Stocks Broke Tradition in 3rd Quarter

Interest Rates, Oil Prices Credited for Strong Market

A trader deals in Dow Jones industrial average futures at the Chicago Board of Trade. The Dow was up in the third quarter. (By Scott Olson -- Getty Images)

NEW YORK, Sept. 29 -- Historically, third quarters are losers. Over the past 16 years, the Standard & Poor's 500-stock index has on average lost 2 percent between the end of June and the end of September. "Sell in May, stay away," the Wall Street adage goes.

Not this year. Though the markets briefly dipped in mid-July, the major indicators have been on a hot streak since, and each ended the quarter with significant gains. The S&P 500, which rose 3.30 points to 1335.85 Friday, was up 5.2 percent for the quarter and at a 5 1/2 -year high. The Nasdaq composite index, which fell 11.59 Friday to 2258.43, was up nearly 4 percent.

The Dow Jones industrial average is flirting with its highest close, 11,722.98 in January 2000. The Dow briefly topped that level during the day Thursday and again on Friday before closing at 11,679.07, down 39.38 for the day but up 4.7 percent for the quarter.

"Every now and then the market serves up a reminder that history is a guide not gospel," said Sam Stovall, Standard & Poor's' chief market analyst, who had predicted a third-quarter correction. "It was a pretty good quarter across the board."

Strong sectors in the S&P 500 included health care, telecommunications and technology, which all gained more than 8 percent. The losers were energy, materials and industrial stocks. .

The third-quarter results were all the more welcome to some investors because they came after a six-week swoon in May and June, during which the S&P lost 7.7 percent and emerging-market and small-company stocks did even worse.

Market analysts attributed the turnaround to two key factors. The Federal Reserve, which had raised its benchmark short-term interest rate at 17 straight meetings over more than two years, finally took a break and held the rate at 5.25 percent at its August and September meetings. Crude oil prices, which peaked at $78 a barrel in July, fell precipitously and closed the quarter at $62.91. Accordingly, gasoline prices, which topped $3 a gallon this summer, also fell significantly.

Debt payments and energy are huge expenses for both businesses and consumers. The halt in interest-rate increases reduced fears of an economic slowdown, while the drop in energy prices eased concerns about inflation.

"Two of the biggest headwinds in this market, rising interest rates and high energy prices, became tailwinds, and the fundamentals shown through," said Arthur R. Hogan III, chief market analyst for Jefferies and Co.

Steven Wieting, U.S. economist for Citigroup, said he thought the third-quarter rally was due in large part to market overreaction in May and June to news of a major slowdown in the housing market.

"People were exaggerating the risks for the U.S. economy," he said. "The third quarter was a recovery from exceptionally low expectations."

The recovery was not universal. Large-company stocks -- the blue chips in the Dow and the S&P 500 -- are up from where they were in May, but the smaller companies aren't doing as well. The Russell 2000 index, which measures companies with smaller market values, was up slightly for the quarter, but down 6 percent from its peak in early May. Analysts said the contrast suggests that small- and medium-size companies have already had their run and that larger companies are also comparatively cheap.