Spring's Rally Fades, and Dark Clouds Settle In

Once again, it was a disappointing quarter for U.S. stocks, as a spring rally fueled by investors' optimism that the worst of the financial crisis was over gave way to concerns about inflation, soaring oil prices and renewed fears about the ongoing credit crunch.

The Dow Jones industrial average, hurt by recent analyst downgrades of key companies such as General Motors and Citigroup, was down 7.4 percent for the quarter, after skirting bear market territory late last month. For the year, the Dow is off 14.4 percent, due in part to a first quarter in which the stock market had its worst performance in six years. The Standard & Poor's 500-stock index ended the quarter down 3.2 percent and is off 12.8 percent in the first six months of the year. The tech-heavy Nasdaq composite index was up 0.6 percent for the quarter but is down 13.6 percent for the year.

Mutual funds that invest in stocks recovered slightly, ending the quarter up 0.13 percent. But the year-to-date picture is much bleaker, with diversified U.S. stock funds off 10.1 percent.

"The first half of the quarter . . . [was] fairly optimistic. It looked like the economy was firming up a bit and consumers were coming back," said Christopher Low, chief economist at FTN Financial. "Now, we've ended the quarter with a fairly tremendous burst of pessimism."

With oil prices escalating, home values dropping, foreclosures rising, and major financial institutions continuing to take write-downs, it is unclear when a wave of optimism will once again be warranted. "Certainly not in the third quarter, and not anytime soon," said Charles McMillion, president and chief economist of MBG Information Services, a District-based business forecasting firm.

There were few safe havens last quarter. From large-cap funds that invest in big companies to international stock funds, which have been touted in recent years as safer bets, most mutual fund categories have been in the red, if not for the quarter then for the year.

Since January, the hardest-hit funds have been financials, telecoms, real estate and consumer services. The best-performing ones have been commodities and natural resources.

Looking ahead, analysts said that would likely remain the case, at least through the next quarter. Some analysts said commodities have become too speculative and would not be able to sustain such returns. Others say commodities, gold, biotechnology, metals, mining, and oil are still the way to go, while financials and real estate are not.

"All of those stand the best chance of upside," said Mike Tarsala, managing analyst at Thomson Financial's Squawk Box, which provides market analysis. "They're all giving us the strongest trends."

In the second quarter, small-cap funds were slightly better off than large-cap funds, reversing results from the previous quarter. While shares of small companies tend to outperform their larger peers when the economy is headed toward recovery, analysts said it was unclear whether this trend would continue in the months ahead.

"I don't know why small caps are doing well. I would be reluctant to hop on them," said Mark A. Coffelt, president and chief investment officer of Empiric Funds.

Tom Winmill, manager of the Midas Fund, a gold mutual fund, also said large-cap funds were still more stable. "With the freeze on credit, it's harder for smaller companies to raise debt financing than it is for larger companies," he said.