Bear of different kind mauls 1st quarter

By Adam Shell, USA TODAY
NEW YORK — Undone by the fallout from the real estate bust, Wall Street resembled a house of pain in the first three months of 2008.
When the first quarter ends Monday, it will take its rightful place among the stock market's most treacherous periods. It will forever be linked to the collapse of investment bank Bear Stearns (BSC) after a 1930s-style run on the bank and the Federal Reserve's dramatic move to rescue the financial system.

The key debate now is whether the worst is over, whether stocks reflect all the bad news, or whether the downward trend is still in force.

The 9.7% first-quarter loss posted by the Standard & Poor's 500 index through Thursday is puny compared with the biggest quarterly drop ever: 39.4% in the second quarter of 1932, S&P says. If the decline holds, it would barely make it into the top 40.

But while the loss might not be of historical proportions, it still underscores how vulnerable the financial system is to the toxic combination of rampant speculation and leverage. It also is a clear reminder of how quickly financial markets can unravel if all-important investor confidence takes a major hit.

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Stock declines of this magnitude in a quarterly span are relatively rare — often coming during the doom-and-gloom of bear markets or shock-induced scares. Indeed, the credit-crunch-inspired plunge in the first quarter ranks right up with the market angst caused by America's most famous financial crises:

•The 10.3% drop in the third quarter of 1998 when hedge fund Long-Term Capital Management collapsed.

•The 14.5% decline in the third quarter of 1990 in the aftermath of the savings-and-loan crisis.

•The 23.2% plunge in the fourth quarter of 1987 after the October market crash.

Four of the five biggest quarterly losses came in the years after the 1929 stock market crash. The fourth worst came in the third quarter of 1974, at the tail end of the 1973-74 bear market.

The big question now: What happens next? Patrick Adams, a hedge fund manager at Choice Investment Management, sees gains ahead. "The second quarter is not likely to look like the first quarter," he says. The Fed's aggressive move to support ailing Wall Street banks and the hard-hit mortgage market has reduced the odds that another major negative bombshell is out there.

Adams says investors should buy stocks on price drops. He expects stocks to react negatively at first to weak first-quarter profit reports but to rebound quickly. "We are close to a trough, and once the market is confident (a bottom is in), we could have a pretty big rally," he says.

But with the economy slowing, joblessness on the rise and the real estate market reeling, caution might seem a more prudent choice. "Bulls will say the current slowdown is a mere flesh wound, while bears may use it as a road map for what is likely to come. We're somewhere in the middle," Jason Trennert of Strategas Research Partners wrote to clients recently.