Risky Bets Won Last Quarter

07/14/2009 9:22 am EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor and publisher of NoLoad Fund*X, says stocks had their best quarter since the last bull market began in 2003, and smaller, riskier stocks set the pace.

Although US stocks ended June only slightly ahead for the month, they still posted their best quarterly advance since 2003. A powerful rally off 12-year lows in March lifted all boats. And last quarter finally showed that taking risk can pay off. Technology has taken a lead in the recovery with impressive gains.

After losing ground in five of the last six quarters, major market indices enjoyed substantial rebounds. During the second quarter, the Standard & Poor’s 500 index was up 16%, the Dow Jones Industrial Average 11%, the small-cap Russell 2000 21%, [and] the tech-oriented Nasdaq Composite index 20%.

Global stock markets had their best quarter in 20 years. The FTSE All-World Developed Market index enjoyed its strongest performance since 1987, while the All-World Emerging Markets index gained 36%, its best performance since it began in 1993. European markets were about on par with the US, [while] Japan gained 23% as most Asian markets put in strong quarterly performance.

Within small cap, both growth and value performed well in the second quarter, but growth continued its performance advantage over value. For this year to date, the growth advantage was pronounced, with the Russell 2000 Growth index up 11% versus a decline of 5% for the Russell 2000 Value index.

Small caps as a group led large caps off the bottom, as is common in strong markets and recovery periods. When confidence improves, small caps are often the first to sprout; they’ve led 12 of the past 15 bear market recoveries.

Typically, small caps have more to recover, because they take a more severe drubbing than larger firms. But with large financials at the center of the recent crisis, the S&P 500’s drop was almost as bad as the Russell 2000’s. For this decade, from December 31, 1999 to June 30, 2009, small caps have outperformed large caps dramatically, with the Russell 2000 up 14% versus the S&P 500’s 26% loss.
 
Historically, stocks have tended to bottom about four months before the economy, and earnings growth has bottomed about two months after the economic trough. But as markets continue to teach us, stock prices are unpredictable and simply do not move in a straight line.

Although market declines are normal, we’ve been through the most extreme drop of our lifetimes and it has taken a toll. We all know that over the long term, stocks have provided the best returns. Money that will stay invested for 20 years should be in stocks. Cash, for all its ability to buffer a portfolio, has not offered protection against eroding purchasing power in the long term. The price we pay for higher long-term returns is market volatility, and recent volatility has been extraordinarily high.

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