Stock market has good second quarter even if off early June highs

Stocks closed out the second quarter on a down note Tuesday, further evidence that the rally that has sent major indexes a third or more above their March depths has stalled.

Analysts said that while traders no longer fear a complete collapse of the financial system — what one observer called the "Armageddon averted" rally — they'll need to see concrete signs of recovery before stocks can gain further.

"I think the market has gone about as far as it can go with the news being 'bad, but less bad,' " said Mark Eibel, director of client investment strategies for Russell Investments in Tacoma.

The benchmark Standard & Poor's 500 index fell 7.91 Tuesday to close at 919.32, for a 15.2 percent gain on the quarter. The Dow Jones industrial average slipped 82.38, to 8,447.00 and an 11 percent quarterly gain. The Nasdaq composite index lost 9.02, to 1,835.04, but ended the quarter with an impressive 20 percent gain.

The Seattle Times index of Pacific Northwest companies beat the S&P and the Dow, with a 17.8 percent gain in the quarter. The Times index finished at 1,382.76, but like the broader market measures was off somewhat from its recent highs in early June.

Since March 9, when all the major indexes hit low points, the economic free-fall has slowed and the global financial system no longer seems on the verge of imploding. The slippage in recent weeks is a sign that traders have moved from abject fear — pouring money into only the safest investments — to a more familiar posture of trying to gauge when the recession will end.

"We're fighting two illnesses at once," said David Kelly, chief market strategist for JPMorgan Funds. "We seem to be recovering from the world financial crisis, but we're still trying to get over a fairly nasty recession."

If it's true that stock-market rallies precede real-world recoveries by six to 12 months, the markets seem to be predicting that recovery will take root late this year.

That jibes with Eibel's view that gross domestic product — which fell 6.3 percent in the fourth quarter of 2008 and 5.5 percent in the first quarter — will fall 2.5 to 2.7 percent in the second quarter, be "slightly negative" in the third quarter and finally "slightly positive" in the fourth.

A striking feature of the springtime rally was the extent to which cyclical stocks — those whose performance is strongly correlated with the ups and downs of the economy — small-cap companies and others perceived as riskier outperformed the safer, more defensive issues.

For instance, the quarter's best-performing Northwest stock was Seattle-based biotech company Dendreon, which exploded after a key clinical trial showed its therapy, Provenge, extended survival time in men with terminal prostate cancer. Dendreon's shares almost sextupled in value, from $4.20 to $25.

Several of the best-performing industrial sectors — automakers, financial services, real-estate services — were precisely the ones traders had shunned not too long ago.

"The cyclical companies were so oversold, by any measure — price-to-sales ratio, EBITDA, enterprise value, take your pick — that it's natural for them to swing back," said Mark Corcoran, senior analyst at D.A. Davidson in suburban Portland. "The rubber band stretches just so far."

Looking ahead, market watchers said they expected a fairly flat summer, with little in the near term to kick-start stocks. Trading volume typically is low, and corporations likely will continue talking down their sales and profit expectations — the better to meet or beat them.

"No CEO is going to go out and say 'Hey, everything looks great' — you can only disappoint," Corcoran said. "I don't think anybody's going to miss out on a big stock rally this summer."

After Labor Day, though, traders will look more and more to 2010, which if nothing else should be better than 2009. Industrial production, GDP growth, retail sales, house prices, unemployment — those are the indicators that will tell investors whether the economy is truly headed for a recovery or falling back into 1970s-style "stagflation," with low growth, high unemployment and rising inflation.

But just as March 9 marked the bear market's trough only in retrospect, the second half's key turning point probably won't be apparent until the recovery is well under way.

"If investors wait for the white flag to be flown that says 'The economy has come back,' the markets will have already moved there," Russell's Eibel said.

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