Fourth Quarter 2007 Market Review

Fourth Quarter 2007 Market Review


An environment of uncertainty prevailed in the fourth quarter, which led to heightened volatility in the markets as stocks and interest rates fell. The latter caused U.S. Treasuries, investment grade U.S. bonds, and foreign bonds as well to appreciate. The broad U.S. economy continued to expand, but confidence about its future weakened amid continued frailty in U.S. housing markets, rising defaults among residential mortgages, distress in the short-term credit markets, signs of declining consumer demand, and significant asset write-downs from large well-known financial companies. Oil prices continued to rise, and the U.S. dollar continued to weaken versus most major foreign currencies.

Equities Review

The stock price decline was widespread; only commodities and emerging markets stocks were up. U.S. stocks provided moderate losses for the quarter amid changing perceptions of Fed policy and frequent announcements of reduced profits or asset write-downs. The average diversified U.S. equity fund returned -3.3% for the quarter. Large cap stocks performed moderately better than small caps, but more noticeably, growth indices significantly outperformed their value counterparts. The Morningstar U.S. Growth Index fell 1.1% while the Morningstar U.S. Value Index declined a much steeper 6.8%. From a sector perspective, financials, consumer discretionary, communications, and real estate stocks fared poorly, dropping more than 7%, technology and health stocks were almost flat, while natural resources stocks, buoyed by rising oil prices, rose 7% for the quarter. 

Foreign stock markets were also hurt by declines in the financials, consumer discretionary, and industrial sectors. The U.S. dollar decline of 1.2% during the quarter versus 19 currencies tracked by the J.P. Morgan Dollar Index boosted foreign returns for U.S.-based investors but not enough to offset moderate local currency losses in developed foreign markets, especially Japan. The MSCI EAFE Index returned -1.8% in U.S. dollars while the average diversified international equity fund earned -2.0%. Diversified emerging markets mutual funds continued their stellar run and returned 3.7% for the period. Emerging markets are major producers of commodities, including oil, and benefited from soaring commodity prices globally.

Fixed Income Review

Bonds provided modest to moderate gains on average during the quarter, but sector and credit selection was important. U.S. Treasury securities benefited from investors’ avoidance of credit risk. The Lehman U.S. Aggregate Index, a broad index of quality bonds, returned 3.0% for the fourth quarter. The credit yield spread above treasuries widened considerably; high-yield bond yields increased almost a full point. As a result, the Lehman High Yield Index returned -1.3% due to price declines in excess of interest yield. The Fed reduced the Fed Funds Target Rate to 4.25%. As intended, interest rates declined across the yield curve, and quality bonds across the maturity spectrum appreciated. The two-year Treasury rate fell by 90 basis points (0.9%) to about 3% amid rate declines that were more pronounced on the short end. Notwithstanding, financial institutions and other short term debtors competed vigorously for deposits, and money market fund rates remained high at about 4.75% at quarter end. The combination of falling yields and rising currencies helped global bonds to a solid return; the Lehman Brothers Global Aggregate Index returned 3.3% in U.S. dollars for the quarter.