ADR

MARKET COMMENTARY - 1st Quarter 2008

The first quarter was certainly full of discouraging news and headlines. Ongoing housing deflation, tight liquidity in global credit markets, record high oil prices, spiking agricultural commodity prices, a plummeting dollar, rising odds of a US recession, earnings estimate downgrades – it just kept on coming. Not surprisingly, investors were rattled and pushed market volatility higher and equity prices sharply lower. At its lowest level in February, the EAFE Index was selling 20% below its record close last fall. The markets recovered some in March, but still ended the quarter solidly in negative territory. Of the major developed markets, the 10.5% loss in the UK was the worst, although Japan and Europe also declined 7.8%. The emerging markets also struggled, and slid 11.0%. There weren’t many places to hide. Consumer staples and materials stocks fell the least but still lost 3.7%. The worst stock sectors were telecommunications -15.5%, technology -13.7%, energy -10.6%, and financials -10.5%. Overall, the EAFE Index fell 8.9% in $US terms. The losses in local currency terms were 6% worse, but foreign currency gains against the $US improved net results.

For the quarter, PIA’s ADR portfolio outperformed the index. The most significant positive contributors were financial and consumer stocks, which were partially offset by health care stock selection combined with an overweight to the telecom sector. Regionally, our European stocks performed well against the markets, while Japanese and UK stocks lagged slightly.

There’s still plenty of bad news to keep investors jittery. Recent weak employment data in the US, and deteriorating business sentiment surveys in Europe and Japan, suggest further weakening, but not recession. Consensus estimates still reflect expectations for earnings gains in 2008, which seem too optimistic. While the Federal Reserve has introduced several new policies to address the liquidity crisis, overall credit conditions remain restrictive and constitute a powerful headwind limiting global growth. Nevertheless, there are also compelling reasons to be more optimistic. For the first time in this bear market, stocks started to rally on bad news in March. When bad news no longer has the capacity to surprise, it suggests that most of the bad news could already be discounted. Further, much of the selling by individuals may be done. Lehman Brothers research indicates that European investors hold nearly 32% of household financial assets in cash. Last, equity valuations in the developed markets are low, which further supports the contention that an earnings recession is already priced in. If earnings fall by 20% instead of rising 6%, as forecast in 2008, valuations would still be in line with historic averages. Within the markets, we are noticing an increased dispersion among stock valuations. Nine months of bear market risk aversion has increased the spread between stocks, so that growth and safety are becoming increasingly expensive. We are optimistic that our continued, disciplined focus on attractively valued stocks will again be rewarded.