Second Quarter in Stocks: Equities Recover

Equity markets powered a bit higher in 2005's second quarter in anticipation of the end of the Federal Reserve's interest-rate hikes. Nevertheless, skittish investors continued to fret over rising energy prices and the mounting trade deficit. Equities are flat for the year, and the markets remain cautious regarding the strength of the economic recovery.

Equally flat is the yield curve, presenting Federal Reserve Chairman Alan Greenspan with a conundrum, as longer-term rates stubbornly refused to be goosed by his raising of short-term rates. Chinese government and pension fund purchases of U.S. debt appear as strong as ever, causing observers to wonder whether this is an unusual moment or whether a flattening curve indicates a looming recession as it has in the past. Bonds and bond funds continued to deliver steady returns, with the yield on the 10-year note hovering around 4% and an anticipated sell-off resulting from Greenspan's eight hikes seemingly nowhere in sight. Additionally, lower rates maintained residential real estate prices in even the most buoyant areas of the country.

Speaking of bonds, the quarter saw the debt of the nearly century-old automaker  General Motors (GM) downgraded to "junk" status by Standard & Poor's and Moody's. In addition to lowering earnings forecasts and suffering the debt downgrade, the stumbling industrial also endured the seemingly ageless raider Kirk Kerkorian taking a large stake in its shares. The firm's stock rose for the quarter in the wake of Kerkorian's bid and as management began negotiations with its union regarding crushing pension and health-care obligations.

Another ageless wonder, Warren Buffett, began to put some of Berkshire Hathaway's $42 billion cash hoard to work as he purchased U.S. utility PacifiCorp from Britain's  Scottish Power (SPI) for $5.1 billion (plus debt assumption) through  Berkshire Hathaway's (BRK.B) subsidiary MidAmerican Energy. The "Oracle of Omaha" appears ready to consider other energy- and utility-related deals, especially as the Senate nears passing an energy bill that will overturn the 1935 Public Utility Holding Act, which prohibits certain utility mergers. An announcement in April also indicated that Buffett acquired shares of brewer  Anheuser-Busch .

If Berkshire stock itself was unimpressive, large caps fared comparably with their small- and mid-cap brethren in the second quarter's broad surge, and the large-growth category finally outpaced large value after five years of underperformance. Chipmakers  Intel (INTC) and  Texas Instruments (TXN) and health-care stocks  Pfizer (PFE) and  UnitedHealth Group (UNH) powered the large-growth group.

Surveying the Sectors
Energy finally took a back seat as yield-hungry investors continued to bid up utilities, with the group posting a 10.4% gain for the trailing 13 weeks through June 28 to lead the way among Morningstar's 12 economic sectors. Latin American companies such as  Companhia Energetica de Minas Gerais (CIG) performed well, as did smaller domestic utilities such as  Allegheny Energy  and water utilities such as Aqua America (WTR).

Energy finished strong again, however, surging 9.50%. Smaller integrated companies such as Southwestern Energy (SWN) led the charge. Exploration companies either based in or with operations in Canada--such as  Canadian Natural Resources (CNQ),  Quicksilver , and  EnCana (ECA)--also fared well. Larger integrated companies such as  ExxonMobil (XOM) and  Chevron (CVX) finished at the back of the pack, posting slightly negative returns, and although  PetroChina  did well, other foreign companies such as  China Petroleum & Chemical (Sinopec)  and PetroKazakhstan  also tended to lag the group.

After recent periods in the doldrums, the hardware and health-care sectors enjoyed surges, with respective returns of 4.74% and 6.81% for the trailing 13 weeks through June 28, though the averages mask a more mixed bag for both sectors. In hardware, equipment maker  Corning (GLW) and storage provider  LSI Logic  charged ahead, while other tech names  QLogic ,  Apple Computer (AAPL), and China TechFaith Wireless  posted losses. In health care, biotechs  Genentech  and  Celgene  and managed care companies  Universal Health Services (UHS) and  Cigna (CI) roared ahead, but equipment and device makers  Zimmer (ZMH),  Stryker (SYK), and  Biomet  lost ground in the wake of a Justice Department investigation into how the companies pay physicians as consultants. The device-makers have been under additional pressure from hospitals to lower their prices for access. Additionally,  Guidant's  warnings on some of its cardiac devices hurt its stock's performance.

Only industrial materials had negative returns, as commodity-sensitive businesses suffered in light of a slowing global economic recovery. Steel companies such as Mittal Steel (MT) and  Posco (PKX) saw significant declines, as did copper miners  Southern Peru Copper  and  Phelps Dodge .

Industry Performance
On an industry level, there has been a role reversal from last quarter. Business/online services topped the list this time, with companies such as Google (GOOG) turning in stellar results. However, the continued housing boom put title insurers, REITs, and home builders near the top of the industry lists as well, with  First American (FAF), Gables Residential Trust , and  Toll Brothers (TOL) turning in exceptional performances in their respective industries.

Steel/iron, aluminum, land transport, employment, and paper landed at the bottom of the industry list, as investors anticipated a slowing economy.