January 17, 2008
When we look at 2007 from a financial perspective, investors will remember it as the year of the subprime mortgage debacle. It seemed like these bad loans were in the news virtually every day in the latter half of the year. Throughout 2007, several large financial firms exposed their portfolio of subprime loans as they announced huge losses in their mortgage departments. Jobs were lost…foreclosures spiked…credit tightened…the stock market gyrated.
To help alleviate the pain, the Federal Reserve has taken some aggressive action and has lowered the federal funds rates in the second half of 2007 to 4.25% from 5.25%. This medicine will probably not impact the economy until later this spring – it usually takes nine months from the date that the rate was lowered for the economy to feel the effects of lower rates. Hopefully these lower federal funds rates will translate into lower mortgage rates and will give many an opportunity to refinance and secure better mortgages. We also hope this will help our financial stocks that are held in many of our mutual funds.
As for the equity market returns in 2007, the total stock market index (as measured by the Dow Jones Wilshire 5000) was up 5.73% while the S&P 500 (the largest 500 companies in the United States) was up 5.49%. Small-cap stocks, which make-up a portion of the total stock market index, did not perform as well this year; the Russell 2000 was down 1.57%. This was not surprising – small-caps have gone up a lot faster than their large-cap counterparts since 2002. The overseas stock markets were up again this past year. In fact, the MSCI EAFE index showed a gain of 11.17%. The continued global economic boom is providing the support for these gains. It will be interesting to see what kind of impact slower U.S. growth will have on the global front
As for the fixed income area, I was pleasantly surprised this year. The Lehman Brothers U.S. Aggregate was up 6.97% in 2007. Going into the year, I would have been pleased with a 5% return from our overall fixed income allocation. We ended up receiving an approximate 5% return from our short-term fixed income securities (Touchstone Ultra Short Duration fund and the Schwab taxable money market funds); our intermediate-term fixed income investments were up even more.
As you know, our portfolios continue to be slightly tilted to the value side of things. While two of our mutual funds held stocks that were dragged down by the subprime market in 2007, I still believe that value investing, as defined by Graham and Dodd or Warren Buffet, should offer us the best way to ride out a slowdown in the U.S. economy. Some examples of this type of investing would include the Dodge and Cox funds, Selected American Shares, Third Avenue Value funds, as well as the First Eagle and Royce fund families. One journalist offered that buying a value stock is akin to trying to catch a falling dagger – you hope to grab the handle and the not the blade. In other words, the value manager hopes the individual stock has reached its bottom upon the manager’s purchase. I truly believe the managers we have in your portfolios will catch more of the handles than the blades when it comes to putting your hard earned money to work.
Expect more of the same stock market volatility in the weeks and months ahead. Wall Street still needs to work through the subprime issues and the fourth quarter earnings reports. If we are going to have a slowdown, investors will see the signs in the earnings reports for this past quarter and the next two quarters.
Enclosed you will find your Portfolio Performance Summaries, Portfolio Holdings Statement as of December 31, and a quarterly Account Management Fee Statement. Please call us should you desire the most recent copy of our Form ADV, Part II. In addition, do not forget to notify us should your investment objectives or personal financial situation change. January 17, 2008
Sincerely,
William A. Bullock
P.S. Please note that the 2007 tax information will be mailed in a separate mailing by mid-February.