2011 was shaping up to be a washout for the stock market just two weeks ago. Now, it's within shouting distance of its biggest comeback in nearly three decades.
The Standard and Poor's 500 index has jumped 11.4 percent since hitting its lowest level of the year on Oct. 3, largely because investors have become more confident that Europe will shelter its banks from huge losses on Greek bonds should that country's government stop making payments on its debt. For much of the summer, investors feared that a Greek default could lead to a freeze of lending between European banks and cascade into a credit crisis similar to the one in 2008.
The S&P 500 was down 12.6 percent for the year as of Oct. 3, when it closed at 1,099. As of Friday, it had trimmed the loss to 2.6 percent. It needs to gain just 33 points, or 2.8 percent, to get above 1,257, where it started the year.
If the S&P 500 finishes the year with a gain, it will be the biggest turnaround since 1984. That year, Apple Inc. introduced the Macintosh, and President Ronald Reagan's campaign ads proclaimed that it was "Morning Again in America." It was also the last time that the S&P 500 fell more than 10 percent during a calendar year and finished the year in the black. The index finished that year up 1.4 percent.
Edging out another gain of that size in 2011 wouldn't make anyone rich. But consider the hand that investors were dealt this year: A tsunami and nuclear disaster in Japan plunged the world's third-largest economy into a recession and created a worldwide parts shortage. Uprisings throughout the Arab world sent the price of gas skyrocketing to an average of $3.98 a gallon in May. The U.S. lost its top-notch credit ranking for the first time. And Europe has teetered on the edge of a financial crisis that could hobble the region's banking system.
With all of that going on, investors might wonder how the S&P 500 index could possibly end the year higher than where it started. The biggest reason: some think stocks may be the best value out there.
With dividend payments alone, the S&P index offers a return on par with low-risk U.S. Treasurys. From Aug. 24 through Thursday, the yield on the 10-year Treasury note was below the dividend yield of the S&P 500 index. Since 1962, the only other time that's happened was during the 2008 credit crisis, according to J.P. Morgan.
"You have to have pretty dark thoughts to think that there's not a chance that the S&P 500 beats out Treasurys at this point," said Bill Stone, chief investment strategist at PNC Bank.
Stone also thinks company earnings are going to be better in the third quarter than many analysts expect, driving stock prices higher. Since July, analysts have cut back their estimates for the S&P 500's third quarter earnings 3 percent because of concerns that the U.S. economy might be heading into a recession. Since then, retail sales, applications for unemployment benefits, and the number of jobs added in August have been better than Wall Street expected. "The market has been priced for the worst, but that's not bearing out in reality," Stone said.
Others point to the fact that the S&P 500 was stuck in a narrow trading range since Aug. 4th. That day, the index fell below 1,260 during a broad sell-off. The stock market has moved up and down a lot since then, but hasn't really gone that far. The S&P 500 has mainly traded between 1,099 and 1,218, a relatively small band. On Friday it broke out of that range, closing at 1,224.
Investors who buy and sell the S&P 500 index based on analyzing patterns in charts — known on Wall Street as technical traders — believe that indexes will tend to keep moving steadily in the same direction once they break out of a trading range. That's because investors tend to follow the herd. Increased confidence in Europe's ability to prevent a widespread financial crisis may help the S&P 500 move out of that range and stay there.
"If we have truly averted the worst of Europe then a large dark cloud is going to be lifted off of this market and momentum is going to take over," said Richard Ross, global technical analyst at Auerbach Grayson.
Seasonal investor behavior might also lift the S&P 500. The S&P index typically gains an average of 3.9 percent during the last three months of the year. "Positive market psychology hits a fever pitch as the holiday season approaches and does not begin to wane until the spring," according to the Stock Trader's Almanac. Professional investors also tend to readjust their portfolios at this time of year, buying stocks that have done well and selling those which have fared poorly for tax purposes.
That could have a greater than usual effect this year because the S&P 500 remains cheap, analysts say. At the start of the year, the S&P 500 traded at 15 times its earnings over the last 12 months. That was below the average price-to-earnings multiple of 18.6 over the last 10 years. Friday, the S&P 500 traded at 12.9 times earnings.
It's not quite time to count on gains, however. The S&P 500 has fallen more than 10 percent 43 times since 1900, according to Sam Stovall, chief equity analyst at Standard & Poor's. It finished the year with a gain only 11 times, a comeback rate of 26 percent. The average gain in those years was 1.8 percent.
"I'm skeptical of this rally," Stovall said, noting that Europe's debt problems still aren't solved. "But even if there is a gain, history says that you're not going to end up with anything to be too excited about."