Stocks: A Positive 2009?

Investors who dare look at their retirement accounts this week may get a pleasant surprise: Their equity holdings may actually be up for the year.

Not by much, to be sure. On May 5, the S&P index of 500 stocks—a good gauge of the broad stock market,—closed at 903.80, just 0.55 points above its close on the last day of trading in 2008.

Still, market participants were marveling that the stock market could trade in positive territory in spite of the state of the economy and the troubles that still plague the financial system.

Stocks peaked in October 2007 and then began a slide that picked up speed in late 2008 and early 2009. By Mar. 9, the S&P 500 had lost 57% of its value.

The reversal in the last two months has surprised skeptics. As of May 5, the S&P 500 is up 34% from its Mar. 9 low—although it remains 42% below its 2007 peak.

Mutual Funds need that upward break

Among those celebrating are mutual funds. After their dismal performance in 2008, mutual fund customers quit in droves. According to TrimTabs Investment Research, $245 billion was yanked from equity funds in 2008 and another $43.5 billion was withdrawn in the first three months of 2009. In April, that trend started to reverse, with $8.3 billion flowing back into equity mutual funds.

"The fund industry desperately needs this, given how much they lost last year," says Russel Kinnel, director of mutual fund research at Morningstar (MORN). A positive stock market in 2009 "builds investor confidence," he says.

If the last two months' gains can be sustained, the next round of mutual fund and retirement statements could show increases in client accounts, a rarity in the past 18 months.

Another boost to the industry, Kinnel notes, is that many prominent mutual funds with the biggest losses in 2008 have seen the greatest recent advances.

Richard Sparks of Schaeffer's Investment Research believes the rally could have the biggest effect on "smaller investors" shell-shocked by the past year's losses. It "makes their mood better and makes them feel better about taking on more risk," he says.

Can the stock market keep it up?

Beyond the investors themselves, a positive stock market can have profound economic effects, says James King, president and chief investment officer at National Penn Investors Trust.

"It's been such a terribly negative time," King says. Americans have been losing their jobs and seeing their homes and retirement accounts lose value. A modest gain for equities in 2009 doesn't solve those problems—particularly unemployment, which is expected to keep rising. But, says King: "The recovery in stock prices takes the edge off."

There are serious questions as to whether the stock market can maintain such a steep rally.

Throughout history, bear markets have varied widely in length and severity. If March 2009 turns out to have constituted the low, this bear market will have lasted 17 months. By contrast, the stock market fell every year from 1929 to 1932. The last bear market—from 2001 to 2003—lasted 30 months.

No one is certain this bear market is finished, however. "You can see rallies like this in bear markets," Sparks says. "They don't mean that everything is over."

Hopeful words from Chairman Bernanke

There are some hopeful signs. Chris Johnson of Johnson Research Group says that this rally seems to be based on fundamentals, not just psychology. First-quarter earnings weren't as bad as expected, for example.

Hopeful words from Federal Reserve Chairman Ben Bernanke on May 5 helped confirm what many market participants have noticed in some economic data: The U.S. economy may have seen the worst of the current downturn.

The "pace of contraction may be slowing," Bernanke said, though he added that "the recovery will only gradually gain momentum and that economic slack will diminish slowly."

Many remain deeply skeptical about both this stock market rally and the world's economic situation. If they're proven right, investors could have little to celebrate for the rest of 2009.

But if they're wrong, these skeptics could drive the market higher.

S&P 500 Gains Press Fund Managers

Fund managers are often judged against benchmarks such as the S&P 500. When the index gains a lot, investors don't want to be left behind, says Peter Cardillo, chief market economist at Avalon Partners.

"As the market climbs higher and higher, [fund managers] have got to show performance," he says.

Investors who have played it safe—by for example, keeping heir assets in cash—"are being left in the dust," King says. "For [investors] who try to time markets, there's tremendous pressure to get on board."

For others, King says, there is pressure to move into market sectors that have gotten the biggest bounce recently, included troubled financial stocks.

Let's be clear: Happy days are not here again. It would take another 73% advance for the S&P 500 to recover all of its losses since that October 2007 peak.

But the stock market's positive year-to-date performance has the potential, if it's sustained, to begin healing investor psyches after a traumatic year.

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