Economic Environment

The massive turmoil seen in economies across the globe resulted in a plethora of eye popping statistics for the year. The Dow fell 34% which was its third worst year ever. Real estate investment trust returns reflected their worst year ever falling by almost 40%. Home prices on average fell by close to 20% after a weak 2007. Mortgage delinquencies and foreclosures hit all time high level. Job losses totaled 2.6 million (a level not seen since WW II) with an astounding three quarters of that occurring in the last four months of the year. Compared to many countries, the US experience would not have been considered the worst.

Governments and central banks across the globe have responded with massive packages. The Federal Reserve slashed interest rates to just about zero, doubled the amount of credit it provides to the financial system to more than $2 trillion, committed to purchasing up to $800 billion of mortgage-backed securities, agency bonds and consumer loans, and bailed out numerous institutions. The Treasury, meanwhile, extended its Temporary Guarantee Program for Money Market Funds until April 30, 2009 and decided that a better use of the $700 billion TARP funds was injecting capital directly in to banks in return for preferred stock. Furthermore, President-elect Obama has already indicated that additional stimulus plans are in the works. Across the pond, the U.K. announced a $30 billion stimulus plan of its own while cutting its benchmark interest rate to the lowest level since The Bank of England was founded in 1694. Elsewhere, the European Union rolled out a $264 billion stimulus package, and slashed its key lending rate from 3.75% to 2.5% during the quarter, China unveiled a $586 billion stimulus package and cut interest rates five times in three months, while the Bank of Japan cut its key interest rate to 0.1% from 0.3% and said it would be buying corporate debt and expanding its purchases of government debt.

Will all this action work to revive economic activity? We believe that much of it will have a beneficial impact, although the exact timing of recovery is difficult to predict. There is a reasonable chance that some recovery could be seen as soon as the middle of this year and a strong chance that it would be seen by early next year. We do not believe this outlook is overly optimistic. The monetary and fiscal responses we have seen to date were not executed in the depression of the 1930s and took Japan ten years to execute in their deflationary spiral of the early 1990s. Further, commodity prices, particularly oil, have plummeted. Mortgage rates and consumer interest rates are also quite low and the continued loosening of credit should go a long way with a small amount of improved consumer sentiment. We are not projecting a short term economic boom by any means, but the fundamentals of US consumers increasing their savings rate and reducing debt, over time will be more of a benefit rather than a detriment.

Equity Markets

Given the state of affairs which transpired during the end of 2008, stocks around the world fell precipitously during the fourth quarter. Coming off a relatively weak market for the few quarter preceding this, the annual return statistics are even more abysmal. The unprecedented aversion to risk resulted in investors flocking to what was considered the safest haven. This turned out to be the United States Treasury and little else. Yield on short term US Treasury obligations stand just basis points above zero. Further, the flight to dollars strengthened the currency and further depressed already weak foreign equity market returns. The various index returns experienced during the quarter and year are reflected in the table below.