At the beginning of every calendar quarter, we share our perspective on recent economic
and market developments and our expectations for future market performance.
First Quarter Comments 2008
Although it appears we are in the eye of a financial storm, we believe rays of sunshine are beginning to
break through, in the form of more aggressive government action and a possible bottoming-out of the stock
market. Considering the speed with which the economy weakened (it now looks as though the downturn began in
earnest during the last two weeks in December), policymakers reacted in a timely fashion to minimize the
damage. Even the legislative branch chimed in with a stimulus package, which will take effect during the second
quarter.
Led by the very astute Ben Bernanke, who is, as luck would have it, an expert on the policy errors which
led to the Great Depression, the Federal Reserve has relied thus far on lowering interest rates and, more
recently, on an aggressive and innovative program to provide enhanced liquidity to the financial system. This
program provided $200 billion in high-grade Treasury securities to commercial and investment banks in an effort
to unfreeze liquidity and to stimulate lending and borrowing. However useful these measures are, they provide no
direct aid to homeowners who cannot qualify for refinancing.
Fourth Quarter Comments 2007
Despite considerable market volatility during the fourth quarter, the ongoing effort by policymakers to contain
the fallout from the subprime mortgage situation is beginning to have an impact. At the very least, concerns have
shifted from the effects on individual companies (already largely discounted by the market) to the potential
consequences on economic growth next year.
Third Quarter Comments 2007
While everyone in the financial world was aware that there were problems in the housing markets
and that defaults on mortgages were rising, the severity of the problem was underestimated to say the
least. By bundling large numbers of mortgages together and then adding an amount of cash sufficient to
cover a default rate forecast by sophisticated (and unfortunately backward looking) computer models, the
resulting mortgage backed security was viewed as relatively bullet proof and therefore often carried a
AAA credit rating. Only when default rates soared well above the level forecast by the computer models
did problems arise. As defaults escalated, the value of the mortgage backed securities fell and those
creditors holding such paper as collateral for loans ultimately were forced to call the loans, thereby
creating a liquidity crisis of substantial proportions.
Second Quarter Comments 2007
The second quarter 2007 produced strong returns across the board. The quarter began with investors believing
the economy was neither too hot nor too cold but "just right". Investors' optimism was reflected in the strong
gains seen in April and May, as many equity markets saw their best gains since the early 2000s. By June,
however, investors began to worry that a hotter economy would keep inflation high enough that the Federal
Reserve Board would be forced to raise interest rates and, in response, stocks moved down.
