Keep the faith: There are good reasons to ride out stock market declines By Erik Ristuben, Chief Investment Officer, Multi-Strategy Solutions Russell Investments July 2008 Up, down, up, down, like a yoyo. That's how U.S. stocks have behaved recently. The short-term outlook for U.S. equities is decidedly mixed. June was the market's worst month in six years; the Russell 3000® Index ended the month at -8.25 on concern that deepening mortgage losses will force more banks to cut dividends or sell shares at a discount. I believe the markets are reacting to people's fears on several fronts:   Fear that high oil prices, staying at these levels, will really filter through the economy, triggering a recession. Fear of inflation due to the high cost of energy and related goods and services. Fear that credit deterioration may get worse as the economy slows. Here's my perspective: I don't believe that the economy is out of the woods yet; I think we're in for a difficult slog through the remainder of 2008. But I also don't believe that a serious recession is upon us. I remain guardedly optimistic about our changes for an economic and market recovery. The economy and markets are ugly now, which means we all need to put our heads down and wait it out. This is easier said than done. So, let me offer what I believe are some encouraging reasons why investors should remain positive about the prospects for equities over the next several quarters. Consumers are highly pessimistic You're probably asking, "What's good about that?" Take heart. A very low consumer confidence number may mean we're at, or near, the bottom of an economic downturn. As a result, better investment opportunities may exist than when the good times have been rolling. The data bear this out. Looking at chart on the next page, Consumer Confidence averages from January 1967 to March 2008 were broken into quintiles with the lowest (1-20%), middle (41%-60%) and highest (81%-100%) shown here along with the corresponding consumer confidence average for the quintile and the Average U.S. Equity next 12 months return, based on the S&P 500 Index. For the last 50 years, when consumer confidence has been high, subsequent equity returns have been modest. Conversely, when confidence has been low, subsequent returns have been generous. January 1967 - March 2008   Confidence average   U.S. equity returns, next 12 months Lowest quintile   65.7   17.0% Middle quintile   98.1   12.7% Highest quintile   129.5   6.0% Conference Board Consumer Confidence Index (data from February 1967 through June 1977 were collected bi-monthly - for purposes of this analysis the omitted months were estimated by averaging the adjacent index values on either side of the estimate). The U.S. Average next 12 mo. returns represent the average historical S&P 500 returns for the subsequent 12 months from Feb 1967 to March 2007 that correspond to all of the sample periods represented in the specific consumer confidence quintile. Given the low 64.5 confidence rating in March 2008, the data suggest that we may be nearer a point where better-than-average returns await those with the courage to ignore the current environment. The fed has been busy The Federal Reserve has been extremely aggressive in terms of policy changes. Expanding access to the Fed's discount window to investment banks and the broadening of types of acceptable collateral have been important steps in monetary easing. The Fed activity is clearly positive for equities. Remember that since monetary policy operates with a lag effect of 6-12 months, we have yet to see the full effects of monetary stimulus. Stimulus plan is underway In February, the Bush Administration and Congress reached agreement on a fiscal stimulus plan; checks from the IRS are arriving in taxpayers' mailboxes. These checks should energize consumer spending. Additionally, the Bush administration and Congress are working on housing legislation that could provide more relief. The dollar is weak A struggling U.S. economy and aggressive rate cutting has caused the dollar to reach all-time lows versus the Euro. While the weak dollar does pose some risks for the economy, it makes for a strong environment for exports, which have helped to offset some of the weakness from the housing market. The weak dollar has also been a positive for large U.S. multinational companies that derive a significant percentage of their revenues from outside the United States. We've had the big "crisis event" Historically, financial crises are often accompanied by the failure of a major financial institution, such as Continental Illinois in 1984, Drexel Burnham Lambert in 1990, Kidder, Peabody & Co. in 1994 and Long Term Capital Management in 1998, according to a 2007 study published in Economic Theory1. In all of these examples, the S&P 500 Index was up double-digit percentages in the 12 months following these failures. In the current credit crisis, we have the Bear Stearns collapse on March 14, a symbol of the magnitude of the credit crisis, but also an opportunity for the Fed to use its balance sheet to guarantee the solvency of major financial institutions. The market has been effectively "flat" since then, though highly volatile. The credit markets are improving Credit markets have improved noticeably since mid-March, and I believe credit-related problems have become more transparent. Many investment banks and other financial institutions have been reporting massive write downs in their earnings statements over the past couple of quarters. Bad news will continue to occur but it's unlikely that the news will be as bad as what was feared in January of this year. There is a lot of value to be found Stock valuations have become extremely attractive. Price-to-earnings ratios for stocks are at their lowest range in over 10 years. So there you have it, the reality of the current environment mixed with a dose of cautious optimism for the future. Until the markets turn around, the best thing investors can do is stay properly diversified, avoid chasing past performance and keep a sense of perspective. The economy will recover; it is just a matter of when. 1"Inflation in Open Economies with Complete Markets," Marco Celentani, J. Ignacio, Conde-Ruiz Klaus Desmet, Economic Theory, 2007. These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The opinions expressed in this material are not necessarily those held by Russell Investments, its affiliates or subsidiaries. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. The Russell 3000® Index: measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market. S&P 500 Index: An index, with dividends reinvested, of 500 issues representative of leading companies in the U.S. large cap securities market (representative sample of leading companies in leading industries). Copyright© Russell Investments 2008. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty. Russell Investment Group, a Washington USA corporation, operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. The Russell logo is a trademark and service mark of Russell Investments. Securities distributed through Russell Fund Distributors, Inc., member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. RFD 08-0747 First used: July 2008			Expert insights Read more Russell market analysis.   Investment products LifePoints funds Russell funds Separate accounts Institutional funds   Printer friendly version of this page Send feedback or comments Site Search

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