Stock market outlook remains hazy

WASHINGTON — After riding a remarkable stock market turnaround in the second quarter, investors cannot help but ask: Will the drive continue or do pitfalls lurk on the horizon?

Stocks staged their biggest quarterly rally in years during the three months ended June 30, with the Standard &Poor’s 500-stock index — the broadest U.S. market barometer — rising 15.2 percent. That nearly reversed the steep losses of the first quarter, when the S&P 500 dropped by 11.7 percent, hitting its lowest level in nearly 13 years on March 9.

Wall Street regained its momentum over the past three months as a variety of economic indicators suggested that the recession could be easing and that government efforts to contain the financial crisis were working. But any number of things could send the market tumbling — or soaring — in the third quarter, analysts said.

“The market is kind of pausing to look ahead and see what happens next,” said Jerry Webman, chief economist of Oppenheimer Funds.

Investors have plenty of places to watch for signs of how much longer the recession could last: corporate earnings, economic growth, unemployment, foreclosures, oil prices.

They will also keep a close eye on Washington as the Obama administration continues to roll out the stimulus package.

Conflicts overseas could shake investor confidence. Any crisis in the Middle East or tensions with North Korea could stall a sustainable market recovery.

“I think the third quarter is a really important one for investors,” said Jeffrey Kleintop, chief market strategist for LPL Financial Services.

For now, investors can at least take a breather after the first upbeat quarter since the recession took hold in late 2007. The results were not blockbuster, but they shined against the deep gloom of the credit crisis.

“The bar was set so low that investors were convinced the banks were going to be nationalized, the Democrats were not going to be able to put forward a proposal that would quell investors’ concerns as well as those on Main Street, and stock prices would decline to levels rivaling what was seen in the 1929 to 1932 crash,” said Sam Stovall, chief investment strategist for Standard &Poor’s Equity Research. “Yet just at the bleakest point, stocks turned around.”

The Dow Jones industrial average, which measures the performance of 30 blue-chip stocks, rose 11 percent. Mutual fund investors also saw gains. Funds that invest in diversified U.S. stocks climbed 17.05 percent, according to Lipper, a fund-tracking firm.

Every sector of the S&P 500 posted gains in the second quarter, reaching a high on June 12. Financials soared 100 percent, industrials 55 percent and materials 54 percent. Even the three worst-performing sectors — health care, telecommunications services and consumer staples — were up 17, 18 and 21 percent, respectively.

Looking ahead, some analysts point to historical data as evidence that the market will lose some ground this quarter but eventually recover.

Bear-market bottoms are often followed by a sharp bounce. During the ensuing few months, the market tends to drop 10 to 15 percent, Stovall said. Then it gains an average of 36 percent in the 12 months that follow this corrective phase, he said. “Right now, the market is going through what I believe is a normal historic event,” Stovall said, adding that the S&P 500 will probably drop to between 800 and 825. The index closed Friday at 879.13.

Webman, meanwhile, said the third quarter will mark the beginning of the recovery from the recession, which will keep abating gradually into next year. The market, he said, is “not going to get there in a linear fashion and it’ll get freaked out at some points.”

Robert Loest, a senior portfolio manager for Integrity Mutual Funds, offered a bleaker outlook, pointing to unemployment — which he expects to continue to climb — and a new wave of foreclosures set to hit next year. “There’s some big negative events out there,” he said. “We’re sort of right now in a temporary placid period.”

That placid period began after the market fell so far in March that investors were tempted to return to the market to scoop up bargain prices. They were also buoyed by economic data, such as retail sales and consumer confidence, that began to look either a little more upbeat or a little less dire.

Global financial services funds were the top performers, up 32.35 percent. Global science and technology funds and global natural resources funds also did well, up 24.96 and 24.47 percent, respectively, according to Lipper. Emerging markets funds also made a comeback, up 36.85 percent.

Bond funds didn’t fare as well as stock funds, with many U.S. government bond funds posting negative or flat returns. Still, the average domestic fixed-income fund was up 6.97 percent.