3Q results | Northwest stocks shine, but market fears remain

Stocks finished their second strong quarter in a row Wednesday, but continuing worries about the health of the U.S. economy trimmed the quarter's gains and called into question whether the nearly seven-month rally will continue.

The Dow Jones Industrial Average gained 15 percent in the third quarter, after an 11 percent gain in the second quarter. The Standard & Poor's 500, a broader and arguably better measure of the U.S. stock market, also rose 15 percent in the third quarter, nearly matching its second-quarter performance.

The Seattle Times index of Northwest companies, however, beat them both. The index, comprising all companies headquartered in Washington, Oregon and Idaho, rose 18.7 percent in the quarter, on top of a 17.8 gain in the second quarter.

But all the impressive gains have merely brought the major indexes back to where they were about a year ago — as stocks were free-falling after the global financial crisis. David Kelly, chief market strategist for JPMorgan Funds, called it an "Armageddon averted" rally.

But, Kelly added, investors have yet to be convinced the economy is fully back on track. If they were, he said, presumably the stock indexes would be above the highs they reached in October 2007, instead of 25 to 33 percent below them.

That hesitancy was on display in Wednesday's trading. Stocks got a lift from the government's stronger-than-expected final revision of second-quarter gross domestic product (GDP), but were hurt when a report on Midwest manufacturing came in weaker than expected.

David Darst, chief investment strategist for Morgan Stanley Smith Barney, said investors have moved through the "grief" and "relief" stages, and are now in a "where's the beef?" mood.

People will need to see clear signs that business investment, corporate profits and especially consumer spending have recovered, he said, before they're willing to put more money into stocks.

"The person who is still missing from this party is the consumer, and that's got to happen if this leg (of the rally) is going to have any strength in it," Darst said.

Consumer spending may take awhile to recover, though. A Federal Reserve report last month showed total consumer credit decreasing in July at an annual rate of 10.4 percent. And a Rutgers University report released this week projects that the U.S. labor market may not fully recover to pre-recession levels until 2017.

The bleak employment outlook may be one reason investors have been pulling money out of stock funds and putting it into bond funds throughout the current rally.

"Many individuals are still shellshocked" from last year's plunge, Kelly said. "They don't believe in the stock market. They think it's a good place to lose money."

"The sentiment is, I got part of my money back, so I'm going to get it out and leave it on the sidelines for a while," added Phil Scott, a financial adviser for Merrill Lynch Global Wealth Management in Bellevue.

Nonetheless, 108 of the 133 Northwest stocks in the Times index gained in the quarter.

Local stocks were topped by Richland-based IsoRay, which makes radioactive "seeds" for use in cancer therapy. IsoRay's shares more than quadrupled (granted, from 25 cents) after an encouraging clinical trial and an FDA ruling opened up new potential markets for its seeds.

Half of the 24 Northwest stocks that fell during the quarter were banks — evidence that investors don't believe the worst is over for the region's banking sector. The worst performer, Cowlitz Bancorporation of Longview, lost nearly half its value, finishing the quarter at $1.18.

Regional banks remain out of favor in large part because of their heavy lending to homebuilders, many of whom can't repay their loans.

Nationally, the bursting of the housing bubble continued to weigh on thrifts and mortgage-finance companies; they were one of the quarter's weakest sectors, gaining less than 5 percent.

Barring any new economic shocks, market watchers generally expect the bull run to continue, though not without some stumbles.

"Stocks look overbought to me, and I wouldn't be surprised at a correction of 5, 7, 10 percent," Morgan Stanley's Darst said.

Kelly, while expressing optimism about the longer-term prospects for both the economy and the markets, said investors should take "a good long look at the calendar" before deciding whether to dive back in.

"I would not be in stocks unless you're going to be in for a minimum of three to five years," he said. "If you need the money in a year or so, it's probably best to play it safe."

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