February 2008 Market Commentary
|Feb-08||Y-T-D||1 Year||3 Year||5 Year|
|MSCI Emerging Markets||7.38%||-6.02%||33.21%||28.63%||36.22%|
|Lehman Muni Bond||-4.58%||-3.38%||-1.17%||2.52%||3.35%|
|ML High Yield||-1.19%||-2.53%||-2.80%||4.12%||9.26%|
|SSB Global Bonds||2.44%||6.24%||16.79%||5.66%||7.52%|
A quick look at the financial markets’ performance numbers for February fails to tell the full story of the markets for the month. The financial markets remained volatile throughout February with large and mid-cap domestic equity indexes holding up well until late into the month. The final few trading days of the month pushed these stocks into negative territory as concerns about profits, weaker housing and higher inflation pulled down all portions of the domestic equity markets.
While the dollar’s value dropped to its lowest point in almost 40 years, inflation persisted and housing sales fell to a 13-year low, inventory levels remained strong and exports continued to make meaningful contributions to economic growth. Equity markets appeared to be caught in the middle of these competing forces and have been trading unevenly since the Federal Reserve became aggressive about easing policy in late January. Investors were able to find some gains in the uneven market as disparity of returns among regions, style, sector and issues exemplified the market for the month. Regionally, emerging markets shrugged off a very difficult January and rebounded nicely, easily out-performing developed and domestic markets. The MSCI Emerging Markets index rose 7.38% for the month. Commodities, as represented by the Dow Jones-AIG Commodity Index, returned 12.28% in February, the biggest monthly gain for commodities since 1990. Prices were driven by the weakened dollar and concerns over inflation as other asset classes were beset by worries about the slowing economy. Prices for crude, gold and wheat hit all-time highs during the month. The SSB Global Bond Index gained 2.44%, with international bonds benefiting from declining U.S. interest rates.
Broad-based domestic gains were more difficult to find, with domestic equities down across the board. However, the S&P 500 energy and materials sectors sustained their runs with energy up 6.66% and materials up 1.85% for the month. Growth stocks, while still negative for the month, regained the upper hand on value stocks they held throughout 2007, out-performing value stocks across all market capitalizations. Mid-cap stocks were the best performing domestic market capitalization with the S&P 400 falling only 1.86%. Gains were just as difficult to find in domestic fixed income, the LB Aggregate Bond Index was up only 0.14%, while the LB Municipal Index posted a loss of 4.58% for the month. The municipal bond sector was under particular duress during the month due to a number of factors, including a disruption of the auction rate market, forced liquidations and concerns regarding the municipal bond insurers. In some cases insured fixed-income securities traded at the same levels as uninsured positions, assigning no value to the insurance.
Late in the month the markets focused on Federal Reserve Chairman Ben Bernanke’s testimony on Capital Hill. Bernanke admitted the Fed faces a balancing act, with an economy at risk of falling into a recession, volatile financial markets and pressures coming from the rising risk of inflation. Bernanke confirmed that the economy remains the Fed’s priority and expressed his concern that housing activity may continue to weigh on the economy. When combined with a falling dollar and rising prices on consumer goods, the consumer may be pinched.
The headwinds facing the economy have caused investors to become pessimistic. Sentiment appears quite depressed at present, with the consumer confidence index reaching its lowest point in five years. Investors appear uncertain as to whether they should be more concerned about the slowing economy or more worried about a serious inflation problem down the road. However, investors should remember that inflation is a lagging indicator, meaning that recent data reflect earlier economic strength. Additionally, the contraction in home prices, the credit market seizure and the economic downturn are all disinflationary factors. These issues possibly warranted Bernanke’s remark that the Fed’s “current view is that inflation will moderate this year as oil and food prices don't rise as much this year as they did last year." Additionally, policymakers appear to be working to offset these headwinds by focusing on unfreezing credit markets and remaining biased toward providing additional monetary and fiscal stimulus. In the end, there remains considerable near-run uncertainty, both in terms of the overall economy and the possibility of another shock in the credit markets. However there is a great deal of cash on the sidelines that could eventually be reinvested in higher-risk assets.