Stocks Could Come Back

A few strategists see a silver lining.

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It's rough out there for investors. We're deeply mired in a bear market, and the problems that caused it—housing and credit crises, the slow economy—haven't turned around in a meaningful way yet.

Still, a few folks do see reason to hope that the stock market could end the year with a sizable rally.

Jeff Kleintrop, chief strategist at LPL Financial, says the rest of the summer is going to be frustrating for investors as they face down volatile oil prices (hurricanes? Iran?), the threat of a consumer spending collapse (back-to-school shopping season is looking bad), and the possibility that corporate earnings expectations are still too high. But by the time the end of the year rolls around, he says history points to an S&P 500 that winds up in the green, thanks to a giant fourth-quarter rebound. He writes:

How powerful might the fourth quarter rally be? History shows that the more pessimistic investors are, the better returns are over the next 12 months, and this observation is especially true for bear markets. During each of the three other bear markets over the past 20 years, the S&P 500 gained 25% within about 90 trading days of the end of the bear market. A fourth quarter rise in the S&P 500 of 25% would result in a solid gain for 2008.

Kleintrop isn't the only one who thinks things might be a bit less bad than most investors think.

Bill Stone of PNC Financial says stocks—and primarily U.S. stocks—are still a place to be heavily invested.

Despite the current ugly environment, the market and the economy have always rebounded and we expect them to do so again. We believe it is really a question of when and not if. Though it may seem counterintuitive, historically stocks have not been more risky, they've been less risky, following a significant decline. Investors like to move with the herd, but experience has shown that owning stocks at lower valuations has led to higher future long-term returns, not lower.

Basically, this line of thinking involves believing we're already through a good chunk of this bear market, based on an assumption that the current downturn will look more like most others, where the pain of a 20 percent-plus drop in stocks winds up accounting for the majority of the hurt. The exceptions—1973 and 2000, when the S&P 500 lost almost half its value—are the worry. The tech bubble spawned the latter, so it's less comparable to today, but the '70s drop came care of roaring inflation. Right now, we're not seeing a broad surge in prices, despite record energy costs, and analysts expect inflation to calm in the months ahead, as the Fed's latest decision to leave interest rates alone shows. For stocks to recover, that cooling has to happen. Stone says the economy having time to recover sans soaring prices is a central concern for investors and the "main tenet" of his positive view for stocks.