Despite head winds, U.S. stocks eke out small gains in first half

Despite head winds, U.S. stocks eke out small gains in first half
Traders gather on the floor of the New York Stock Exchange. (Richard Drew / Associated Press)

World financial markets ended the first six months this year amid the uncomfortably familiar sound of bubbles popping: debt bubbles in Greece and Puerto Rico and a potential stock bubble in China.

Still, U.S. stocks overall managed to grind out small gains in the half, extending the six-year bull market, as many investors continued to bet on a stronger economy. Foreign markets mostly beat U.S. shares.


But what was good for stocks was bad for bonds, as the prospect of Federal Reserve interest rate hikes depressed U.S. fixed-income markets.

Wall Street ended Tuesday with the Dow Jones industrial average up 23.16 points, or 0.1%, to 17,619.51, stabilizing after Monday's 350-point plunge triggered by Greece's worsening financial woes.

Although the 30-stock Dow lost 1.1% in the first half, most broader U.S. market indexes were in the green.

The Standard & Poor's 500 index, a benchmark for many retirement savings accounts, added 5.48 points Tuesday, or 0.3%, to 2,063.12 and eked out a 0.2% advance in the half. Counting dividends earned, the S&P's return was 1.2% in the period. But the S&P fell in the second quarter, breaking a nine-quarter winning streak.

In a surprise, the U.S. market's strength in the first half was in shares of small- and mid-size companies. The Russell 2000 small-stock index, for example, gained 4.8% in the six months, including dividends, and hit an all-time high last week.

The smaller stocks' rally ran counter to what many financial pros were recommending at the start of the year, which was to stick with higher-quality, big-name companies. Sam Stovall, U.S. equity strategist at S&P Capital IQ in New York, said it appeared that some investors were shunning American multinational companies in part because of the dollar's appreciation, which devalues profits earned abroad.

"I think investors were turning away from international exposure," Stovall said. Because many smaller companies do the bulk of their business domestically, they seemed a safer choice.

Yet stocks in Europe, Japan and China produced bigger gains for U.S. investors than domestic shares in the half, a shift from the trend of the last three years.

In the last week global markets have been rattled by events that seem to echo the debt-driven calamity of late 2008.

After years of bailouts by the rest of Europe, Greece failed to make its payment Tuesday on its massive debt — and may end up exiting the euro currency. Puerto Rico, another heavy borrower, said its debts are "not payable."

And in China small investors using borrowed money helped fuel a wild first-half stock rally that hit a wall in mid-June. The Shanghai stock index, which rocketed 60% from year-end to its June peak, has since plunged 17%. It's still up 32% this year.

Many market pros said the events in Greece, Puerto Rico and China were widely expected and are unlikely to rattle Wall Street for long. Investors' main concern remains the health of the U.S. economy, which has rebounded from a winter slowdown caused mainly by terrible weather and a labor dispute at West Coast ports.

"Most of the economic evidence suggests the U.S. has recovered from its first-quarter economic contraction," said Russ Koesterich, global chief investment strategist at money management giant BlackRock Inc.

On Tuesday, the monthly consumer confidence report from the Conference Board showed that Americans' optimism about the economy surged in June.


"Overall, consumers are in considerably better spirits, and their renewed optimism could lead to a greater willingness to spend in the near-term," said Lynn Franco, director of economic indicators at the Conference Board.

If that boosts corporate earnings, it could help offset the stock market's biggest worry: investors' reaction when the Fed starts raising short-term interest rates from near-zero levels. That could happen toward the end of the year.

Here's a look at first-half highlights in major markets:

U.S. stocks: Investors appeared to be preparing for the Fed to start tightening credit. Some of the weakest stock groups in the first half were those considered most vulnerable to higher interest rates, such as utility shares.

The Dow utility stock index slumped 11% in the first six months.

By contrast, investors continued to snap up stocks in sectors that would benefit from stronger consumer spending. Those sectors included smaller stocks, healthcare, restaurants, financial services and technology. The tech-heavy Nasdaq composite index rose 5.3% in the half.

Bearish analysts, however, pointed to weakness in sectors that often are good barometers of the economy, including transportation stocks. The Dow transports index slid 11.5% in the half.

Steven Ricchiuto, chief economist at Mizuho Securities USA, said investors should be concerned about what he called "a loss of momentum in manufacturing" this year.

Foreign stocks: European and Japanese stocks were standouts in the first half as investors bet on two trends to continue: rock-bottom interest rates in those regions and weakness in their currencies against the dollar. A devalued currency automatically lowers the price of a country's exports abroad.

A weak currency also reduces foreign investors' returns in a country's securities. Even so, U.S. investors in the iShares MSCI EFA exchange-traded fund, which owns developed-markets stocks outside the U.S., earned 6.1% in the half — a better return than most U.S. stock sectors generated.

Many emerging markets, however, continued to disappoint, despite China's gains. Currency weakness weighed on U.S. investors' returns in Brazil, Mexico, India, Turkey and other markets.

U.S. bonds: After falling at the start of the year as the economy struggled, longer-term bond yields rebounded in spring. The bellwether 10-year Treasury note yield ended Tuesday at 2.35%, up from 2.17% at the end of last year.

Market yields also rose on corporate and municipal bonds in the half. The net effect was to depress the values of older bonds issued at fixed rates.

Many bond mutual funds posted modest losses in the half, meaning their interest earnings weren't enough to offset the drop in the value of their bonds. The popular Vanguard Total Bond Market exchange-traded fund lost 0.3% in the half.

For bond investors, the question is whether the first half was just a mild warning of what could happen when the Fed begins raising its benchmark interest rate.

With bond yields still near historic lows, the risk is that any Fed hike could drive yields higher across the board, devaluing older bonds.

Even so, experts note that high-quality bonds aren't likely to experience the kind of fast, deep losses that stocks can suffer.