Shock therapy in the form of interest-rate cuts rescued a wobbly Wall Street in a volatile third quarter. History could provide the next big lift for stock investors in the final three months of 2007.
The record books show that the fourth quarter, which kicks off Monday, has been a very profitable period for stocks since the early 1990s. In the past 15 years, the broad U.S. stock market, as measured by the Standard & Poor’s 500 index, has declined in value in the fourth quarter only two times, according to Bespoke Investment Group. The average gain in the 13 instances where stocks have risen in the final three months of the year: 6.3 percent.
“The fourth quarter has been a good time to be in the market,” says Paul Hickey, managing partner at Bespoke.
This year should be no different, adds Hickey, despite the fallout from a credit crunch, ongoing housing slump and rising odds of a recession. “You don’t want to bet against the trend,” he says.
But it’s not just the seasonal tailwind that favors a year-end rally.
Another big perceived plus for the stock market is the fact that the Federal Reserve has stressed that it will do what is necessary to prevent the economy from falling into recession, says Bruce Bittles, chief investment strategist at R.W. Baird.
The Fed is credited with injecting much-needed confidence into the market when it cut its target for short-term interest rates a bigger-than-expected half-point to 4.75 percent on Sept. 18. That surprise move sparked a one-day rally of more than 335 points on the Dow Jones industrials and seemed to cement a stock market recovery.
The Dow, despite declining 8.2 percent from mid-July to mid-August because of uncertainty surrounding the potential losses on securities tied to subprime mortgages, was able to regain its footing with help from the Fed, finishing the third quarter with a gain of 3.6 percent. The Dow is up 11.5 percent in 2007. The S&P 500 is up 7.6 percent this year.
Despite major risks, such as a more severe housing contraction and resulting negative fallout on the economy, bulls think more gains – and new highs – are likely.
The reason: There is a strong belief on Wall Street that the nation’s central bank, headed by Chairman Ben Bernanke, is likely to cut rates again in the months ahead.
“If the Fed continues to lower rates, it is bullish,” Bittles says. Lower rates will boost economic growth, lower borrowing costs for consumers and businesses and provide a lift to corporate earnings.
But despite the bullish seasonals, downside risks remain, says Chris Johnson, CEO of Johnson Research Group. If inflation rises or the U.S. dollar continues to lose value, it could make it more difficult for the Fed to cut rates. He also fears corporate earnings will disappoint and that the good feelings from the Fed rate cut will dissipate. “Investors who have dismissed worries like subprime and housing will realize they are not going away,” he says.
