Will It Get Worse?

Stock markets worldwide in the second quarter tried to shake off the deep gloom that gripped them in the first three months of the year. They succeeded -- for a while.
But as the quarter drew to a close a major issue that had spooked investors in winter was looming large again: the financial system's fractured state in the wake of the housing market's crash.
As if that weren't enough, investors were forced to focus more sharply on the fearsome threat of rising inflation, as prices of oil and many other raw materials continued to streak higher.
Given all of that, the surprise for many stock mutual fund investors may be that their portfolios didn't fare worse in the three months ended June 30. The average U.S. diversified stock fund eked out a 0.1% gain in the quarter, after diving 10.6% in the first quarter, according to Morningstar Inc.
Positive returns in energy, utility, technology and healthcare funds, as well as in portfolios that target stocks of small and mid-size firms, helped offset losses in financial, real estate and blue-chip-oriented funds.

Foreign stock funds had a rougher go of it. They lost 1.8%, on average, in the second period, as many foreign markets -- particularly the emerging-market stars of the last few years -- quickly reversed after an early-spring rebound.

All in all, the mixed results were a classic argument for being well-diversified with funds, said Paul Merriman, a principal at financial advisor Merriman Berkman Next in Seattle.

At a time like this, he says, "I think it's better to just stay the course if you have the right portfolio allocation."

Even investors whose funds were in the black in the second quarter haven't had much time to savor their gains. As worries mounted in June about the economy, the financial system and soaring commodity prices, stock markets suffered broad declines.

By last week, the Dow Jones industrial average fell into an official bear market, meaning a drop of at least 20% from its recent high. The Dow is down 20.3% from its peak in October. The last bear market was in 2000-02, amid the tech bust.

Investors' upbeat view in April and May, as stocks revived, was that the financial system, at least, was on the mend.

But as warnings continued from financial companies about more loan write-offs, Wall Street's optimism faded.

And the wild run-up in oil has only deepened concerns about the financial health of consumers.