1/5/2009 - Fourth Quarter 2008 - Year in Review

“One may surmise that the current credit lock up and real estate excesses are not confined to the United States.” Those ominous words were written approximately one year ago, in our year end report of 2007. Yet we had no idea how significant those words would become in describing the calamitous year 2008. The severity and breadth of the world’s economic decline blindsided even the most astute economists and seasoned investment managers. Major US institutions would cease to exist, and global real estate values would collapse under the weight of easy credit, over leverage and thin collateral. All confidence had been lost in the capital markets. The United States and world markets were in basic free fall and the entire global financial system succumbed to wide spread panic. There were not many places for refuge absent FDIC insured cash and the long US government bond. The auction rate market had stopped functioning all together, the municipal market became illiquid, and commercial paper froze. Banks ceased lending to businesses and individuals as they worried about their capital balances negatively affected by asset write-downs. Many companies disappeared, many more are now suspect and remain on life support. Just recently, the automotive industry and most banks were thrown lifelines by the US Government.

The stock market swoon and the commodities bubble grabbed the headlines but the real story of the year was in the credit markets. They simply just stopped functioning. Today, government action led primarily by the United States (as always) finally has restored order from the extreme volatility and the end of the year actually saw modest rebounds in the value of fixed income and most equity indices.

Fixed Income Markets

Fixed income markets underwent a seismic re-pricing of debt as a result of the sub prime and credit market crisis. Non-investment grade debt is now trading, some say accordingly, at significant discounted prices to par, and is more reflective of the risk inherent in the investment. “Junk” bond yields have doubled over the past year and now sport average yields of just short 20%. If one has an appetite for risk, eventual market recovery in this sector could easily outpace equity returns. Just don’t ask for your money back anytime soon.

The Barclays Capital Aggregate Bond Index returned just 5.24% for the year (most of it in the final days of the final month). The US Intermediate bond index had a year end yield of 3.99%.The 20-year Treasury bond yields just 2.84% versus 4.48% (a year ago); the ten-year Treasury note yields 2.21% versus 3.95% (a year ago)and the three-month Treasury bill yields a puny 1.55% versus 3.08% (last year). International bonds performed poorly as a result of the global recession and declined by (8.65%) for the year. The Barclays Capital Global Aggregate now has a yield to worst of just above 7%. How bad was the bond market in 2008? Even the benchmark has a new name, since the company that created the index went to zero. Need we say more?

Equity Markets.

As a rule, every stock sector was negative for the year. (Please refer to attached benchmark sheet) It painfully played out like this: Most US stocks lost anywhere between 34-40%, Developed International lost 45% and the Emerging Market Countries index lost nearly 55% during 2008. Emerging market losses were amplified in part due to extreme natural resource value declines, such as precious metals, oil and agricultural products, as well as perceived risks in their underlying currencies.

Key Rates

The discount and prime rate which were just recently cut again on December 15, 2008, ended the year at .5% and 3.25% respectively. On December 31, 2007 the discount rate was 4.25% and prime rate was 7.25%. Fidelity Cash Reserves now has an effective yield of 1.89% as opposed to the past 12 month effective yield of 4.76%.

As Good as Gold

In a year of the Olympics, Gold did not disappoint. It began the year at $840 a troy ounce and ended at nearly $879 per ounce, despite wide fluctuations, settling on a modest but positive 5% gain. However, the trading range was quite dramatic with a 40% price swing between the trading low and the 2008 high of over $1,000 per ounce.

Oil Spike & Commodity Rout

Oil began the year at $95.64 and shot above $140 per barrel in the sessions leading up to the July 4th holiday.What happened next was beyond the realm of most everyone’s belief. A massive devaluation of all commodities attributed to the global slow down including crude, that led to oil’s retreat to the $35 dollar range by December 26th. It has since bounced back some 30% in the last remaining trading sessions and ended the year just above $46 per barrel. Needless to say, most energy, agricultural and mining stocks were adversely affected by the sharp downturn in commodity prices during the fourth quarter. However, there appears to be a compelling argument for those with any time horizon for at least an attractive entry point into many commodities and commodity related stocks based upon the massive unwinds that took place in the latter half of 2008.

Final Word