 |
|
|
|
|
|
|
|
|
|
 |
|
||||||||
 |
 |
 |
 |
 |
 |
 |
 |
 |
|
| Recent Thoughts |
January 2008 - From Client Review Letters
Click here to view and print in Adobe PDF format.
The stock market faced a number of headwinds during the fourth quarter. Oil prices increased over 50% in 2007, reflecting supply and demand imbalances, geopolitical tensions and speculative activity in the futures markets. The housing market continued its slide during the quarter. Sales of both existing and new homes declined, prices fell and the supply of homes for sale rose. The correction currently underway in the housing market will likely take some time to play out. However, the story that captivated the financial headlines was the continued problems with the sub-prime mortgage market.
The sub-prime mortgage meltdown that started this summer accelerated in the fourth quarter, culminating in massive write-downs at financial institutions and ultimately the departure of several high profile Wall Street CEOs. Although difficult to quantify, total mortgage-related losses are likely to grow from current estimates of around $100 billion. It will most likely take some time for banks and brokerage firms to assess their exposure to sub-prime mortgages and put the problems behind them.
The Fed responded to recent financial turmoil with two quarter-point rate cuts in the fourth quarter. In addition, the Fed used all the tools at its disposal to supply liquidity to, and ensure the orderly functioning of, financial markets. As the odds of an economic downturn have increased, the Fed has shifted its focus from containing inflation to promoting economic growth. The Fed has stated its intention to act aggressively should the economy weaken further. Additional rate cuts are expected in the coming months, with some calling for a federal funds rate as low as 2.5%-3.0% by the end of 2008 (from 4.25% on December 31, 2007).
Stock market performance in 2007 was defined largely by the degree of exposure to international markets and commodities versus exposure to housing and mortgages. The former generally registered spectacular returns while the latter performed poorly. Energy was the best performing sector in the S&P 500 during the year, while the Consumer Discretionary and Financial sectors trailed.
Click here to return to the top of this page
Investors will be watching the 2008 election
closely in order to determine the direction of fiscal policy. The debate
on whether to make the lower tax rates on dividends and capital gains
permanent or to let them expire (increase) will be closely monitored.
Other issues being discussed include lower corporate taxes, AMT reform
and, of course, health care reform. On the foreign policy front,
As economic growth has slowed and risk aversion has increased, large-cap stocks have started to outperform small-cap stocks. Likewise, growth oriented stocks outperformed value stocks in 2007. This reverses a trend seen over the last several years during which large-cap growth stocks underperformed the overall market while small-cap value stocks tended to outperform the overall market. It is worth noting that the rotation toward large-cap, quality growth stocks bodes well for portfolios with our bias towards such stocks.
The constant barrage of negative news emanating from Wall Street has resulted in extremely low investor sentiment. The odds of recession have increased dramatically over the past couple of months while unemployment has risen to 5%. This has created an environment where stock prices in some sectors are beginning to reflect a worst case scenario. However, if the economy is able to avoid a recession, or only suffer a minor recession in 2008, stock market performance could actually be quite good.
Stocks are the single best vehicle for achieving long-term capital appreciation. Very bright people on Wall Street and elsewhere are always searching for an easy-to-understand investment vehicle that outperforms stocks in the long-run with equivalent risk exposure, but have not found it. Stocks have excelled through the ups and downs of recessions, wars, tech bubbles, housing woes, etc. Some investors see today’s economic and geo-political problems as a "new paradigm". It is not. It is simply the same market pressures witnessed by previous generations repackaged for the current generation. Owning a broadly diversified portfolio of high-quality stocks, and having the patience to ride through the tough times greatly mitigates risk. The savviest investors know to take the bad with the good and let time and compounding perform their magic.
A change in the investment climate can often call for a change in one’s portfolio. However, adjusting one’s portfolio usually only requires small, tactical shifts rather than major moves into or out of the market or into and out of different investment vehicles. Nobody can time the market accurately and consistently so as to get out of stocks at the optimal time and get back in again at the optimal time and do so repeatedly. Recessions are a normal part of our economy. While recessions are not fun, they have always come and gone and they will always come and go. One just needs to remain focused on a few relatively simple fundamental investment "truths", ride through the tough times and make appropriate little changes along the way. Of course, one's age, financial situation and income and expenses are factors, as well.