Risk Rediscovered

It certainly didn’t feel like it at the time, but this past three-month period saw what turned out to be a relatively mild decline in July and August and, except for strong performance by commodities and emerging markets, most equity asset classes finished the quarter about where they started after a solid recovery in September.

Still, this “not quite a correction” seemed sharp, especially for those clients who inaugurated or substantially added to their portfolios early in the quarter. Declines, peak to trough, for the S&P 500, Russell 2000, EAFE, and Emerging Market indexes were -10.2%, -13.8%, -14.3%, and -21.3%, respectively. Investors, in every market, and around the world, rediscovered risk. Volatility measures for equity markets and credit spreads for fixed income securities increased from their very low levels of recent years; but they are still far below the more elevated levels of longer term history.

In the article to follow, our Chief Investment Officer, Jason Thomas continues our comments on the causes and immediate consequences of the near collapse in credit markets around the world and the longer range impacts of this recent jolt to investor confidence.

The Drooping Dollar

The dollar’s decline continued, at an accelerated pace, this past quarter, down 4.6% and 5.8% against the euro and yen, respectively. The Canadian dollar earned new respect, reaching parity with the greenback for the first time in over 30 years. Canadian exporters, however, are less than thrilled. The US is, by far, Canada’s largest trading partner.

We have been observing and attempting to exploit this general trend for quite a long time now and our clients have benefited significantly from the currency components of their large, generally unhedged, overseas allocations. But, exchange rate corrections don’t go on forever. While it’s likely that exchange rates will “overshoot” on their way to a proper revaluation, at some point, conditions (general economic growth rates and monetary and fiscal policies) achieve a new, generally stable equilibrium. Even a dollar pessimist would admit that, at some point, the dollar is cheap enough; an optimist would say that, finally, other currencies have become too expensive. We can’t say that such stability is at hand but we don’t expect that the pace of change will continue at the rates of recent years. Consequently, while we have no plans to encourage clients to reduce exposures to the fundamental opportunities overseas, we don’t expect the exchange rate bonus to be as robust in the coming years as it has been in the last several.

Year-End Expectations

As 2007 nears its end, we continue to expect investment results in the high single digits for the year as a whole. Many of our clients’ portfolio returns are already there. We don’t foresee any special threat in the coming months and economic fundamentals remain strong: inflation is low; employment is high. And, while self-reported “confidence” dipped in August, the consumer’s actual spending behavior increased. Further, to the extent that we can discern any bias in the thinking of the Federal Reserve, we suspect that a further reduction in rates is more likely than an increase…but, no change in rates seems to be the most likely scenario for the near term. All of those factors should bode well for equity market performance.

Anniversaries

We’re celebrating three very special anniversaries this year. Both Young Kim and Tom Tracy have been with Kochis Fitz now for fifteen years. And our co-founder, Linda Fitz, is celebrating her 25th year in the Wealth Management profession. Please join me in congratulating Young, Tom, and Linda on these milestones in their long years of devotion to serving clients.

Tim Kochis, Editor