Market Commentary: December 2007
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Capital Markets

Volatility spiked again in November, ushering in negative returns throughout the equity market. Small caps in particular suffered, surrendering their previously positive year-to-date returns and sinking back into negative territory.

In local market terms, international equity losses for the month were comparable to those of U.S. large caps. Dollar depreciation contributed nearly 1% to returns for the MSCI EAFE Index in U.S. Dollar terms and has now contributed about 9.0% year-to-date. From a style standpoint, growth continues to generally outperform its value counterpart by a considerable margin.


Source: PMFA

The negative returns for November were evident through the first three weeks of the month. After an initial decline of over 9.0% in the S&P 500, the index regained over half of its loss during a robust post-Thanksgiving holiday rally.

VIX - CBOE S&P Market Volatility Index – 1-Year Change

Source: Yahoo Finance

The flight to quality intensified in November amidst continuing housing market anxiety and credit worries. As inflationary concerns mounted, Treasury Inflation Protected Securities (TIPS) returned nearly 4.0% for the month. Year-to-date returns for both TIPS and emerging market currencies have easily exceeded those generated by traditional high quality bonds.


Source: PMFA

Alternative Investments also generally struggled throughout November. REITs sustained heavy losses during the month as investor skepticism of real estate mounted. Commodities pulled back as oil closed below $90/barrel, down over 10.0% from its mid-month peak, while gold also retraced its path, giving back recent gains.


Source: PMFA

Economy

GDP

The preliminary estimate for Q3 2007 GDP was revised upward by a full percentage point to a 4.9% annualized rate. The revision depicts a healthy economy in the late summer months, despite the severe credit market dislocations. The revisions were reflective of increases in private inventory investment and exports. Consumer spending also improved over the second quarter, while residential housing continued to weaken. 

The results for Q3 notwithstanding, consensus expectations for the next several quarters are for a marked slowdown in the rate of domestic growth.

Consumer Spending vs. Real GDP - Quarterly % Change

Source: PMFA, Bureau of Economic Analysis (BEA)

As nominal GDP slowed over the last year, corporate profits have declined as well. With over 95% of the S&P 500 companies having announced earnings, income from continuing operations for the index declined 3.4% from the corresponding period in 2006.

Nominal Gross GDP vs. S&P 500 Operating EPS

Source: Standard & Poors, BEA, PMFA

Inflation


Source: PMFA, BEA, Bureau of Labor Statistics (BLS)

The Consumer Price Index (CPI) increased 0.2%, while core CPI increased 0.3% for the month of October. The 12-month trailing core PCE Deflator ticked upward to 1.9%, remaining on the high end of the Fed’s implied target range. The core inflation indices generally rose over the course of the month, potentially complicating the Fed’s future monetary policy decision-making.

The Producer Price Index (PPI) increased just 0.1%, as energy prices pulled back in October. Although the 12-month trailing PPI increased to 6.0%, this result is an anomaly driven by volatility in gasoline prices in the monthly results in the fourth quarter of 2006. Recent monthly PPI has been comparatively benign, and we anticipate that the year-over-year PPI will recede in coming months.

Inflation Indices – 12-Month % Change

Source: PMFA, BLS


Interest Rates

The Federal Reserve has announced cuts in the Fed Funds Rate coming out of their last two meetings to lower the target rate 0.75% to 4.5%. The market is anticipating an additional cut when they meet in December. Recent public comments from multiple FOMC members have hinted at this likelihood, and the market has reacted accordingly.

Current Probabilities for FOMC Meeting 12/11/07
 
Source: Bloomberg, PMFA

The Fed remains in a potentially difficult position given lingering inflationary pressures in the face of a slowing economy and no apparent near-term relief in the credit and housing markets. The Fed has indicated, however, that as a byproduct to the anticipated economic slowdown, they also expect a moderation in inflationary pressures. Should that expectation become reality, the Fed should find itself in a much better position to ease rates further as needed.


Source: Briefing.com

The ten-year treasury yield extended its six-month downward trend in November to end the month at 3.97%. Short-term rates also dropped in November, as the three-month Treasury yield declined sharply to 3.15%. While the curve has re-steepened in recent months, portions of the curve remain nominally inverted.

Treasury Yield Curve History

Source: PMFA, U.S. Treasury


Employment

The national unemployment rate for November remained at 4.7% for the third consecutive month. The pace of job creation continued to be positive at 94,000.

Nonfarm Payrolls & Unemployment Rate - Monthly Net Change
 
Source: PMFA, BLS

Although job growth remains positive, the pace has slackened considerably in the past twelve months to a pace of about 1.5 million new jobs over that period. That represents a decline of about a third over the rate of creation for 2006. Productivity surged in the third quarter to a seasonally adjusted annualized revised estimate of 6.3% for the non-farm business sector, the strongest quarterly gain since the third quarter of 2003. While contributing to the slowdown in the pace of hiring, the disinflationary benefits of productivity gains should also incrementally afford the Fed some additional room to ease.

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other source believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.