Bulls take markets on first-quarter thrill ride


The stock market posted its fourth straight winning quarter in the three months ended Wednesday, lifting key indexes to their highest levels in nearly 18 months -- and stoking more frustration for sidelined skeptics.

The Dow Jones industrial average fell 50.79 points, or 0.5%, to 10,856.63 for the day, but was up 428 points, or 4.1%, for the quarter. Most broader market indexes scored bigger gains.

Encouraged by fresh signs that the U.S. economy would sustain its recovery, some investors and traders opted to ramp up riskier bets, including on small-company stocks.

The Russell 2,000 index of smaller stocks jumped 8.5% in the three months, more than twice its fourth-quarter advance of 3.5%.

Stocks have continued to demonstrate the kind of resilience needed to keep faith in the bullish trend alive, said Richard Sparks, an analyst at Schaeffer’s Investment Research in Cincinnati.

“The market battles back from every bit of bad news,” he said. For the last year, “you see every dip being bought.”

The bulls last quarter faced their biggest test since the rebound in share prices began in March 2009.

Fear that the Greek government would default on its debt and fuel a new phase of the global credit crisis helped trigger a steep sell-off in stocks worldwide in mid-January.

The Standard & Poor’s 500 index slumped 8.1% from Jan. 20 to Feb. 8, the largest pullback of the yearlong rally. Some broader U.S. indexes fell almost 10%.

But just as market bears began to believe that the bulls had been routed, stocks turned higher again. The S&P 500 climbed with few interruptions from mid-February to mid-March and reached a 17-month high of 1,174.17 on March 23 before easing in recent days.

On Wednesday the S&P slipped 0.3% to 1,169.43. The quarter’s net gain: 4.9%.

U.S. investors generally made more money in domestic stocks than in foreign issues in the quarter, in part because Greece’s debt woes helped bolster the dollar’s image as a haven in times of global turmoil. The weakness of other currencies against the greenback in the three months blunted foreign markets’ gains when translated into dollars.

The German market, for example, was up 3.3% in euros but down 2.6% in dollars.

John Kornitzer, who oversees $6 billion in stock and bond assets at Kornitzer Capital Management in Shawnee Mission, Kan., said that although the U.S. economy should “muddle through” rather than accelerate sharply this year, that would be good enough to keep many investors in the stock market.

“Why would someone sell now?” he said. “What would they do with the money?”

Short-term cash accounts such as money market mutual funds still pay virtually nothing as the Federal Reserve holds its benchmark interest rate near zero, Kornitzer noted.

Meanwhile, even though many small investors have continued to plow money into bonds rather than take a chance on stocks, jitters over European government debt last quarter showed that bonds, too, face risks.

Worries that Greece could default on its debt have receded, but a surge in market yields on Greek, Spanish, Portuguese and other European government bonds since Jan. 1 has caused the principal value of the countries’ previously issued, lower-yielding debt to decline.

The U.S. Treasury bond market got a jolt of its own last week: Market yields on longer-term Treasury issues jumped after the government’s auctions of $118 billion in new two-year, five-year and seven-year notes attracted fewer investors than expected.

The yield on the 10-year T-note, a benchmark for mortgage rates, rose to a nine-month high of 3.9% on Thursday from 3.66% just four days earlier. It ended the quarter at 3.83%, about the same as on Dec. 31.

Some bond pros say the weaker-than-expected demand at the Treasury auctions showed the market was beginning to balk at another year of record government borrowing to fund the budget deficit.

“The big issue is the market’s ability to continue to absorb the supply that’s coming,” said Robert Auwaerter, head of fixed-income investments at mutual fund titan Vanguard Group in Valley Forge, Pa.

The bond market faces another big test as the Federal Reserve begins to pull back from some of the special lending programs it launched in the depths of the credit crisis. On Wednesday the Fed finished its year-old program to buy $1.25 trillion of mortgage-backed bonds.

Auwaerter said he expected longer-term bond yields to rise further this year, but at a moderate pace. He said Vanguard’s prediction was for the 10-year T-note to be in the low-4% range by year’s end.

Given that forecast, “we think Treasuries and mortgage-backed securities are relatively unattractive now,” he said. Corporate bonds, which typically pay higher yields than government debt, are a better bet, Auwaerter said.

At some point, higher interest rates also could test the stock market. But historically it hasn’t been unusual in the initial stages of an economic recovery for share prices to rise even as interest rates rebound.

The best-performing stock sectors in the first quarter were those that typically represent bets on continuing economic growth.

Within the S&P 500 index, the industrial sector posted the biggest gain of 10 major sectors, rising 12%. Industrial equipment maker Eaton Corp. surged 19%; truck engine giant Cummins Inc. rocketed 35%.

Many retail stocks also showed surprising strength amid better-than-anticipated reports on consumer spending. Macy’s Inc. soared 30%; Home Depot Inc. was up almost 12%.

Wall Street bulls are expecting strong first-quarter earnings reports for the S&P 500 companies overall to justify stocks’ recent gains.

S&P companies’ operating earnings are expected to be up 37%, on average, from the depressed results of a year earlier, according to analyst estimates compiled by Thomson Reuters.

But in the near term, one key question will be whether the market has gotten too far ahead of the economy.

With oil prices reaching $83.76 a barrel Wednesday, a 17-month high, consumer spending could face a new head wind.

Even many optimists warn that market volatility is likely to increase as investors become more discerning about corporate winners and losers as the bull market enters its second year.

Stephen Wood, chief market strategist at Russell Investments in New York, said he expected market indexes to post high-single-digit returns in 2010. But from this point, he said, “We see a sloppy, ugly, grinding market -- with an upward bias.”