, bolstering corporate earnings. In that kind of environment the stock market has shined more often than not.
But the U.S. economy’s ability to pick up speed remains a topic of heated debate. In theory, at least, there are more reasons to bet on a turnaround than on a new slump: Interest rates are at or near 45-year lows, and the Federal Reserve -- which cut its key short-term rate to 1% last week -- appears intent on keeping them there; the federal government just cut income tax rates again; and the dollar has weakened, making American exports cheaper abroad.
“I don’t think there has ever been a period of time when the economy has had so much stimulus,” said Joe Carson, economist at Alliance Capital Management in New York.
The stock market’s trend often has anticipated major economic shifts. If investors are foreseeing a healthier economy, then there’s nothing unusual about the market sectors that have led this year’s rally, said Kevin Marder, chief strategist at Ladenburg Thalmann Asset Management in Los Angeles: As investors return to the market after being sidelined for so long, they first seek out growth-oriented companies that might benefit most from a better economy, he said.
The surge in young growth stocks “makes it more likely that this rally is the real McCoy,” rather than a move that will quickly flame out, Marder said.
Still, the economic data have been mixed at best over the last two months. And though earnings for the blue-chip S&P; 500 companies have been rebounding since the second quarter of 2002, the rise in stock prices this year has left the market at price-to-earnings ratios that aren’t cheap, historically.
Earnings-tracker Thomson First Call in Boston says the S&P; now is priced at 32 times actual earnings per share over the last reported four quarters. Based on analysts’ estimates for “operating” earnings over the next 12 months, the S&P;’s P/E is 18. Market bulls, naturally, prefer to use the latter number to make their case.
Wells’ Paulsen concedes that stocks may not look cheap. But the prices investors are willing to pay for shares relative to expected earnings should in part reflect the alternatives, or lack of them, he said.
With money market yields at record lows of under 1%, and longer-term bond yields likewise near their lowest levels in a generation, the smarter bet is on stocks than on “cash” accounts or bonds if you believe the economy can and will do better, Paulsen said.
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U.S. vs. foreign markets
How some key indexes fared in the quarter and year to date:
*--* % change % change Country/index Monday close 2nd quarter Year to date Germany/DAX 3,220.58 +32.9% +11.3% U.S./Nasdaq composite 1,622.80 +21.0 +21.5 Mexico/IPC 7,054.99 +19.3 +15.1 France/CAC-40 3,084.10 +17.8 +0.7 U.S./S&P; 500 974.50 +14.9 +10.8 Japan/Nikkei-225 9,083.11 +13.9 +7.3 Britain/FTSE-100 4,031.20 +11.6 +2.3 Hong Kong/Hang Seng 9,577.12 +10.9 +2.7 Canada/TSX 6,983.14 +10.1 +5.6
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Source: Bloomberg NewsNote: Foreign markets measured in local currencies.
