Issue 35 - February 28, 2007

Unhappy Tuesday

Yesterday’s 416 point sell-off in the Dow Jones Industrial Average was a not so subtle reminder that earning a return does involve an element of risk. Equity markets have been moving strongly higher virtually uninterrupted since last August. Despite yesterday’s pullback, the majority of the broad Russell market indices remain positive for the year and of those which are now down, they are off less than 1.50%.

The markets got off to a bad start in Shanghai as rumors of a capital gains tax spooked an extremely frothy Chinese market to tumble over 9%. Just to put this into some perspective, the Chinese market index had risen over 140% in the preceding 12 months and was up 46% in the fourth quarter of 2006 alone. Europe continued the day’s selling and by the time the U.S. markets had a chance to open, the Dow began the day down well over 100 points. Orderly profit taking took place until well into the trading day. Then just after noon PST a New York Stock Exchange computer error allowed an hour’s worth of sales to be processed in just under two minutes. This drove the index immediately down over 200 additional points to stand down over 500 in total on the session. This also created the impression that some sort of catastrophic issue had just taken place further worrying already worn-out participants. Fortunately, that was not the case and the market regained some of the lost ground to close down 416 points or 3.3%.

As the sun rose on Wednesday in Asia, Japan sold off again, but China rallied on the day and the U.S. has found some buying strength as well.

The Road Ahead

The healthy, basic building blocks of the global economy remain in place. Balance sheets are strong. Interest rates remain low and earnings and valuations remain in reasonable territory. Employment and tax receipts continue to underpin growth in the U.S. Some have described yesterday’s action as a “growth worry” – if China were to slow down dramatically what would be the global implications for demand? Commodity related stocks bore the brunt of the selling pressure and there was a predictable flight to the safety of the U.S. Treasury market. Once again, liquidity and risk do matter, and well-balanced portfolios can withstand and defend well in times of stress.

The bears among the pundits will take this opportunity to make their case that a housing slowdown will be the catalyst to lead U.S. markets lower. Certainly slower housing is a drag, but as we have stated before we rarely have a perfect environment in which to invest. Markets are likely to be choppy in the coming sessions, however, given our long-term view; we would recommend staying the course.

• Unhappy Tuesday
• The Road Ahead