Quarterly Economic Review - 2008 Q4

Overview and Historical Analysis

The headlines from the fourth quarter of 2008 are still fresh in our minds: global financial crisis, market turmoil, brand-name Wall Street firms disappearing or restructuring, massive government bailouts. The result was a massive market decline unmatched in decades, with the S&P 500 Index posting a near 22% loss for the quarter and 37% decline for the year.

The question on most investor’s minds is: What's next? While no one can answer that question with certainty, we believe there are two important trends to consider as we look forward to 2009. The first is the pace of market recoveries after previous bear markets, and the second is rooted in the unusual nature of the September-October 2008 decline in which many asset classes that traditionally act independently declined more or less in unison. Let’s take a look at both.

After a Bear: Pace of Recovery

History is not a guarantee of future performance, but it may offer a potential framework for setting expectations. The table below shows each decline in the S&P 500 of greater than 20% since 1950, with the subsequent market performance one year and two years afterwards.

After each bear market, the market rebounded, often earning back the bear market’s losses by the end of the first twelve month period. One lesson to consider is that investors who suffered the decline, then retreated to the sidelines “waiting for the market to turn around” probably missed some of the gain.

Is the bear market over? Are we in a recovery period? That remains to be seen, but there are some positive signs. A number of commentators are suggesting that mid- to late November 2008 represented a potential market bottom. No doubt, there are challenges ahead, but the near panic of last autumn may be subsiding.

A Return to Diversified Correlations?

The second trend that may be relevant requires some explanation. In portfolio management, the degree to which asset classes track each other’s returns is called correlation. Highly correlated classes rise and fall together, while uncorrelated classes tend to perform independently.

One of the arts of portfolio management is piecing together asset classes that perform differently in a given environment in an attempt to mitigate risk. Unfortunately, one of the challenges at the end of the third quarter and into the fourth was that many equity asset classes became very closely correlated. In other words, the financial storm was strong enough to knock everything down, leaving few places to provide shelter.

This high degree of correlation is unusual. Over the next few months, however, we expect to see correlations spreading as some asset classes, industries, sectors or regions begin to recover more quickly than others, while others slump further.

What this means for you is that while the real economy is expected to face continued difficulties in the coming year, and the capital markets can be expected to rise, fall and drift as well. Spreading correlations create the opportunity for portfolio strategists and investment management firms to find segments of value.

Index Overview

At the end of 2008 the Dow Jones Industrial Average closed down 18.38% for the quarter and down 31.85% for the year. The S&P 500 index finished with a decline of 21.94% for the quarter, down 37.00% for the year. Within U.S. equity markets, large-cap stocks fared better than small- and mid-cap stocks for the quarter. Value generally outperformed growth. In the international arena, the MSCI EAFE Index (a proxy for developed international markets) posted a decline of 19.90% for the quarter and was down 43.06% for the year. The MSCI EAFE Emerging Markets Index posted a decline of 27.56% during the quarter and was down 53.18% for the year. The Dow Jones Wilshire REIT Index was down 39.95%. In the bond markets the Barclays Capital Aggregate Bond Index returned 4.58% during the quarter and 5.24% for the year.

The U.S. Economy contracted 0.5% during the third quarter, after 2.8% growth during the second quarter. The Federal Reserve (“the Fed”) decided to reduce the Fed Funds rate to 0.25% in December. Measured by the Consumer Price Index, inflation for the month of November was 1.1% on a year-over-year basis. Unemployment, as measured by the jobless rate released by the Bureau of Labor Statistics in November was 6.7%. Oil futures closed at $44.60 per barrel in 2008, a decrease of 55.68% in price from its close from the third quarter of 2008. The U.S. Dollar appreciated against the Euro by only 0.85% for the quarter; and depreciated 4.76% versus the Japanese Yen for the same period.

Summary

2008 was a tough year, and the last months, including the fourth quarter, offered an unprecedented combination of challenges and headlines. Certainly the past few months may have raised questions or concerns. Separately, your objectives or circumstances may have changed. Please do not hesitate to contact us; we will be happy to review your investment plan with you. We believe that by working together, we will be able to help you achieve your financial goals.

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Note: The opinions expressed are those of Genworth Financial as of 12 January 2009 and are subject to change based on market and other conditions.

Note: An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indices are unmanaged, with no associated expenses, and investors cannot invest directly in an index. Past performance is no guarantee of future results. Index returns are all total returns with dividends reinvested, which means the return includes not only the change in price for the securities in the index, but also any income generated by those securities.

Sources: Bloomberg, Bureau of Labor Statistics

 For more information, please contact Jonathan E. Brochstein at Weston Wealth Strategies—(203) 319-9876 or contact Jonathan via email.

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