Market sell-off starts fourth quarter on a down note

NEW YORK -- The hoped-for fourth-quarter market rally failed to materialize the first day of the quarter, an ominous start to what is normally the most profitable quarter to own stocks.

If there were a silver lining after the broad U.S. stock market tumbled more than 14% in the just-ended third quarter — its worst quarterly drop since the dark days of the financial crisis in December 2008 — it's the knowledge that the October-through-December quarter has been the best quarter for stocks in the past 50 years, with average gains of 3.6%.

But instead of a seasonal bounce, the market fell nearly 3% on fears that Greece may not get its needed bailout funds to avoid default after it said it would not meet its lower deficit targets this year. Continued uncertainty over how the eurozone's debt woes will play out overshadowed better-than-expected manufacturing, auto sales and construction spending data in the U.S.

The drop left the Standard & Poor's 500 down 19.4%, or $2.4 trillion, from its April high and on the brink of a bear market, a drop of 20% or more. But there is still hope on Wall Street that stocks, which are stuck in a downward spiral, will mount a year-end rally. Keys to a resurgence:

•U.S. avoids recession. There are two camps: bears who say another recession is unavoidable and bulls who believe the economy will muddle along in slow-growth mode. David Kotok, chief investment officer at Cumberland Advisors, is in the no-recession camp. He expects the U.S. economy to grow at a 1.5% to 2% clip despite headwinds such as Europe's debt woes, a lack of confidence in policymakers and signs of a slowdown in China.

"Slow growth is still growth, not shrinkage," Kotok says. If the S&P 500, which closed at 1099 Monday, can stay above the 1100 level, which was its low in August, it would suggest the price floor has held, setting up a nice rally into year's end.

•Earnings keep growing. U.S. companies start reporting third-quarter earnings next week. If profits and what CEOs say about business conditions are more optimistic than bears expect, that could act as a "powerful catalyst" to fuel a rally, says Quincy Krosby, market strategist at Prudential Financial. Analysts have been trimming forecasts and now expect third-quarter profit growth of 13.5%, down from 16.9% forecast in early July.

•Eurozone's debt woes get resolved. "More clarity and some resolution in Europe" will remove the unknowns that are causing investors to flee risk, says Andrew Fitzpatrick, director of investments at Hinsdale Associates.

Pat Adams, manager of the Dunham Loss Averse fund, says data don't point to recession. And if recession is avoided, stocks should move higher. "Some stocks are obscenely cheap," he says. The price-earnings ratio for the next four quarters is 11, vs. the historical average of 15.