Special Market Commentary:  February 28, 2007

As you are undoubtedly aware, the U.S. and global equity markets experienced a sharp selloff yesterday. In the U.S., this selloff was widespread, crossing over all style and market cap boundaries. The S&P 500 Index declined almost 3.5%, while the Russell 2000 Index lost 3.8% on the day. The EAFE Index also gave up 1.5% for the day, and likely continued that decline overnight.

What appears to have caused the market downturn?

• The primary catalyst was a significant selloff in the Chinese market, whose benchmark index lost almost 9% on the day. Fears that the Chinese government was poised to take steps to curtail capital flows in an attempt to ease the ‘hot money’ that has been flooding into Chinese equities precipitated the selloff.
• Secondly, comments by former Federal Reserve Chief Alan Greenspan in Hong Kong further exacerbated the situation. Greenspan’s suggestion that the U.S. economy may slip into a recession by the end of the year remains in stark contrast to the stated position of the Federal Reserve. After the last FOMC meeting, the Fed’s statement indicated that they believe the greater risk still lies in persistently high inflation rather than an unwanted downturn in growth.
• An overdue market correction and return to volatility. Many market observers have stated that the market had not been fully pricing in risk for some time. Yield spreads across a number of segments of the bond market (e.g. - corporate bonds, junk debt, dollar-denominated EM debt) have been unsustainably low for some time. Valuations in the smallest cap stocks in the U.S. – especially value-oriented issues – and the surge in interest in emerging markets equities are also indicative of a high appetite for risk on the part of investors. While much of the volatility in recent years has exhibited itself to the upside vis a vis strong performance, overall market volatility has been driven much lower.

This spike in volatility can be seen in the graph above which illustrates movements in the VIX index over the past year. (The index is a means of measuring market expectations of near-term volatility conveyed by S&P stock index option prices.) While market risk (measured by volatility) spiked yesterday, it remains below its high for the past year which was reached during the market turmoil in late spring last year. Moreover, as compared to the volatility of the market over the preceding five years (see below), market risk remains very low.





The last one day drop of more than 2% on the S&P 500 occurred on May 19, 2003…..yes, 2003! This kind of a drop was long in coming, and in short, the market will periodically experience periods of increasing volatility – both to the upside and the downside. At times, this may result in days like yesterday, which appears to have been driven much more by short-term fear than a material change in the fundamental outlook for either the markets or the economy.

Beyond Alan Greenspan’s very candid public comments, the probability of a recession in the near term did not change yesterday. Economists (including those at the Fed) have been expecting a slowdown in the rate of growth for some time. Just this morning, the preliminary estimate for GDP growth for the 4th quarter of 2006 was adjusted downward to a 2.2% annual rate from the advance estimate of 3.5%. The Fed’s policy over the past few years was intended to slow the rate of growth and we are now experiencing that result. While the risk of recession remains, the Fed does not appear to believe that risk to be as high as the former Fed chief’s comments suggest.

In the end, market corrections such as this are healthy for the capital markets, as it often exposes the speculative capital in the market and unwinds the excesses that build up from time to time. (Remember - the Dow was up over 20% since July 2006). When those periodic corrections do not occur, those excesses build up and bubbles form. The bursting of a bubble inevitably results in even more pain and extended periods of underperformance. We continue to believe that the fundamentals of the market look reasonably good.

We continue to anticipate a slowdown in U.S. and global growth, but believe that the probability of a recession in the near term remains relatively low given currently available data. We believe that overall equity market valuations remain reasonable, although the outlook for earnings growth in 2007 remains murky, and will likely slow.

In short, there is no way to reliably predict the short-term movements of the market. It is possible that the market could sell off further in the short-term, although any continuation is far from certain. In China, the market surged 4% in the trading session following the 9% selloff. Given the practical impossibility of predicting short-term market movements, attempting to time the market is not a fruitful exercise.

Remaining committed to one’s long-term plan and seeking opportunities to re-balance one’s portfolio during times of volatility remains the most appropriate strategy during times of uncertainty. We continue to believe that decision-making based on a rational, long-term plan rather than short-term fears and uncertainty will put investors in the best position to be successful and reach their long-term goals.

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 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 Plante Moran Financial Advisors for investment advice regarding your own situation.