The Year That Was, The Adventure Ahead

4Q 2007

The year that was 2007 is now one for the history books. To summarize, equities (represented by the S&P 500) finished this past year with a total return of 5.5%, while fixed income securities (as measured by the Lehman Aggregate Bond Index) gained a more impressive 7.0%. Interestingly, this was only the 8th time since 1900 (the beginning of our available data) that bonds outperformed equities in a year when both investment classes delivered positive returns. Since World War II, this has occurred only four other times: 1960, 1970, 1982, and 1984.

It was really during the fourth quarter, as investor confidence began to wane, that this virtual anomaly came into being. With housing woes spilling over into the broader credit markets and beginning to impact the economy in general, the S&P 500 turned in its first fourth-quarter decline in seven years. However, given a tumultuous 10.1% correction between October 9th and November 26th, you could say we were fortunate to emerge with the more palatable full quarter loss of only 3.3%. At the same time, a flight to quality drove the price of Treasury bonds significantly higher and the yield on the 10- year note dropped to 4.03%, near its low for 2007. We would remind you that as recently as July, before all the credit worries hit, this yield was comfortably above 5%.

While many economists and money managers remain confident that the U.S. economy will escape recession in 2008, and that stocks will rise for a sixth consecutive year, a growing number of analysts have become concerned that interest-rate cuts by the Federal Reserve and continued strong growth internationally (where equities again outperformed domestic issues) will fail to lend enough support. Some, including former Fed Chairman Alan Greenspan, argue that the current Fed’s efforts may be hamstrung by an inflation rate that persistently exceeds stated goals (think $100/barrel oil, gold above 1980 highs, and many agricultural products setting records). As these costs slowly trickle through, we could see pressure on corporate profits and perhaps even employment, which has been widely regarded as the cog that holds consumer spending in place. Representing more than two-thirds of overall GDP, consumer spending levels ultimately define the country’s economic health and play a big part in the direction of the markets.

Well, as you can see by now, many fear-inducing headlines could potentially paint the tape in the year to come. That said, we would reiterate our core belief that fear itself is not an investment strategy and that discipline over time can overcome even severe market fluctuations. As uncomfortable as it may be, price volatility is actually the friend of long-term investors in that it provides an opportunity to rebalance into underperforming assets.

Regardless of the eventual outcome, we can promise at least two things about 2008: it will be an adventure, and we will be there each step of the way to serve you, our clients, in the design and implementation of your specific wealth plans.