2nd  Quarter 2008 Newsletter
Following the steep sell off in the capital markets in June, which saw the S&P 500 Index slide – 8.43% for the month i, it may be difficult
to recall that the second quarter began with some optimism. A rally from mid-April through May encouraged speculation that a market
bottom had been established. Risk appetite started to pick up as we saw large inflows into global equities and corporate bonds.

Unfortunately, optimism was cut short by a very difficult June for the S&P 500. A number of emotionally fraught issues, combined with
some fundamental headwinds, pushed the markets into pessimism. Among the issues were:

Commodities and Oil: While high oil prices were being blamed on commodity speculators in some quarters, this analysis ignores
significant fundamental issues. Demand for oil in emerging markets was up 147.7% in 2007
ii, highlighting the continued growth in
demand despite limited supply. OPEC may be close to maximum output and non-OPEC supplies are disappointing

Inflation: Inflation is rising across the globe and central banks have differing views about how to manage it. The European Central
Bank has so far focused on headline inflation – that is, the total inflation across an economy—while the Federal Reserve Board has
focused on core inflation, which excludes food and energy costs. Inflation in Asia is particularly high and is starting to impact returns.
Many Asian central banks have begun to raise rates

Earnings growth under pressure: Early year earnings forecasts have proven to be too optimistic and have been substantially
trimmed. S&P analysts have cut forecasts by half since the beginning of the year. Estimates have been reduced for 8 of 10 S&P
industry sectors. (Information Technology and Energy were the exceptions.) Financing costs have slowed share buybacks, which had
been a big driver of earnings over the last three years.

The continued housing slump and credit crunch also contributed with the pessimism that finally took hold by the end of June. This
table shows overall Second Quarter and Year-to-Date returns for the major indexes:

Some notable trends for the quarter include:

  • Mid and Small Caps outperformed Large Cap stocks. In particular, Mid Caps proved to be nimble enough to capture upswings
    while retaining some of the defensive qualities of larger companies.vi
  • Growth outperformed value.vii
  • The best performing sectors were energy, utilities, materials and technology.viii
  • The weakest sectors were financials, industrials, consumer discretionary and consumer staples.ix
  • International trailed U.S. equities, while developed markets trailed emerging markets. Significantly, among emerging markets,
    commodity exporters (Brazil, Russia, South Africa) had positive returns while others (China, India, Korea, Taiwan and Turkey)
    had negative returns.x
  • Shorter-term maturities outperformed longer-term maturities while treasuries trailed corporate bonds due to the strong start to
    the quarter.xi
  • International fixed income trailed domestic fixed income for the quarter, however emerging market local currency debt provided
    positive returns.xii
  • Commodities had stellar returns for the quarter, up 16.1%, driven by strong returns from not only oil but also agricultural

The Outlook: Will There Be Good News Ahead?

Those looking for good news can take some solace from the fact that the S&P 500 Index has lost 8% in a month 21 times and has
rebounded to show gains two-thirds of the time
xiv. Even without an immediate rebound, it is useful to remember that June 2008, while
bleak, was not unprecedented. Corrections, even bear markets, are simply part of the investing cycle. Having a carefully considered
long-term plan can help guide investors through.

Another thought to keep in mind: just as a rising tide lifts all boats, an ebbing tide lowers them. Many investments have lost value
based on the tide and not their intrinsic value. History shows us that the tide comes back in eventually, and many market-battered
investments may become opportunities.

No one can say definitively when the markets will reverse course and begin the next bull cycle. The important thing is to remain clear-
eyed and seek opportunities as they arise.


Robert Valentine


i Standard & Poor’s
ii Ned Davis Research
iii Goldman Sachs
iv Financial Times, Avatar Associates
v Standard & Poor’s
vi Russell Indices
vii Russell Indices
viii Standard & Poor’s
ix Standard & Poor’s
x MSCI Barra
xi Lehman Brothers
xii Lehman Brothers, JPMorgan
xiii Dow Jones Indices
xiv Standard & Poor’s

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