After a Grueling Quarter, Investors Still Can’t Relax

Financial markets took a haircut at the hands of the Federal Reserve and other central banks in the second quarter.

For now, the bankers have just taken some off the top. The question for the second half of the year is whether the markets risk a serious buzz cut.

U.S. stocks ended mixed Friday in a relatively quiet finish to a raucous quarter. The blue-chip Standard & Poor’s 500 index closed at 1,270.20, off 2.67 points, or 0.2%, for the day. The S&P; lost 1.9% for the quarter, leaving it up 1.8% year to date.

The average U.S. stock mutual fund fell 3.6% in the quarter through Thursday and was up 2.7% year to date, according to Lipper Inc.

In the span of three months, stock markets worldwide went from giddy optimism about the future to deep foreboding before ending the quarter with a renewed sense of hopefulness. The markets’ relative calm of the last three years gave way to wild volatility in the second quarter.

The main driver of the emotional swings was the usual suspect: the Federal Reserve. With a flurry of warnings in early May about the threat of rising inflation, the Fed dashed expectations that it was near the end of its two-year credit-tightening campaign.

That triggered a stock plunge around the globe, provoked by fear that the Fed and other central banks would kill the global economic expansion.

But on Thursday, with a fresh hint that it might, in fact, be finished raising interest rates, the Fed helped stoke one of the strongest rallies on Wall Street in years. The Dow Jones industrial average rocketed 217.24 points, or 2%, on Thursday before ebbing 40.58 points Friday to end the quarter at 11,150.22.

“It may be premature, but I’ll take this mood adjustment,” said Robert Morris, an investment strategist at Lord, Abbett & Co. in Jersey City, N.J., who is bullish on stocks. “I think people were going too far the other way.”

The Dow was one of the few major stock indexes to eke out a positive return in the quarter, inching up 0.4% and lifting its year-to-date gain to 4%.

The big-name companies in the Dow benefited from investors’ sudden aversion to risk. Small-company stocks and those of emerging economies such as Russia and Brazil had far outpaced the Dow in recent years. But as the global sell-off picked up steam in May, money poured out of those more volatile markets.

On Wall Street, the Russell 2,000 small-stock index lost 14% from May 5 to June 13. That was nearly double the decline in the Dow index for the period.

Russian stocks plummeted 30% from their record high on May 6 to June 13. Brazil’s main index sank 22% from its peak on May 9 to June 13.

But money has crept back into stocks across the board in the last 2 1/2 weeks. The Russell 2,000 has jumped 7.7% from its mid-June low, including Friday’s gain of 1.4%.

The Russian market has rebounded 21% from its June low; Brazil’s market is up 12%.

Even the technology-heavy Nasdaq composite index, bedeviled by a growing scandal over many tech executives’ stockoption grants, has gained 4.8% since June 13. It ended Friday at 2,172.09, down 2.29 points for the day. It’s down 1.5% year to date.

The late-June recovery in stocks has given many investment pros more confidence that the spring sell-off was a normal short-term pullback.

“Our feeling is that what we’ve experienced is a correction in a bull market, not the beginning of a bear market,” said Sam Stovall, investment strategist at Standard & Poor’s.

The optimistic view centers on what Wall Street has come to call the Goldilocks scenario: The Fed and other central banks will tighten credit just enough to damp inflation and slow the global expansion to a more moderate pace but not enough to risk a recession.

But the chances of missteps clearly have increased, analysts say. One challenge for the central banks, and for the global economy, is that crude oil prices -- the source of much of the inflation anxiety in the markets -- refuse to come down.

Oil futures in New York rose 41 cents to $73.93 a barrel Friday, up from $66.63 at the start of the quarter and close to the record of $75.17 set on April 21.

“The Fed would feel better about stopping if oil were to fall,” said John Lonski, economist at Moody’s Investors Service.

The newly sinking dollar also could complicate matters. The buck has tumbled the last two days on expectations that the Fed might be done tightening. That could leave U.S. interest rates less attractive relative to foreign rates. A drooping dollar helps U.S. exporters, but it also can fire up inflation by raising the prices of imported goods.

Another more basic risk for stocks: Cash accounts and bonds are providing more competition for investable assets. Six-month Treasury bills now yield 5.23%. The yield on the 10-year T-note was 5.14% on Friday, down from 5.20% on Thursday but up from 4.85% at the start of the quarter and near a five-year high.

For some nervous investors, Lonski said, “cash is king right now.”