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 which 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 dollar terms. The losses in local currency terms were 6% worse, but foreign currency gains against the US
dollar improved net results.
For the quarter, the
Fund matched the Index results. Relative
to the Index, our most significant positive contributors were financial and consumer stocks, which were offset by poor
energy and health care stock selection. We are of the opinion that regionally our European stocks performed well against the markets, while
Japanese 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, we
believe this 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, it appears 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.
Mutual fund investing
involves risk; loss of principal is possible.
Sector allocations are subject to change
at any time.
MSCI EAFE - The MSCI EAFE Index is a group of unmanaged securities
widely regarded by investors to be representative of the stock markets
of Europe, Australasia, and the Far East. The index is a total return
index net of foreign withholding taxes on dividends. One cannot invest
directly in an index.
