Stocks Broke Tradition in 3rd Quarter
Interest Rates, Oil Prices Credited for Strong Market

By Brooke A. Masters
Washington Post Staff Writer
Saturday, September 30, 2006

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.

Analysts are divided as to where the markets go from here. Historically, the fourth quarter is positive. Since World War II, the average gain in the S&P has been 4.3 percent, and the market has lost money in only one of every five years.

"If it has happened in the past, it can happen in the future. A Dow of 14,000 would not be too surprising," said Curtis A. Teberg, who runs a fund of mutual funds that moves money from cash to equities and back based on historical patterns. He didn't do so well the third quarter but remains optimistic about his model. "The four most abused words in the financial sector are 'this time it's different,' " he said.

S&P's Stovall remains cautious, noting that the market took its biggest single-day dive ever in October 1987. "I think the market is getting ahead of itself," he said. "We could still experience a bull market correction. When nobody's looking for it, that's when it is likely to happen."

Movers

General Motors rose 78 cents, to $33.06. Kirk Kerkorian said he was interested in buying up to 12 million more GM shares as he presses for an alliance with Renault and Nissan.

Hewlett-Packard rose 58 cents, to $35.97.

American Greetings fell $2.21, to $22.83.

Indexes

New York Stock Exchange composite index fell 21.03, to 8469.65.

American Stock Exchange index fell 10.06, to 1906.86.

Russell 2000 index of smaller-company stocks fell 6.97, to 725.59.

Volume

NYSE: 2.28 billion shares, down from 2.36 billion on Thursday. Decliners outnumbered advancers 10 to 7.

Nasdaq: 1.86 billion shares, down from 1.91 billion. Decliners outnumbered advancers 3 to 2.

Commodities

Crude oil for November delivery: $62.91, up 15 cents.

Gold for current delivery: $598.60 a troy ounce, down from $605.00 on Thursday.