Will Bulls Continue to Run in 2007? By Richard Yasenchak Russell Investment Group June 2007 "It's not where you start; it's where you finish." The title of a couple of current books, the phrase dates back to at least 1973 as the hit song from the Broadway musical "Seesaw." Where will you finish is a good question for equities. Stocks began strong in 2007 with several indexes, including the large cap Russell 1000®, reaching new highs. Where will the run finish? No one can say, but market fundamentals offer some insight. Will stocks continue to outperform? We believe stocks continue to be undervalued relative to bonds. Lower, but steady corporate single-digit earnings should continue to drive the large cap Russell 1000® upward. In the face of a slowing but growing economy, stock prices should also benefit from global liquidity and lower inflation. Annual real Gross Domestic Product growth appears to be slowing because of the lagged impact of falling home prices, declining mortgage equity withdrawals and surging gasoline prices. As seen by the high numbers of mergers and acquisitions, global liquidity is fueling demand for financial assets. Perhaps most importantly, core inflation appears to be contained and there are signs that interest rates may decline later this year. These factors should propel U.S. equities higher relative to bonds as investors position themselves ahead of economic data and look forward to a recovery. How do international stocks compare to U.S.? Non-U.S. developed equities remain attractively priced relative to U.S. equities, although my preference has diminished some given the long-run performance of non-U.S. stocks. One important factor not included in some models, but which continues to bode well for non-U.S. stocks, is the likelihood of continued weakness in the U.S. dollar. This should be additive to non-U.S. stock returns in the coming months. Where to invest - large cap or small? Growth or value? A viewpoint shared by many strategists is that large cap and growth stocks are set to outperform small cap and value stocks. The rationale behind this viewpoint can be summed up in three points.   Compressed valuations. Models show that large cap and growth valuations have compressed too far relative to small cap and value. As a result, investors are now paying growth-type multiples for value stocks, making growth stocks more attractive. Tight credit spreads. Credit spreads serve as a proxy for investors' risk appetite. These have reached extremely narrow levels for a long duration. If spreads widen as I expect, small caps and value stocks should under-perform large cap and growth stocks. Smaller corporate profits. Generally, value stocks are rewarded during extended periods of profit recoveries such as we have seen the past five years, but hurt during periods of slowing profit growth such as we expect to see this year. What about REITs and bonds? U.S. Real Estate Investment Trusts (REITS) continue to look expensive relative to U.S. equities. Equity REITS distribute a vast majority of their income, so the dividend yield is equivalent to the earnings yield used for equities. Thus, we believe the return prospects for equity REITS are not encouraging for the remainder of the year. U.S. Treasury bonds appear to be attractive relative to U.S. investment grade bonds. The likelihood of defaults for corporate and individual loans remains high, which may result in widening credit spreads. In my view, investors are not fully compensated for the extra risk inherent in corporate bonds. Where will the Bulls end up? July 7 marks the annual running of the bulls in Pamplona, Spain. The event ends when the bulls return to the bullring. However, there's no formula ending for the running of the U.S. bull market. Any number of things could distract it and cause a detour. Given the current direction, though, I think we can expect that 2007 will be a stronger year for stocks relative to bonds, non-U.S. stocks relative to U.S. stocks, large cap stocks relative to small cap stocks, growth stocks relative to value stocks, stocks relative to equity REITS, and Treasury bonds relative to investment grade credits. It may be time to consult with a financial advisor to make sure your portfolio is positioned to capitalize on these anticipated trends. Richard Yasenchak, CFA, CFP, is a portfolio analyst and member of the Investment Strategist Team for the Tacoma, Wash.-based Russell Investment Group. This article is part of a monthly series of columns by Russell analysts. Yasenchak has been at Russell since 2005. Fund objectives, risks, charges and expenses should be carefully considered before investing. For a prospectus containing this and other important information call Russell at 1-866-676-7680 or go to the prospectus and reports page to download one. Please read the prospectus carefully before investing. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000® Index, representative of the U.S. large capitalization securities market. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Index performance is not indicative of the performance of any specific investment and is provided for general comparison purposes only. Index return information is provided by vendors and although deemed reliable is not guaranteed by Russell Investment Group or its affiliates. Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market. Bond investors should carefully consider risks such as interest rate risk, credit risk, securities lending, repurchase and reverse repurchase transaction risk. Greater risk is inherent in portfolios that invest primarily in high-yield bonds. They are subject to additional risks, such as limited liquidity and increased volatility. Large capitalization (large cap) investments involve stocks of companies generally having a market capitalization between $10 and $200 billion. The value of securities will rise and fall in response to the activities of the company that issued them, general market conditions and/or economic conditions. Small capitalization (small cap) investments involve stocks of companies with smaller levels of market capitalization (generally less than $2 billion) than larger company stocks (large cap). Small cap investments are subject to considerable price fluctuations and are more volatile than large company stocks. Investors should consider the additional risks involved in small cap investments. Growth investments focus on stocks of companies whose earnings/profitability are accelerating in the short term or have grown consistently over the long term. Such investments may provide minimal dividends which could otherwise cushion stock prices in a market decline. Stock value may rise and fall significantly base, in part, on investors' perceptions of the company, rather than on fundamental analysis of the stocks. Investors should carefully consider the additional risks involved in growth investments. Value investments focus on stocks of income-producing companies whose price is low relative to one or more valuation factors, such as earnings or book value. Such investments are subject to risks that their intrinsic values may never be realized by the market, or, such stock may turn out not to have been undervalued. Investors should carefully consider the additional risks involved in value investments. Specific sector investing such as real estate can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes and tax laws and interest rates all present potential risks to real estate investments. Non-U.S. markets entail different risks than those typically associated with U.S. markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile. Gross Domestic Product (GDP) is the market value of the goods and services produced by labor and property in the United States. Treasury Bills (T-bills) are short-term debt securities issued by the U.S. government with maturities of usually one year or less. Russell Investment Group, a Washington USA corporation, operates through subsidiaries worldwide and is a subsidiary of The Northwestern Mutual Life Insurance Company. The Russell logo is a trademark and service mark of Russell Investment Group. 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. Copyright© Russell Investment Group 2007. All rights reserved. First used July 2007. RFD 07-6887			Expert INSIGHTS Read more Russell market analysis.   The Power of RUSSELL AND YOU Learn more about Russell's investment approach.   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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