Financial Update: Fourth Quarter 2007
Release Date: 03.17.2008
The fourth quarter ending Dec. 31, 2007, brought a turbulent year to an uneasy close, with the subprime mortgage market meltdown contributing to a serious real estate slowdown and a real threat of recession hanging over the economy.
The seriousness of the subprime mortgage crisis was highlight repeatedly during the quarter as major financial institutions posted large write-downs related to these securities. Real estate markets with large bubbles in property prices watched valuations sink in response to tighter credit, increased loan defaults and property foreclosures. Indeed, foreclosure rates increased all over the country as more homeowners defaulted on newly adjusted, high-rate ARM loans. Continued, record-high crude oil prices contributed further, with oil closing out the quarter at $95.98 per barrel. Faced with the possibility of the economy suffering a painful slowdown and tipping into recession, the Federal Reserve lowered the bellwether Federal Funds overnight rate to 4.25 percent in two moves on Oct. 31 and Dec. 11. Overall, economic turmoil impelled investors to sell stocks and seek lower-risk investments such as U.S. Treasury paper. Non-U.S. markets followed, with the equities of developed markets losing ground to high-quality fixed income.
All broad indexes lost ground in the quarter. The Standard & Poor’s 500 Index ended the period down 3.33 percent, and the broader Dow Jones Wilshire 5000 was down 3.22 percent. As is often the case, economic uncertainty played out with investors favoring stocks of larger companies over those of smaller, riskier companies; DJW’s Large Cap index ended the period down 2.90 percent, while the DJW Small Cap index lost 4.91 percent. On the S&P 500, energy stocks – especially petroleum-related issues – yielded the strongest returns (4.09 percent). The utilities sector was the only other group with positive performance in the period (up 1 percent). Finance was the worst performer, down 14.10 percent. The consumer durables sector finished the period down 10.26 percent.
Yields on two-year Treasuries fell 91 basis points to 4.01 percent, while yields on 30-year Treasuries dropped 38 basis points to 4.46 percent. As befits falling interest rates, long-term paper outperformed shorter-term issuance.
For the fourth quarter, the Cleveland Foundation reported a decline of 1.08 percent vs. a return of 6.06 percent during the same period in 2006. For the year, the return was 8.36 percent, compared with 15.34 percent in 2006.
The first quarter of 2008 is expected to yield some opportunities – the S&P 500 is cheaply valued now and the Fed is expected to continue cutting short-term rates – along with challenges, including ongoing tightening of credit standards, falling housing prices and high-priced oil.
Overall for 2008, there is reason for optimism: as housing bottoms out, its drag on the overall economy is expected to stop. Also, while larger companies likely are feeling squeezed by the credit crunch, middle-market companies are still landing loans. On the manufacturing side, shipment growth thus far is running higher than inventory growth, pointing toward ongoing production rather than a slowdown. By September – one year from the first in a series of Fed rate cuts in 2007 – the economy may start to feel the benefits. Rate cuts typically take one year to make an impact on a lagging economy.
In the meantime, a broadly diversified portfolio remains a key ingredient for staving off downturns in particular sectors.