Undoubtedly, it is reassuring to see an upward trend in the stock market. Based on the chart below, depicting quarterly levels of the Wilshire 5000, it appears that prices bottomed out in the third quarter of 2002. Price activity came to a virtual standstill in the following two quarters as investors faced Iraq and North Korea and a greater degree of uncertainty than usual. The beginning of the U.S. war with Iraq ended the uncertainty of anticipation and was viewed as a positive. Even before President Bush declared an "end" to the war, stock prices began to climb … and climb higher than they did over the course of the preceding year. Prices gained steadily until September when the "September curse" apparently took hold and retraced a small portion of the summer gains.

While the public is more aware of October's stock market crashes (1929, 1987), September has historically been a month in which stock prices tend to show the most and largest losses. In case new investors don't know about the September curse, each year the financial media makes sure to remind investors of the fact. (Does this become a self-fulfilling prophecy?)

Is there a rational explanation for the September curse? Indeed there is. September marks the end of the third quarter and is near the end of the year. Money managers who have made profits over the year may like to book them. As a result, professionals are taking profits - which means selling equities - all month long.

Just like interest rates are widely lumped together into one market rate, it is conventional to talk about "the stock market" as if it was a market in which all company prices move in tandem. In fact, stock market measures are aplenty and each cover different market segments. Indeed, all sorts of companies in the U.S. (and abroad) move separately from each other over the business cycle. Below, we cover only a few of the countless market indexes.

Despite a September decline, stock prices generally rose in the third quarter, but gains varied from the Dow Transportation's high of 10.8 percent to the Dow Jones Utilities' low of -0.2 percent.

Dow Jones
The Dow Jones Industrial Average (DJIA) is commonly cited in the media, especially the nonfinancial media, as the primary indicator of the stock market. Financial professionals have come to call this blue chip index a measure of the old economy. The DJIA rose 3.2 percent in the third quarter after posting a stronger 12.4 percent gain in the second quarter.

Over the July-to-September period, the industrials posted their largest monthly gain in July, moderated in August, and posted a decline in September, the final month of the quarter. This same pattern was evident in the second quarter, with the largest monthly gain in April and softer gains in May and June.

The Transportation index exhibited a similar pattern with a spurt registered in April and July and much smaller gains in the second and third months of the quarter. Historically, the Transportation index has served as a leading indicator of the Industrials index. As producers ship more goods, whether they are finished goods, work-in-process or raw materials, it implies a faster rate of economic growth. The Dow Jones Transportation index jumped 10.8 percent in the third quarter, more than twice as much as the more-widely reported industrial average.

The Utilities index has posted robust gains since March, except for July when the index fell sharply. It took August and September to recuperate this loss. Indeed, the Utilities index ended down 0.2 percent for the quarter. Historically, utility stocks are very sensitive to interest rate changes since utilities offer steady dividend checks. Since deregulation, these old relationships don't hold to the same degree, although the utilities index still exhibits a stronger relationship to interest rate changes than other broad stock market measures.

Standard & Poor's
The S&P 500 is considered a broader measure of blue chip companies than the Dow Jones Industrials. In recent years, however, high tech firms have grown in importance, now representing about 30 percent of the companies in the S&P 500. Nevertheless, the S&P 500 has moved in tandem with the Dow, although not by the same magnitude. In the third quarter, the S&P 500 rose 2.2 percent, less than the DJIA. However, in the second quarter, the S&P 500 gained 14.9 percent, 2.5 percentage points faster than the DJIA. The overall quarterly trends are quite similar, while the monthly movements are diverse.

Standard & Poor's also covers the Mid cap and Small cap market segments. Typically, these market segments outperform the large cap sector (the 500) during economic recoveries just as they underperform during economic downturns. (Smaller companies tend to suffer more from economic downturns since they are riskier propositions than large companies; conversely, their market performance is sharply improved during upturns since entrepreneurial spirits are higher.) In the third quarter, the Mid cap index increased 6.4 percent and the Small cap index gained 6.8 percent. These are minor gains for these two indexes relative to their second quarter performance when the Mid cap surged 17.3 percent and the Small cap jumped 19.6 percent!

Other major stock indexes
While the other major stock indexes have increased in three of the past four quarters, the Nasdaq composite index has posted gains in each of the past four quarters. The Nasdaq recovery has accelerated so sharply in the second and third quarters that some analysts have worried about a repeat bubble in the high tech sector. Keep in mind that the Nasdaq plunged 71.8 percent from its March 9, 2000 peak to its September 21, 2001 low. The Nasdaq has now increased 25.6 percent from its low. Whether it is appropriate to call the resurgence a bubble depends on one's point of view. Typically, prices will overshoot on both the upside and the downside. The 2000 bubble is well documented, but less so is the 2001 low that occurred after September 11. There is no question that plunging stock prices in September and October 2001 were a reaction to the terrorist attack.

Because the Nasdaq is outperforming the Dow, it is fashionable to think that a bubble is forming. However, the Nasdaq declined substantially more than the Dow last year. In the meantime, new orders and production of high tech equipment are surpassing production of other goods by a wide margin. Why shouldn't the Nasdaq outperform the Dow these days?

The Russell 2000, which measures small cap stocks, has also posted fairly healthy gains these past two quarters, almost matching completely the monthly gains garnered by the Nasdaq composite index. Certainly, a good number of the small cap stocks are probably related to the high tech market. Moreover, small cap stocks tend to outperform large cap stocks in the early years of recovery since they tend to get hurt more during a downturn. The Russell 2000 rose 8.8 percent in the third quarter after a whopping 23 percent gain in the prior quarter.

The Wilshire 5000 covers all U.S.-based companies. Thus, the Wilshire is the broadest market measure which reflects growth in blue chip companies as well as risky and/or non-performing firms. The Wilshire did manage to post a gain of 3.3 percent in the third quarter after growing 16 percent in the second quarter. The gain appears modest relative to the Nasdaq and the Russell, but it is a solid gain nonetheless.

BOTTOM LINE
Stock prices generally grew more slowly in the third quarter compared to the second quarter. However, just like interest rate instruments with different maturities, different market segments performed better or worse. Making summary judgments is not always useful in such cases. Better to compare the market performance of your specific portfolio with a variety of measures that more accurately describe your personal asset allocation.

Evelina M. Tainer, Chief Economist, Econoday