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Stock Analyst Update

Stocks Suffer During Third-Quarter Sell-Off

But Morningstar analysts say some shares are still overvalued.

One day does not a quarter make--most of the time.

When future history books are written, September 11, 2001, will be--and should be--remembered for the senseless loss of life, not the stock-market plunge, that followed the terrorist attacks on the World Trade Center in New York and the Pentagon in Washington. Yet there's no denying the effect that September 11 had on the markets, with an estimated $2.2 trillion of U.S. stock wealth vanishing during the past quarter.

And unlike the Nasdaq plunge earlier this year, which left some blue-chip and value investors gloating that the highfliers of the1990s had finally received their comeuppance, this sell-off was almost universal.

Airlines and insurers obviously took their knocks, but so did financial firms, such as Morgan Stanley  and American Express (AXP), that had a major presence in or around the World Trade Center.

However, the reaction in the broader market has few parallels.

The Dow Jones Industrial Average posted its worst weekly performance since 1940, dropping 14.2% in the first five trading sessions after the attacks. Seventeen of the 30 blue-chip components that constitute this index traded at multiyear lows during the quarter, with Eastman Kodak , hitting prices not seen since 1992.

The post-attack losses, compounded on top of earlier quarterly losses, related to fears of a looming recession. For the quarter through Wednesday, the Dow ended down 18.8%, the Standard & Poor's 500 index dropped 18.1%, and the Wilshire 5000 lost 19.5%.

Of Deodorant and Cars
Few stocks escaped unscathed.

Of the 10 broad sectors that Morningstar divides its stock database into, only one--consumer staples--delivered a positive return to investors during the quarter. Even that category, which includes companies such as Coca-Cola (KO) and Gillette , improved by only 1.5%--a slim fraction.

The food manufacturers and household-product makers in this sector often hold their own during trying markets because they're expected to deliver reliable earnings in recessions as well as boom times. Simply put, the economy would have to sink to an unfathomable low before consumers would cut back on basics such as food, beverages, soap, and deodorant.

That said, investors also seemed to bet that consumers won't manage to keep the country out of a prolonged recession. The worst-performing group of stocks during the quarter was consumer durables, down 27.4%.

This sector, which includes companies like General Motors (GM) and Whirlpool (WHR), tends to run in cycles because people frequently postpone big-ticket purchases when the economic outlook is uncertain. But before now, solid demand for houses, cars, and other durable goods had been widely credited with keeping the economy growing so far this year even as businesses cut back on spending. 

Climbing Back
Now that the stock-market losses have been counted, however, the bigger questions are whether the sell-off was justified and whether shares will rebound.

Generally, that assessment is best made on a case-by-case basis by looking at the fundamentals of each individual company, along with the broader macroeconomic factors that are likely to affect the company.

On this basis, a handful of high-profile companies, such as Home Depot (HD) and Yahoo , were hardly bargains even after this quarter's sell-off, according to Morningstar analysts. However, our analysts thought that dozens of other firms--including Sun Microsystems , Boeing (BA), and General Electric (GE)--had become very attractive purchases, whether their business weakens in a recession or not.

Investors clearly think a slowdown is coming. From a more long-term perspective, the Nasdaq on September 21 hit a point that was 73% below its March 2000 peak, a major-market index drop matched only by the 89% decline of the Dow from 1929 through 1932 during the Great Depression.

The Dow is also down 28% from its early 2000 peak. By comparison, preceding the country's last major recession in the early 1980s, the index shed 25% from March 1981 through August 1982. But nearly two decades of continuous economic and stock-market expansion followed that contraction.

So while the aftershocks of September 11 may have rattled investors' nerves and shaped the direction of stocks this quarter, the markets historically have always climbed back. It's only been a matter of time.

Craig Woker does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.