 January through March 2008 The first calendar quarter of 2008 was an exceptionally turbulent and challenging period for equity investors, with "perfect storm" being an apt descriptor of what transpired. Pessimism dominated the markets throughout the quarter. Stock prices buckled, bowing to an ever-growing array of concerns that encompassed, among other factors: slowing US economic growth, intensifying housing price declines, renewed credit market turmoil, an absence of liquidity and capital creation, surging commodity (including energy and food) prices, higher home foreclosure rates, rising credit card delinquencies, weakening employment, and softening consumer discretionary spending. Consumer confidence, as measured by a University of Michigan survey, recently faded to its lowest level since 1973. Financial institutions remained in the spotlight during the quarter, continuing to grapple with asset markdowns, weakened balance sheets, and liquidity. Capital raises, designed primarily to shore up balance sheets weakened by major write-downs and stock price declines, became increasingly common. The level of distress in the financial markets was perhaps best exemplified by Bear Stearns & Co., which was brought to the brink of bankruptcy with stunning velocity due to a liquidity "crunch." The company ultimately was rescued–at a drastically reduced price–through the combined efforts of the Federal Reserve and JPMorgan Chase & Co. Amidst the market turmoil, the Federal Reserve and US government responded to the financial system's problems in extraordinary fashion during the first calendar quarter. The Federal Reserve shifted to an ultra-easing monetary policy mode, acknowledging that the economic outlook had deteriorated markedly. The Federal Reserve also undertook a variety of initiatives geared at unclogging the bottlenecked credit markets and restoring some semblance of investor confidence. The Term Auction Facility ("TAF"), created by the Federal Reserve in December 2007 for commercial banks, was considerably expanded in size and scope during the first calendar quarter of 2008. Two more lending facilities were created by the Federal Reserve to promote liquidity, including one specifically designed to allow the primary credit dealer community (including some investment banks) to borrow from it directly–the first time that has ever happened. The Federal Reserve also moved to accept more types of collateral from borrowing institutions including certain mortgage-backed debt instruments. Finally, the Federal Reserve essentially orchestrated the proposed JP Morgan-Bear Stearns merger by providing up to $29 billion in financing. On top of all of that central bank activity, other Washington, D.C. institutions were very busy as well. Congress, acting with unusual speed, passed a $168 billion fiscal stimulus package that included tax rebates for some taxpayers and tax breaks for businesses. Other important forms of "capital relief" directed at housing price declines and associated mortgage finance problems were provided by regulators' decisions allowing the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association (more commonly known as "Freddie Mac" and "Fannie Mae") to reduce their excess capital requirements and the Federal Home Loan Board Investment Authority's doubling of its allowable mortgage-backed security ratio. In April, legislation to help troubled homeowners refinance their mortgage loans appeared to be gaining momentum. Stock prices were largely unresponsive to these policy developments and initiatives in the first calendar quarter of 2008. However, towards the end of the first calendar quarter, the Federal Reserve's creation of a lending vehicle for primary dealers and its role as a "back stop" for JP Morgan's proposed acquisition of Bear Stearns seemed to assuage markets to some extent. Credit spreads narrowed, mortgage interest rates declined, government bond yields rose, and Visa Inc. had a successful initial public offering. Nonetheless, fragility remained the overarching theme. Markets in general were highly volatile. Rising commodity prices, with soaring oil, grains and rice as perhaps the most prolific "headline" examples, stoked renewed inflation worries. Investor risk aversion rose. To the latter point: gold prices–which oftentimes are thought of as a "store of value" in uncertain economic times – temporarily surged past $1,000/ounce, and Government bond yields–reflecting a near-complete shunning of credit risk and "flight to safety"–were down sharply for most of the first calendar quarter. The three-month Treasury bill yield dipped to as low as 0.55% during the quarter, a level it hadn't seen since the 1950s. From an economic sector perspective, the overall equity markets were characterized by widespread and, in many cases, steep declines. No sector was spared. In the US, the most severe downturns took place in areas such as Information Technology, Telecommunication Services, Financials, Health Care, and Utilities. Meanwhile, sectors such as Consumer Discretionary and Energy–hamstrung by concerns about lower global economic growth and a dimming outlook for consumer spending–also struggled. There was virtually no leadership per se in terms of market capitalization and equity style performance during the first calendar quarter. All 26 market-cap and style indexes maintained by Russell Investments posted negative quarterly returns. The investment landscape was similar in international equity markets. Thank you very much for the opportunity to be part of your investment program. |
Thomas F. Marsico
Chief Executive Officer
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