Quarterly Market Summary Q1 2008

April 1, 2008

Quarterly Market Summary

The first day of the second quarter of 2008 experienced better than 3% moves in both the NASDAQ Composite and the S&P 500. The Fed’s action to cut interest rates, inject liquidity through open market operations, and extend lending to primary dealers like JP Morgan and Goldman Sachs has seemingly begun to impact the market positively and has kept the major indexes flat to up over the past four-week period.[1]

As you are well aware, the same cannot be said about the first quarter of 2008 where the major markets have trended lower due in large part to a national housing downturn, a credit crisis in the private credit markets, and a US currency correction that has increased oil and other commodity prices.

The housing problems can be attributed to homeowner debt outpacing homeowner equity. This is in part due to faulty lending practices and a big bet that housing valuations would continue to grow at a steady rate. In the trailing 12-month period about 8.8 million homeowners, or about 10 percent of homes, will have zero or negative equity by the end of March due to a reduction in housing valuations.[2] To battle this issue the government has created legislation that will begin to regulate mortgage brokers and how they calculate appraisal values.[3] Also, funding has been provided to buy up problem mortgages including adjustable-rate mortgages (ARM), which have been the chief antagonist in the unraveling of the housing market.[4] Additionally, it must be noted that the write-downs are not limited to the sub-prime market. According to the Fed Governor Ben Bernanke, “In 2007, about 45 percent of foreclosures were on prime, near-prime, or government-backed mortgages”.[5]

The weakness in the housing market has led to a credit crunch in the financial arena. Many primary dealers and other financial giants developed innovative debt products based on leveraging and combining mortgages. Now these mortgage backed securities and their derivatives are being written down due to the devaluation of the underlying asset. To strengthen the credit market the Federal Reserve has opened up its credit facility to primary dealers and has committed $420 billion in treasury swaps for debt including mortgage-backed securities.[6] This has helped to strengthen the balance sheets of the investment banks and has provided much needed financing. Additionally, the treasury secretary Henry Paulson has designed a blueprint for regulatory restructuring that should streamline and update the current method of regulating the financial markets if passed.[7]

The currency devaluation, like the credit crunch, is partially correlated to the weakness in the housing market. As the US economy weakens the Fed is forced to cut rates, which negatively affects the strength of the dollar. Because of the dollars current valuation imports have become more expensive for the American consumer. This weighs on our economy as consumer staples like gas, heating oil, and food stuffs demand more of the family budget, reducing overall spending habits. Although the weaker dollar comes with negative implications, it comes with opportunities as well. The current state of the dollar encourages foreign investment in our nation, which can induce job creation. As well, the weak dollar increases exports of domestic goods to foreign consumers. This can lead to a decline in the trade deficit, something that has weighed on the American economy. Although the political agenda supports a strong dollar policy, the weak dollar may have beneficial affects on our economy.

We must also take into consideration the five-year bull market the global economy has enjoyed where the S&P 500 climbed from 768.6 points in April of 2003 to a high of about 1550 in late 2007, a 50% move[8]. It is common within regular market cycles for the major markets to reverse while they digest the previous market gains like those we have enjoyed over the past five years. This is not to take away from the real threats our economy is facing, but it must be reflected upon when considering economic conditions.

Whether the economic condition will respond in a sustained positive manner to the moves by the Fed and the changing business landscape remains to be seen. Trying to project such market action is difficult and not something this writing aims to do. But that is not to say one does not prepare for dynamic market environments. Preparation for these events comes with careful planning, a broad allocation, and quality assets within the portfolio.

Market Commentary

Bill Gross, a leading bond fund manager at PIMCO believes the Fed must begin attacking the core issue within the downturn, namely housing, through federal backing of the mortgage market.[9]

Ken Heebner, a successful market practitioner with CGM Funds, believes we will avoid a recession and experience slower growth throughout 2008. He sees bright spots and opportunity in the commodity markets.[10]

Ken Fisher, founder of Fisher Investments and a columnist for Forbes Magazine, states in his most recent commentary that the US economy is in the first full correction of the new leg of the bull market, but does not believe we will experience a recession.[11]

Don O’Neal, a portfolio counselor from American Funds, sees a tumultuous market for the remainder of 2008 with sharp swings on both the up and downside. He does make note that PE ratio’s are at very attractive levels and points to opportunity within selected areas.[12]

Index Returns

S&P 500
Q1: -9.9%
1-Year: -7.10%
NASDAQ Composite
Q1: -14.07%
1-Year: -5.89%
Dow Jones Industrials
Q1: -7.6%
1-Year: -1.00%
MSCI EAFA Index
Q1: -9.5%
1-Year: -2.70%
Source: The Wall Street Journal

Opportunities

One area that has been extremely bullish during the market correction has been the commodity market. This is to a degree due to the weakness in the US currency, but also due to supply constraints. Non-renewable natural resources like oil and natural gas and non-replenishable resources like copper are in increasing demand, which producers cannot keep up with. Companies that manufacture or refine related products have benefited from the increased global demand.

Select emerging markets have shown signs of strength. Latin America and Southern American countries have held up during the global downturn due in large part to their connection to the commodity market. Also, the internal growth characteristics of the industrialization of these markets have helped to fuel the economies.

Recently, up turns in some select retailers, the solar market, the financials, and specific technology leaders may be pointing to a short-term bounce in the domestic marketplace. With the recent Fed action and a possible end to the write-downs of the primary dealers buyers have seemingly returned to the table at least for the time being. It remains to be seen if the action is sustainable though, as some of the financial balance sheets are still in question.

As expected during a downturn, Fixed Income Products have performed well, benefiting from rate cuts and a shift away from the equity markets. Specifically, Treasury Inflation Protection Bonds (TIPS) and Municipal issues have led the debt instrument market.


Jason Dohaney, MBA
Financial Analyst / Registered Representative

[1] See http://news.morningstar.com/
[2] See http://www.economy.com
[3] See http://www.fanniemae.com
[4] See http://www.freddiemac.com
[5] See http://www.federalreserve.com
[6] See http://www.bloomberg.com
[7] See http://www.ustreas.gov/
[8] WONDA™ Williams J. O’Neil Institutional Database
[9] See http://www.pimco.com
[10] See http://www.cnbc.com (video)
[11] See http://www.forbes.com/fisher
[12] See http://www.americanfunds.com/funds/commentary/index.htm?r=l




Past results are not indicative of results in future periods. Investors should carefully consider the investment objectives, risks, charges and expenses before investing. This and other important information is contained in each fund’s prospectus, which can be obtained from a financial adviser and should be read carefully before investing.