January 2008 Market Commentary

January proved to be an exceptionally disappointing month for global equity markets. Nearly all major equity indices fell significantly in the first three weeks of the month as markets began to price in the increasing likelihood of a U.S. recession. The Dow Jones Industrial Average experienced its worst January since 2000. Declines were widespread as no sector, investment style, market capitalization or region was fully immune. Growth stocks at every capitalization level were particularly battered and underperformed their value counterparts. In a flight to quality, the more defensively positioned mega-cap value stocks tended to sustain milder losses. The smallest growth stocks registered the largest downturn. In fact, the Russell 2000 Index technically entered bear market territory, as defined by a 20% decline from an index’s peak. International equity markets also endured significant declines as the worsening U.S. economy stressed markets throughout the world. Even the continued strengthening of non-U.S. currencies could not offset the decline in international equities, which were off more than 9% for the month. The sell-off was worse in emerging markets, as fear of declining sales from their largest customer, the U.S., would lead to slow or negative economic growth. Chinese stocks alone fell more than 21%. Commodities, on the other hand, continued their positive run and proved once again to be a good diversifier in many portfolios.

In the midst of this excessive market volatility, investors were rattled with dismal economic news. New U.S. residential building in 2007 suffered its biggest drop in nearly three decades, and housing starts fell by more than 25% for the year. On the consumer front, retail sales for all of 2007 grew at the slowest pace in five years, and unemployment jumped to 5%. These reports of a slowing economy and the ongoing credit crisis put The Federal Reserve on alert. In an emergency meeting on January 22, they announced a surprising rate cut of 0.75% in an attempt to calm the financial markets. Further, just eight days later, the Fed followed up with an additional cut of 0.50%, bringing the Federal Funds rate to 3.00%. The committee commented that “broader financial market conditions have continued to deteriorate, and credit has tightened further for some businesses and households.” These rate cuts and reduced fears of inflation were particularly welcomed by the fixed income markets. As investors’ appetite for risk decreased, high-quality bond indices closed in positive territory, and U.S. Treasuries had their best month since 1998.

Following a disappointing month and concerns about a recession many investors are left wondering what to do next. We recognize that many economic indicators point to a slowing economy. Historically, most recessions have resulted from tight monetary policy and growing inflation. On the one hand the Fed’s recent aggressive efforts to lower interest rates should mitigate some of this risk and spur economic activity by helping consumers to borrow. However, one could also argue that the Fed should have started the easing process much earlier. A steeper yield curve should help, but credit remains tight as lending standards have noticeably increased. The consumer is also highly leveraged at 98% debt to disposable income versus 65% in 1995. This being said, we also feel it’s important to keep in mind that markets often overact both on the upside and downside to news. The recent market correction has resulted in many equities trading at attractive valuations. Therefore, we would advise long-term investors not to panic but to remain invested in a well diversified portfolio. Those investors with excess cash have a good opportunity to dollar-cost-average into new or existing positions and should consider rebalancing their portfolio.