Outlook for 2008: Cautious Optimism
by Jim Baird
Universal Advisor, 2007 Issue No. 3

As 2007 draws to a close, we remain cautiously optimistic regarding our outlook for the economy and capital markets. Although the advance estimate for third-quarter GDP growth is not yet available, indicators that the economy may be softening include a slowdown in consumer spending and hints of weakening in the pace of job creation.

As we look toward 2008, the Fed’s decision to cut interest rates is an indication that they’re attempting to alleviate the impact of the continuing downturn in the housing market as well as credit concerns that have surfaced over the past several months. While the risk of a recession has certainly increased, it still appears that the Fed will attempt to navigate the economy to a soft landing.

Expect Volatility Within the Capital Markets

After a multiyear period of relative calm, there has been a marked increase in capital market volatility in recent months. Investors have reacted to the lingering uncertainty regarding the severity and duration of the housing recession, credit market turmoil, and concerns about a further slowdown in the economy with a broad repricing of risk. While treasuries were the beneficiary of substantial demand in recent months, riskier bonds and stocks have had a marked increase in volatility. We expect that volatility to continue as these issues are absorbed by the market and the relative severity of the recent turmoil becomes clearer.

We expect that large cap stocks are likely to continue to outperform small cap stocks in this environment, given the easing in the pace of economic growth, the relative valuation fundamentals, and their ability to hold up in the face of a falling dollar. Growth stocks, which have also trailed traditional, value-oriented issues in recent years, also appear reasonably well-positioned for resurgence.

We continue to expect weakness in the dollar coupled with stronger economic growth overseas than in the United States. As such, we favor a healthy allocation to international equities and non-dollar denominated positions, which are supported by these macro factors and reasonable fundamental valuations.

Disruptions in the credit market and a reversal in course in Fed policy to an accommodative stance are already changing the environment for fixed- income investors. The Fed is beginning to ease short-term rates, which should result in a decline in yields on cash and equivalents. Falling bond yields may also provide opportunities for treasury returns slightly above their effective yields, although riskier bonds may continue to falter until the economic outlook notably improves.

What Does This Mean to You?

When investors hear “volatility,” the immediate reaction is often negative due to fear of risk and the potential for loss. When we speak of volatility, we think of both the negatives and the positives, as large, single-day losses are offset in part by impressive single-day surges.

Market vacillations challenge investors to shrug off the fear of loss and remain focused on their goals and strategies that were evaluated and implemented in a more rational environment. During periods of uncertainty, investors are also presented with more frequent opportunities to rebalance their portfolios, which — at least at the margins — embraces the very simple “buy low/sell high” mantra. One’s ability to maintain a long-term perspective is challenged during times of uncertainty and heightened perception of market risk — ironically, the very time when maintaining that perspective is most critical. Staying the course, rather than giving in to fear during such periods, can be the difference between failure or success in the achievement of one’s long-term financial goals.