Stocks: A Midyear Assessment

Six months of roller coaster drama in the stock market leaves investors no less confused about where we're headed

Laurel Daunis-Allen

By Ben Steverman

Halfway into a tumultuous 2009, investors are no doubt ready for their summer vacations. The first six months of the year—which officially ended June 30—have seen some of the wildest swings in stock market history.

Stocks started 2009 with a strong one-day rally, but soon began a nose dive that lasted two long months. By Mar. 9, the broad Standard & Poor's 500-stock index was down 25%—on top of the index's 37% loss in 2008—and trading at levels not seen since 1996.

Then suddenly, as if a switch had been flipped, the market started rallying. The S&P 500 ended the second quarter at 919.32, 36% above the March low.

Like passengers on a roller coaster, investors now find themselves almost exactly where they started. The S&P 500 is up 1.8% for the year. "We've had a whole lot of drama, and we haven't gotten a whole lot done," says Richard Sparks of Schaeffer's Investment Research.

Investor Confidence lost, regained

Other closely watched but less representative indexes had slightly different results. The Dow Jones industrial average, which includes just 30 of the biggest U.S. companies, has fallen 3.8% in 2009. The Nasdaq composite has rallied 16.4% this year, reflecting the strength of technology stocks.

At the beginning of the year, there was a great deal of uncertainty about where the economy and markets were headed. Little has changed in this respect. "We're looking for clues of what comes next," Sparks says. "The future isn't easy to see."

Not that investors haven't learned a thing or two from the past two quarters.

Market participants lost—and then regained— their confidence in the last six months. "We saw a crescendo of negativism about the state of the credit markets and the economy," says James King, president and chief investment officer at National Penn Investors Trust.

The news is still bad—in some cases, terrible—but, King says, "The hopelessness seems to have been removed from the market."

"we're shoveling money at companies"

The bolstered confidence has been a vast improvement in credit markets, say fixed-income investors. Brian Reynolds, chief market strategist at WJB Capital Group, calls it the "the biggest rally in credit in modern history."

"No one could get credit six months ago," he says. Now, "we're shoveling money at companies."

At the beginning of 2009, credit investors were pessimistic while many equity investors thought the credit crisis was ending, Reynolds says. Now, it's the opposite: Reynolds describes credit market participants as far more confident about a recovery than those in the equity market, where stocks have been stagnant for several weeks.

Many indexes of riskier credit products, such as high-yield corporate debt or municipal bonds, are up almost 30% so far this year, notes Bill Larkin, fixed-income portfolio manager at Cabot Money Management. If often-skittish fixed-income investors are willing to take on more risk, that's a sure sign that confidence is returning to financial markets.

But confidence is one thing, and facts and data are another. At least some economic data have showed, as Sparks says, that "the economy has stopped contracting."

The discussion, King says, has shifted from "Are we ever going to recover?" to "When are we going to recover?"

a key question: third-quarter GDP?

When indeed? Other key gauges of economic activity continue to worsen. Economists expect the U.S. jobless rate to rise from 9.4% in May to 9.6% in June when the government's employment report for June is issued on July 2.

"We're at a fork in the road," Larkin says. "The timing of this recovery is still in question."

A key example is U.S. gross domestic product. In the first quarter, the U.S. economy shrank 5.5%, while GDP is expected to drop at a slower 2.5% pace in the second quarter. But economists offer a wide array of predictions about the third quarter, some positive and some negative. As more data comes in, "people are going to start to move in one direction or the other," Larkin says. And that could be decisive for financial markets, he says.

Although stocks rallied strongly from March to early May, major indexes have been stuck in a narrow trading range for the past two months. "It's going to be hard for the market to make another huge rally without some pretty clear evidence [of] improvement," King says.

Thus, in many ways, the last six months of 2009 now look as cloudy and confusing as the first six months looked to be as the year began.

A recovery may be on the way. Credit markets have improved. Stock indexes have stopped falling and even recovered some losses. But nothing guarantees that the second half of 2009 will be any quieter or calmer than the first half. For investors, frazzled by the last six months and preparing for more craziness, maybe a brief vacation isn't such a bad idea.

Steverman is a reporter for BusinessWeek's Investing channel.

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