Second-Quarter Stalwarts

To paraphrase Frank Sinatra: It was a very good quarter. Through Mar. 31, international equity markets advanced from 4% to 20% in dollar terms. The S&P 500 gained more in the year's first three months than it did in all of 2005, and posted its best first-quarter performance since 1999.

The S&P SmallCap 600 index outpaced the large-cap 500 by a more than 3-to-1 margin, and all but one of the 10 sectors in each of the S&P Large, Mid and Small-cap benchmarks posted advances in the quarter. Only the S&P 500 Utilities sector declined this period. In addition, more than 4 out of 5 of the 130 subindustry indexes in the S&P Composite 1500 index (the combined S&P 500, S&P MidCap 400, and S&P SmallCap indexes) posted gains for the quarter.

Only fixed income investors saw an across-the-board touch of red ink as the markets anticipated the 15th consecutive increase to the Fed funds target rate and began to more convincingly price in a possible 16th rise at May's Fed policy meeting.


  Driving forces for equity markets' advances, in our opinion, included a surge in M&A activity, erratic economic reports that gave investors hope of an accelerated end to the Fed's rate-tightening program, moderating oil prices, improving consumer confidence, and the expectation that first quarter 2006 S&P 500 operating earnings will post their 16th consecutive quarter of double-digit advances. Many of these catalysts -- an earlier end to rate increases, benign inflation, and moderating oil prices, in particular -- began to be challenged, however, as the quarter came to a close.

What does experience say lies ahead? Historically, the stock market appears to have been as motivated in the second quarter as a High School student staring down summer vacation. The S&P 500's average second-quarter price rise since 1945 was 2%, which was below the stronger average advances of the first and fourth quarters, but higher than the third quarter's seasonally dismal performance.

What's more, sector performances typically have been less than dynamic. As seen in the table below, the best-performing sectors during the second quarter -- info tech and financials -- posted above-market frequencies of outperformance (F.O.) at a rate that was not much better than a coin toss.


  We think the worst performers, however, were a bit more convincing as telecom services and utilities, along with the consumer discretionary and staples sectors, posted frequencies of outperformance that were each less than 40%.

Looking below the surface, however, we see those subindexes whose average price advances and frequencies of market outperformance were historically encouraging. But don't forget that past performance is no guarantee of future results.

  Best Q2 Track Records
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