Third-quarter markets roundup | Northwest stocks outperform other regions

Stocks recovered somewhat Tuesday from their heart-stopping plunge a day earlier, providing at least a modestly upbeat ending to the most volatile third quarter in decades.

But despite Tuesday's gains, market watchers warned that more instability is almost certainly ahead, even if Congress succeeds in enacting a rescue package for the mortgage-battered financial industry.

"People are freaking out on a day-by-day basis," said Mark Corcoran, a senior research analyst in D.A. Davidson's private client group. "They can be either euphoric or depressed."

He said traders were displaying "bipolar" reactions to the ongoing financial crisis, as they speculate about which financial titan might be next to topple and assess the government's as-yet fruitless efforts to settle things down.

The past two days exemplified that dynamic. Major indexes plunged after the House of Representatives unexpectedly shot down the proposed $700 billion bailout bill: The Standard & Poor's 500 index, perhaps the single best gauge of the U.S. stock market, fell 8.8 percent.

But markets rebounded Tuesday, on hopes that lawmakers would be able to salvage a rescue plan later this week. The S&P jumped 58.35 points, or 5.3 percent, to finish the month and the quarter at 1,164.74.

The Dow Jones industrial average, which sank nearly 7 percent, or 777.68 points, Monday — its biggest point drop ever, though not its biggest percentage drop — rose 485.21 points Tuesday, for a 4.7 percent gain.

The technology-heavy Nasdaq composite followed its 9.1 percent drop Monday with a gain of nearly 5 percent Tuesday.

Still, all the major indexes fell during the quarter and are down deeply for the year. The Dow is off 4.4 percent for the quarter and 18.2 percent so far this year; the S&P is down 8.9 percent and 20.6 percent; and the Nasdaq is off 9.2 percent and 21.5 percent.

The Seattle Times index, which includes all companies traded on a major exchange and headquartered in Washington, Oregon or Idaho, behaved much like the regional economy: Down, but still better than the rest of the nation.

The Times index closed out the quarter at 1,517.50, for a 2.5 percent gain on the day. However, the index was down 2.9 percent for the quarter and is off 12.5 percent so far this year.

The financial sector has been at the epicenter of the crisis. So far this year, Bear Stearns, Lehman Brothers, AIG, Wachovia, Fannie Mae, Freddie Mac, Merrill Lynch, IndyMac — and, of course, Seattle's own Washington Mutual — have gone bust, been taken over by the federal government and/or been bought out by competitors.

But those headline names obscured the fact that many smaller financial institutions were among the quarter's strongest performers, though they achieved that status only after steep declines earlier this year.

The Northwest's top-performing bank, for instance, was Sterling Financial of Spokane. After losing three-quarters of their value in the first half of the year, Sterling shares more than tripled in the third quarter.

In fact, of the 10 best-performing Northwest companies in the third quarter, eight were community banks. And S&P's small-capitalization financial index was up 17.6 percent on the quarter, while its large-cap index was flat.

Corcoran, though, suspects that the full force of the financial crisis hasn't hit the smaller banks yet.

"I don't think we're going to have as many banks fail as we did in the savings-and-loan crisis" of the 1980s and early '90s, he said. But, he added, the fate of regional banks depends on the outlook for the overall economy, especially the construction sector with which many smaller banks do much of their business.

Beyond the dizzying rises and falls of the past week or so, the markets are wringing out several years' worth of bad debts and overvalued assets that had inflated stock prices beyond reasonable levels.

"The markets are going through a very painful and very volatile deleveraging process, and you're going to see a lot of wild swings during that process," said Michael Butler, CEO of Cascadia Capital, a Seattle investment bank.

Much of the economic growth of the past few years, Butler said, was fueled by low interest rates and oceans of easy money that encouraged borrowing, or "leverage" in finance-speak.

"Leverage works both ways," he said. "It enhances your returns, but when things go south it magnifies your losses."

Both the easy money and low rates have since disappeared, replaced by a credit squeeze that threatens to paralyze much of the global economy.

Neither Corcoran nor Butler expects much improvement for the fourth quarter. Beyond a few sectors that aren't closely tied to the economic cycle — food and beverages, household products, health care, some energy producers — most industries will be dragged lower by the credit crunch and the sluggish economy.

"The typical earnings release will run like this — 'We made our numbers, and we're guiding down,' " Corcoran said.

In the near term, Butler said, a federal bailout plan likely will make the ride even rockier on Wall Street.

By establishing a price floor for dubious mortgage-backed securities and other distressed assets, such a plan would permit companies to start figuring out just what they own, how much it's worth, how to get rid of it and — most important — how to report the results to investors.

"Assuming Congress does something, I think you're going to see increased volatility in the marketplace with increased transparency," Butler said. "Once you get through that period, then you should see some stability."

Drew DeSilver: 206-464-3145 or ddesilver@seattletimes.com