3nd Quarter 2007 Review

From the Desk of Ron Rowland

The financial markets can be confusing and overwhelming. Financial media outlets are seemingly ubiquitous with news channels broadcasting an unbroken stream of market news. Adding to the confusion, these various sources often reach contradictory conclusions, change their views, or the market responds in an unanticipated way. For a good example, consider this last quarter.

July began on a positive note. Manufacturing reported strength in the overall economy. The Dow Jones Industrial Average climbed to new all time highs, cresting above 14,000 points. Nobody knows when it is time for a turnaround, and July 2007 was no exception to this rule. Almost before the euphoria could lapse, the market suffered a series of sharp declines.

When subprime mortgage problems resurfaced this summer, the market finally began to grasp the real issue - unaccountable debt. Trendy new financial instruments like collateralized debt obligations (CDOs) turned out to have an unexpected downside. Institutional credit markets (commercial paper) literally froze. When investors don't understand their assets, what do they do? They sell. In this case, they sold en masse.

Comparing this quarter to a roller coaster ride almost belittles a roller coaster. The market had all the trappings of a made-for-TV movie, complete with exploding commentary from financial analysts, reaction from an untested Federal Reserve chairman, and enough market gyrations to make a futures trader queasy. Third quarter 2007 was a ride to remember.

Times like these may be a primary reason you employ professional asset managers to guard your hard-earned savings. Instead of personally suffering through wild swings of alternating short covering and profit taking, you were able to concentrate on what you do best: work, retirement, life. We hope you will continue to do so. The CCAM team works hard to provide the best money management possible - striving to protect you from disastrous market moves and keeping you vested for the gains.

The Quarter in Review

Stock market benchmarks rediscovered volatility in the 3rd quarter, with wild swings in both directions. Yet you would not know this looking only at the quarterly results. The Dow Jones Industrial Average gained 3.6%, the S&P 500 rose 1.6%, and the Nasdaq Composite was up 3.8%. For those who were watching the news, these results would have been hard to foresee earlier in the quarter.

Subprime mortgage problems dominated the headlines. Digesting data from June, the market began to realize that loans to borrowers with questionable credit were far more widespread than previously thought. Such loans filled portfolios that were thought to be of much higher quality. As a result, the financial sector took a severe beating. Bear Stearns closed two multi-billion dollar hedge funds that miscalculated bets on mortgage-backed derivatives. One of the top mortgage lenders filed for bankruptcy protection soon afterward.

However, the proverbial straw that broke the camel's back was Countrywide Financial (CFC), the nation's largest mortgage lender. Credit markets collapsed when Countrywide confessed to major losses. Countrywide was thought to be immune from these sorts of troubles, and rumors quickly spread about other banks being in trouble. With 20% fewer employees and a $2 billion cash infusion from Bank of America, Countrywide weathered the storm. The bailout, coupled with the Fed's generous 50 basis point cut in the Federal Funds Rate, convinced traders that the worst was over.

Almost every sector rose in the third quarter. Energy led the charge. With Fed action causing inflation fears, commodities fared well. Breaking through the $80 per barrel mark for the first time, higher crude oil prices brought momentum to an already strong sector. Many energy funds and ETFs had double-digit gains for the quarter. Technology was close behind. The launch of Apple's iPhone amid critical acclaim and immense popular support led a wave of innovation. Wireless applications attracted a lot of capital as more and more capabilities were added to mobile devices. Lagging sectors this quarter were no surprise: financial services companies suffered greatly from the mortgage market's collapse, while consumer discretionary stocks fell in anticipation of lower consumer spending and a possible recession.

Other moves in the U.S. economy are worth mentioning. The 3rd quarter witnessed an interesting style shift. Growth stocks, and especially large cap growth, took the lead away from small cap and value stocks. In the bond market, yields plunged in short-term Treasury securities as investors fled from any possibility of credit problems. At the same time, long-term bond yields rose as the Fed's new loose-money policy sparked fears of inflation.

International equities enjoyed continued success while the U.S. economy struggled to find its footing. Due to the declining dollar and underlying strength of the global economy, foreign investments, especially in emerging markets, increased substantially during the quarter. China was particularly strong. Other Asian markets and some parts of Europe were not far behind.