Mainspring in Motion

Winter 2009

Fourth Quarter Market Commentary

By Julie Grandstaff, Vice President, StanCorp Investment Advisers, Inc.

The fourth quarter of 2008 has come to an end, and what a year it was.

In May, we heard the devastating news of the catastrophic earthquake in the Sichuan Province of China. In all, 70,000 people were lost. The war in Iraq continued, and through December, we’ve lost more than 4,000 American troops since the start of the war. More than 30,000 have been seriously injured. The Russian Bear drew the world’s attention by invading Georgia in August. During the year, we saw the price of oil near $150 per barrel and below $40 per barrel.

On the positive side, the world burst with pride for the Olympic athletes and the amazing show put on in China. Michael Phelps was the star for America, bringing home eight gold medals in swimming. In America, we elected a new president, bringing hope for change and a better future.

For the markets, a better future shouldn’t be a tall order. Most investors would be content with a respite from the volatility. After declining nearly 20 percent in the first three quarters of the year, the S&P 500 fell off a cliff in October and November, declining more than 24 percent in the fourth quarter. The sell-off followed the failure of Lehman Brothers, the government bailout of the government-sponsored mortgage companies Fannie Mae and Freddie Mac, and the government takeover of the world’s largest insurer, AIG.

The failure of Lehman set off a liquidity crisis that sent both the market and the economy into freefall. The sharp market decline was the quickest of any bear market decline since the Great Depression. Economic growth also declined sharply, as businesses and consumers felt the liquidity crisis worldwide. What seemed possibly like a mild downturn earlier in the year quickly started looking like one of the worst recessions in decades.

The economic outlook for 2009 is gloomy. Most analysts do not expect to see much recovery before the second half of the year, nor do they see employment recovering before 2010. The downturn is not isolated to the United States; it affects the world economy. Much of the wealthy world is facing recessions, and emerging economies are experiencing slower growth.

However, there is support for improvement in the equity markets sooner than the economic recovery. Fundamentally, the market is inexpensive on a price-to-earnings ratio, even on the weakest of earnings forecasts. While P/E ratios may remain depressed for some time due to the heightened risk aversion in the market, the equity market appears to be a good value at current levels.

Value also can be seen in the current dividend yield (dividends divided by price) on the S&P 500. Its 2.92 percent yield is higher than the yield on 10-year Treasury bonds, which are currently below 2.20 percent, something that has not happened since 1958.

Can the market go lower? Yes, it certainly can. If corporate earnings turn out to be worse than the worst forecasts, the market may not be as good a value as we currently believe. The best defense in times of uncertainty is appropriate asset allocation. Yes, the losses are painful, but long-term investors in the stock market are expected to see recovery and further growth in their investments. Short-term objectives should be supported by more conservative investments. And regular rebalancing can help ensure the allocation remains appropriate and balanced for growth and defense.