What can investors expect after the market beating of 2008?

U.S.stocks rallied nearly 50 percent from March 9 through the end of July, but investors who had suffered through a historic 16-month bear market remained defensive. What did it mean and what are the chances for recovery? Current economic conditions make the picture even more cloudy. Homes continue to go into foreclosure, jobs continue to be lost, and unemployment hovers at 10 percent—in some communities as high as 15 percent.

Morningstar, the investment research company, says a rally at this point seems normal, because the investment markets pick up sharply at the “inflection point” when an economic slowdown has appeared to bottom. Such rallies occur before it becomes apparent that the economy is recovering. “Think of the market’s drastic turnaround in March,” wrote Bradley Kay, a Morningstar analyst. “The signs of hope that incited the rally did not show a growing economy. Instead, the important news merely showed a slowing of the economy’s rate of decline, or an inflection point.” He analyzed past recessions and studied stock market returns during the 12 months following these inflection points, and found that stocks on average returned 2.2 percentage points more than cash per month after it became apparent that the economy had bottomed.

The potential for stocks over the next decade may also be encouraging. The returns on U.S. stocks over the last 10 years have been next to zero. This has only happened twice before in modern market history: The 10-year period ending in 1935 and the 10 years ending in 1974. This has been a traumatic change for investors who were used to the 20-percent plus returns of the late 1990s. However, the abnormally low decades of poor returns in the 1930s and 1970s were followed by long stretches of steadily rising returns as the stock market recovered. Each year after those decades ended, 10-year average returns on U.S. stocks steadily climbed, reaching a peak in the 20 percent range about 20 years later.

The lesson: don’t give up on stocks!