A Tough Quarter... And Where To Now?

There is no sugar coating it: the U.S. markets first quarter performance was simply ugly. The major indexes were all negative with the Dow -7.6%, the S&P 500 -9.9% and the Nasdaq -14.1%. It is important to note that the decline was not contained in the past quarter, as the market slide began late summer of last year with the onset of the credit crisis. From that perspective, we can measure the market deterioration another way from the peak in 2007 to the low point of the fi rst quarter as follows: the Dow Jones Industrial Average surrendered 2,690 points, or 18.9%; the NASDAQ Composite dropped 706 points, or 24.7%; and the S&P 500 lost 319 points, or 20.2%.

The measurable consequence of the past quarter was that U.S. stocks fell harder than any quarter in almost six years. The U.S. decline was the worst three-month return for domestic stocks since a 17% clubbing in the third quarter of 2002. This quarter's performance left investors and market strategists alike questioning if the credit crisis was finally running out of steam, and if this upcoming period could further develop into the fi rst consumer led recession since 1990. For the optimists among us, the hope is that a combination of federal government intervention and bargain hunting buyers will put a fl oor under the global markets and allow the rebuilding process to begin.

So where do we go from here? While the temptation may be there to grasp onto any glimmer of an uptrend in the market and increase our positions, we continue to believe that caution is the best course of action. Recent Federal Reserve and Treasury Department decisions have helped to avoid a further credit meltdown- at least for now. However, the U.S. and global economies are still facing numerous challenges that could prevent any meaningful market rallies.

Since last September, the Federal Reserve has lowered its key interest rate tool, the federal funds rate, by three percentage points, to 2.25%, the lowest level since December 2004. Nevertheless, despite this, mortgage rates have not come down commensurate with the drop in interest rates, as was expected. The simple fact is that banks do not want to extend loans at the present time (not even to each other), given their dwindling capital bases. Interbank rates- short-term loans between banks- are as high, or higher, in the past 30 days, which suggests banks are reluctant to share cash.

Years of liberal lending standards are now coming home to roost and banks are unlikely to return to their carefree ways in the face of huge increases in loan losses and securities write downs. This will obviously have an effect on the housing markets as those adjustable rate mortgages come due for refi nancing and potential homebuyers attempt to secure acquisition fi nancing. None of this bodes well for the housing markets that continue to refl ect a downturn is both unit sales as well as selling prices. Under current market conditions, if we are to see any up tick in home unit sales, it will probably be at the expense of a drop in selling price in order to stimulate interest in what is becoming a very stagnant housing market.

At this writing the University of Michigan consumer sentiment index fell an additional 6.3 points in mid April to 63.2, the lowest it has been since 1982. Concerns over rising food and energy prices are likely to continue climbing and exacerbating an apparent economic downturn. Oil and gas inventories have come in below expectations causing a resurgence in oil prices toward record highs.

We now move into the heart of corporate reporting for the quarterly earnings season. Out of the starting block the news has been somewhat weak, as evidenced by the disappointing reporting of General Electric. We expect to see a plethora of less than favorable reporting this quarter, but the earnings announcements may help to be a barometer for envisioning where the economy is headed.

So what's the investment strategy moving forward? Our feeling is... let's be patient, be cautious, be disciplined and be opportunistic when appropriate. Right now, the best play is one that allows us to rest well at night!

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