Quarterly Market Updates

MARKET UPDATE AND OUTLOOK : JANUARY 2008

What’s new at J.P. King & Associates, Inc?

We welcome our newest Associate, Nancy Gire, CFP^®, CPA to our team as Senior Financial Advisor.  Nancy’s background includes many years in both financial planning and tax advising.  A full description of her background is available on our website, www.jpkingassociates.com.  We are very excited about Nancy’s contributions to our efforts.

We must also report that long time team member Peter Godino has left our firm and returned to his hometown of Boston.  Pete spent seven years in the Bay Area, but he and Michelle decided they wanted to raise their young children close to his family and long time friends.  We will miss him very much and wish him well.

Looking Back:  Fourth Quarter (Q4) and Full Year, 2007

For the first time in seven years, Q4 saw declines in stock markets, both domestic and overseas.  Even during the bear market of 2000-2002, stocks had managed to rally in the fourth quarter, but it was not to be in 2007.  The Wilshire 5000 Index, the broadest measure of the U.S. stock market, was down 3.1% for Q4 and up only 5.7% for 2007.  International stocks fared somewhat better, with the Dow Jones World Index (ex. U.S.) down only 1.6% for the quarter, and up 14.4% for the year.  Among the various U.S. stock mutual fund categories, Large Growth did best, breaking even for the quarter, while Small Value did the worst, losing 6.7%.  For the full year, Mid Cap Growth led the way, +16.5%, while Small Value again had the poorest results, -5.5%.  Among International stock funds, Latin American (+4.6%) and Emerging Markets (+4.4%) performed best during Q4, as well as for the full year, returning a whopping 46.1% and 36.4% respectively.  Among sector funds, Natural Resources funds again turned in a strong quarter, thanks to rising energy and commodity prices, gaining 7.2% for the quarter and 40.4% for the year.  At the other end of the spectrum were Real Estate (REIT) funds, which declined 12.1% for the quarter and 14.8% for the year; their first down year since 1999.

Fixed income funds split along credit quality lines with high quality, especially U.S. Treasuries, enjoying above average returns for Q4 and all of 2007, while lower quality and, to some extent, municipals, posted below average returns.  It was a classic “flight to quality” environment in the markets, especially as the year wore on.  The Lehman Brothers Aggregate Bond Index gained 3.0% for Q4 and 7.0% for 2007, its best year since 2002, the last time it beat the Wilshire 5000 stock index.  The LB Municipal Index returned 1.4% and 3.4% for the quarter and year, below its 5 year average of 4.3%.  High Yield Corporate Bond Funds averaged -1.5% for the quarter and only +1.5% for the year.  High Yield Munis were worse for the quarter (-2.3%) and full year (-3.0%).  The best performing sector was TIPS (Treasury Inflation Protection Securities), +5.0% and +11.6% respectively.

Bank Loan funds, a strong performer the previous four years, slipped in 2007 due to their lower credit quality, losing 0.6% during Q4 and returning only 1.1% for the full year.

Finally, alternative investments did not escape unscathed during the second half swoon that hit the riskier asset classes.  While traditional safe havens such as Cash and Treasuries benefited, Hedged Equity did only slightly better than Unhedged during the quarter, with Long/Short funds averaging -0.3%.  Still, that was nearly 3% better than the average U.S. stock fund.  For the year, the average return of 4.4% was below the average fund of 6.6%.  Similarly, Bear Market funds turned in a positive quarter (+2.5%), but were negative for the full year (-6.0%).  Our primary Hedged Equity Funds had mixed results.  Hussman Strategic Growth (HSGFX) was down 0.3% for the quarter and up 4.2% for the year.  Rydex Absolute Return (RYMSX) was down 0.5% for the quarter and up 4.0% for the year.  The disappointment was with Schwab Hedged Equities (SWHEX), which was down 4.3% for the quarter and 1.2% for the year.  We have liquidated all SWHEX positions due to this underperformance.  We also sold Schwab Yield Plus Fund (SWESX) for similar poor performance, and sold Eaton Vance Floating Rate High Yield Fund (EAFHX) because we feel the Bank Loan Category is not a good place to be in a falling rate environment.

Looking Ahead:  First Quarter and Full year 2008

The big question that remains unanswered is whether the credit crisis/sub prime mortgage mess will tip the U.S. economy into recession and if it does, lead to a worldwide slow down.  The odds of a recession in the U.S. in 2008 range from 30% to 60%, depending upon which economist you believe.  In early 2007, those odds were put at 10% to 25%, so you can see how the events of the past twelve months have made the experts more pessimistic.  Consumer confidence is down, output is growing more slowly, and companies are lowering their inventories, all signs of at least  slower growth if not outright recession (contraction of the economy for at least 2 quarters in a row).

The year is off to a bleak beginning in the stock markets, with virtually all categories, except Bear Market and Gold Oriented, down anywhere from 5-15% in the first half of January.  The markets are anticipating a recession, slower growth and declining earnings.  We expect to maintain a slightly defensive posture with higher cash balances and/or a small bearish position in most client accounts at least through the first half of 2008.  With the election looming later in the year, market volatility may increase so I believe it will be prudent to maintain a slightly defensive posture throughout the year.

James P. King, CFP^®
January 15, 2008