Can Stocks Regain Their Mojo After a Poor First Half?

Oliver P. Quilla for CNBC.com

New York Stock Exchange (NYSE)

It has certainly been a forgettable quarter and a lackluster first half of the year for investors. With two trading sessions left in the quarter, U.S. stocks are on pace for their first quarterly decline since Q1 2009, snapping 4 straight quarters of gains.

Meanwhile, the disappointing second quarter has also erased all of the gains for the markets this year. It’s a story all too familiar to the Dow Industrials. For the third straight year, the blue chip index finds itself in yet another hole as it’s on pace to end the first half of the year with a decline, again.

U.S. Indices Year-to-Date

• Dow Industrials -2.78%
• S&P 500 -3.63%
• Nasdaq Composite -2.14%

But despite the losses so far this year, U.S. stocks have been a better investment than foreign stocks as most major indices have underperformed the big U.S. indices this year.

Looking Ahead to the Second Half

In the wake of a poor first half, what typically happens in the second half and at the end of the year for stocks?

Generally speaking – a first half decline does not bode too well for the markets for the rest of the year. Here are a few key observations:

• First half declines are not as frequent as one might expect. On average, the markets have finished the first half with a decline just about once every three years. Of course, that means two thirds of the time, the markets actually complete the first half with a gain.
• Most of the time (an overwhelming 80% of the time in fact), the direction of the market’s performance for the full year has correlated with its direction at the end of the first half (i.e., a first half gain leads to a full year gain or a first half loss leads to a full year loss).
• Too big of a hurdle to climb: it is fairly rare for the markets to post an annual gain after finishing the first half with a loss.
• The odds that the markets will rise in the second half after declining in the first half of the year are about as good as a coin flip. In the years during which the markets have turned in a first half loss, the markets have typically seen a second half gain about 50% of the time.

Going deeper inside the numbers, here’s the breakdown for each of the 3 major U.S. indices (excluding this year’s results):

Dow Industrials

• Since 1929, the Dow Industrials has fallen in the first half about 40% of the time (32 times over the past 81 years)
• 80% of the time since 1929, the direction of the Dow for the full year has correlated with the direction at the end of the first half
• Only 10 times since 1929 has the Dow finished the full year up after starting out the year with a first half decline
• After turning in a first half decline, the Dow has followed up with a second half gain 44% of the time

S&P 500

• Since 1951, the S&P 500 has fallen in the first half about 34% of the time (20 times over the past 59 years)
• 86% of the time since 1951, the direction of the S&P 500 for the full year has correlated with the direction at the end of the first half
• Only 6 times since 1951 has the S&P 500 finished the full year up after starting out the year with a first half decline
• After turning in a first half decline, the S&P 500 has followed up with a second half gain 50% of the time

Nasdaq Composite

• Since 1972, the Nasdaq Composite has fallen in the first half about 32% of the time (12 times over the past 38 years)
• 82% of the time since 1972, the direction of the Nasdaq for the full year has correlated with the direction at the end of the first half
• Only 4 times since 1972 has the Nasdaq finished the full year up after starting out the year with a first half decline
• After turning in a first half decline, the Nasdaq has followed up with a second half gain 50% of the time

Winners & Losers YTD

Here are some of the winners and losers so far during the first half of 2010:

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