2007 In Review, Not Bad, Considering

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By Marjorie L. Fox,JD, CFP®, AIF®

Not Bad, Considering....Turbulence plagued the capital markets in2007.  Investors will remember theyear for the global credit crisis triggered by a housing slump in the U.S. and awave of mortgage delinquencies.  MerrillLynch, Citigroup, and other investment banks holding mortgage-relatedsecurities absorbed $100 billion in losses, named new chief executives, and soughtcapital infusions from investment funds controlled by foreign governments.  Bank of America initiated abailout/acquisition of Countrywide Financial, the nation's largest mortgagelender, for $4 billion - a fraction of the company's $24 billion market value just12 months earlier. 

But, despite theturbulence, overall performance was positive.  It was a year of double-digit percentage gains and losses.  Commodities and large cap internationalstocks were the best performing asset classes, and fixed income helpedstabilize portfolios.   

  • Led by Treasury Inflation-Protected Securities (TIPS), U.S. and international fixed income asset classes had their best year since 2002.  In 2007, the Lehman Brothers U.S. TIPS index returned 11.6%, in part because of the rush to purchase Treasurys when the credit markets froze.  
  • The total return of the U.S. stock market, as measured by the S&P 500, was substantially below its historical 10% average annual return.  Not surprisingly, as the dollar weakened, companies with significant foreign-based earnings did well, including energy, technology, and materials companies. In a reversal of 2003-2006, value underperformed growth and small caps lagged large caps.
  • International equities, as measured by the EAFE index, performed well because of a weaker dollar and the comparative strength of overseas economies.
  • Related to the overseas story was the continuation of demand for energy and raw materials from China and other high-growth developing countries-a trend reflected in the strong performance of the energy and materials-related commodity sectors.
  • After years of stunning returns, domestic real estate investment trusts (REITs) had their worst year since 1998.  Nevertheless, we continue to believe that the commercial real estate asset class enhances long term returns and offers substantial diversification benefits.

Looking Ahead....2008 began with the prospects of recessionweighing heavily on the U.S. and international equity markets.  As stock indexes reeled and investorsturned to safer havens, Treasury prices rallied, pushing down yields.   The S&P 500 ended the week ofJanuary 14-18 down 5.4%, its largest one-week percentage drop since July 19,2002.  As of January 18, theS&P 500 was down 15% from its October 2007 high and off 9.8% in 2008.  The Russell 2000 is now down 21.3% fromits peak in July 2007, so small U.S. company stocks have reached bear marketterritory (a decline of 20%).

So, if a recessionis coming or one has already begun, what does that mean for the equity markets? In his January 20 column in The New York Times, Paul Lim stated that "recent history showsthat it's often the anticipation of arecession that depresses stock prices, not the actual experience of arecession" (emphasis added).  He then noted that in three of the last four recessions, stocks actuallygained ground.  Of course, history providesa guide not a guarantee.

Risk Tolerance.... Fox, Joss & Yankee designs portfolios basedupon each client's risk tolerance and time horizon.  We keep an eye on the important goal of long term returnsprovided by the equity asset classes, while striving to minimize volatilitywith an allocation to the fixed income asset classes.  We know there will always be uncertaintyin the markets, but what remains a constant for us is this framework for how wemake consistent and disciplined investment decisions.  This common sense approach has served our clients well foralmost two decades. 

All of us at Fox,Joss & Yankee wish you a healthy and prosperous 2008.