World Markets Review First Quarter 2008 Ann Duncan, Portfolio Manager, Balanced Funds, provides analysis and reporting on the U.S. and international markets. Now you can benefit from Russell's extensive research expertise, with timely commentary on the U.S. economy and equity markets, bond markets, and international markets. U.S. Economy: A Bear of a Quarter Weakness in the U.S. economy spread well beyond housing in the first quarter. In addition, losses from mortgage-related securities continued to pressure banks and constrain credit markets in the U.S. and abroad. These conditions sparked tremendous volatility and high drama across global markets, culminating in the Federal Reserve's engineered sale of Bear Stearns to J.P. Morgan Chase in mid-March. The fifth largest investment bank in the U.S. and survivor of a number of financial crises in its 84-year old history, Bear Stearns was brought down by bad bets on mortgage-related securities and the loss of confidence by its counterparties. Putting aside concerns of moral hazard and rising inflationary pressures, the Fed used aggressive and, in some cases, unprecedented tools to bolster the flagging economy, ease the credit crunch and prevent "widespread insolvencies" and "severe and protracted damage to the financial system," according to New York Federal Reserve Bank president, Timothy Geithner. The federal funds rate was lowered in three moves to 2.25%. Among other actions, the Fed increased facilities for lending to banks and, for the first time since the Depression, also allowed brokerage firms to borrow directly from the Fed and to use mortgage and other securities as collateral for loans. The government also worked quickly to pass a fiscal stimulus package of $150 billion in tax rebates for consumers. Gross domestic product (GDP) growth slowed to a near standstill pace of 0.6% in the fourth quarter 2007 and further weakness from January through March increased the odds of a consumer-led recession in 2008. Declining house prices, tougher lending standards, job losses and soaring costs of food and oil caused consumer confidence to fall to the lowest levels since the Iraq war invasion in 2003. In the quarter's crisis of confidence, market volatility jumped sharply, favoring Treasury bonds, gold and other commodities. Elsewhere, there was virtually no place to hide. Stocks sold off sharply without regard to capitalization, style, sector, market or fundamental opportunities. Although the U.S. mortgage crisis will dampen growth overseas, the International Monetary Fund still expects the global economy to grow in the region of 4% in 2008. This growth, together with the weaker dollar, will continue to help U.S. exports. On the domestic front, the impact of monetary and fiscal stimulus should be felt later in the year. While the potential for volatility remains high and the outlook for corporate earnings is uncertain, indiscriminate selling and some reasonable valuations have created opportunities for gains. Index Returns   Month Ending March 2008   Quarter Ending March 2008   Year-To-Date 2008 Russell 1000® Index   -0.68   -9.48   -9.48 Russell 2000® Index   0.42   -9.90   -9.90 Russell 2500™ Index   -0.74   -9.37   -9.37 Russell 1000® Growth Index   -0.61   -10.18   -10.18 Russell 1000® Value Index   -0.75   -8.72   -8.72 Russell 2000® Growth Index   -0.58   -12.83   -12.83 Russell 2000® Value Index   1.51   -6.53   -6.53 Lehman Brothers Aggregate Bond Index   0.34   2.17   2.17 MSCI EAFE Index Gross (USD)   -1.00   -8.82   -8.82 MSCI Emerging Markets Index Gross (USD)   -5.28   -10.92   -10.92 U.S. Stocks: Battered by Rising Risk Aversion Further economic weakness and tighter credit conditions caused U.S. stocks to suffer their worst performance in six years. Even so, they fared better than their international and emerging markets counterparts — a departure from the trends of recent years. The Russell 3000® Index fell 9.52%, ending the quarter almost 15% below its October 2007 high. After outperforming for much of 2007, growth stocks slightly underperformed value as signs of slowing demand, cautious management outlooks, and some weaker-than-expected earnings pushed down technology stocks. Large caps continued to modestly outperform small caps, though there were some surprising rebounds among small cap financials and homebuilders in March. All sectors within the Russell 3000® Index declined in the quarter. Technology was the worst-performing sector, followed by telecommunications services. Financials also underperformed the Russell 3000® Index, despite some sharp gains following J.P. Morgan's improved offer for Bear Stearns and better than expected earnings from Goldman Sachs and Lehman Brothers. Materials stocks benefited from rising commodity prices, while consumer staples outperformed with help from a rebound in Wal-Mart. Among industrials, transportation stocks performed relatively well and consumer discretionary stocks also outperformed the Russell 3000® Index. Analysts forecasted a 5.7% gain for first quarter S&P 500® Index earnings at the start of the year. This was slashed to a 9.3% loss at quarter-end; however, excluding financials, earnings are expected to rise by roughly 7%. While this forecast may prove to be too optimistic, many stocks appear to be reasonably valued relative to historical norms. In addition, many companies offer attractive fundamental characteristics with strong balance sheets, lean inventories and good earnings prospects. U.S. Bonds: Treasuries Continue to Rule Heightened uncertainty about the economy and tighter credit conditions extended the appeal of Treasuries — pushing government bond prices up and yields down significantly. At 3.06% at the start of the year, the two-year Treasury yield fell as far as 1.33% on March 17 before ending the quarter at 1.59%. The 10-year yield, more sensitive to inflation expectations than Fed policy actions, had a smaller decline, from 4.03% to 3.41%. Thus the yield curve steepened substantially in the quarter. The Lehman Brothers U.S. Aggregate Bond Index returned 2.17%. Treasuries were the best-performing sector, returning 4.43% and bringing their 12-month gain to a hefty 12.21% compared with a loss of 6.06% for the Russell 3000® Index. Government agency bonds returned 3.23% while U.S. securitized returned 1.72%, helped by rebounds among mortgage-backed securities and commercial mortgage-backed securities that had been overly punished as investors fled subprime mortgages. Finally, investment-grade corporates returned -0.15%, causing yield spreads with Treasuries to widen to unprecedented levels. Rising risk aversion also continued to punish the extended high yield and emerging market sectors (not held in the Lehman Aggregate) which returned -3.02% and -0.21%, respectively. Non-U.S. Stocks: Mixed Signals in Europe (All returns are in U.S. dollars unless otherwise noted.) The global credit crunch and expectations that further weakness in the U.S. economy and dollar would depress European and Asian exports caused investor sentiment toward non-U.S. markets to waver in the quarter. The MSCI EAFE Index fell almost 15% in local currencies; however, euro and yen gains muted the sell-off to an 8.82% loss in U.S. dollars. All sectors declined with telecommunications, technology and energy the hardest-hit groups. Banks from Australia to Europe suffered from their exposure to subprime-related securities or, in the case of France's Societe Generale, from massive losses through the actions of a rogue trader. The financials sector, 25% of the MSCI EAFE Index, had the largest negative impact given the global nature of the subprime contagion. The materials sector fared best due to commodity price gains and prospects of further consolidation among mining companies. Consumer staples also proved to be relatively defensive. The best-performing region in 2007, the Pacific Basin ex-Japan fell 12.78% in the first quarter as Hong Kong sold off in concert with China. Japan, last year's worst performer, fell 7.75% as the yen's surge to a 12-year high against the U.S. dollar offset an almost 18% drop in yen terms. With the stronger yen pressuring export sales, stagnant wages and rising prices curbing consumer spending, and political gridlock delaying the appointment of a new central bank governor, Japan's economic outlook worsened. Europe fell 8.55%, with the U.K and Germany the worst performers among the major markets. In the U.K., telecoms giant Vodafone declined on concerns that price wars would erode U.S. profits. Germany, up over 30% in 2007, was hurt by weak industrials and financials stocks. After exceeding expectations in recent years, fourth quarter 2007 euro zone GDP growth disappointed; however, business confidence rose in Germany and France in the first quarter and exports also appeared to be holding up despite the ever-stronger euro. The European Central Bank maintained its key policy rate at 4% as rising food, energy and other costs pushed inflation up to a 14-year high. In the U.K., the Bank of England cut rates to 5.25% in response to housing and consumer weakness and tighter credit conditions. Emerging Markets: Reversal of Fortunes (All returns are in U.S. dollars unless otherwise noted.) Seeming to defy gravity in recent years, emerging markets lost their luster in the first quarter. Despite strong regional growth prospects, emerging market stocks inevitably succumbed to the greater odds of a U.S. recession and valuation concerns after five years of strong gains. Industrials and energy stocks fell sharply while the materials, consumer staples and health care sectors held up relatively well. Asia, down 14.11%, bore the brunt of investors' reduced appetite for risk. China fell almost 24% in the quarter (and lost over 37% from its October 2007 high) on a mixture of weaker profits, massive weather disruptions, rising inflation, political turbulence and valuation concerns. India declined almost 27% though evidence of its growing importance in the global economy came through Tata Group's purchase of venerable auto manufacturers Jaguar and Land Rover from Ford. The Times of India proudly proclaimed, "Jaguar is now an Indian beast!" Elsewhere in Asia, Taiwan advanced over 5% as currency gains and rising financials offset weak technology stocks. Political change provided the spark as the victories of new president-elect Ma Ying-jeou and his more business-friendly Kuomingtang Party boosted Taiwan's growth outlook through expectations of greater economic ties with China. The Europe, Middle East and Africa region (EMEA) fell 11.75%. Russian energy company Gazprom, almost 15% of the region's weight, was the largest negative contributor. Turkey, however, was the worst-performing market as its large current account deficit and growing fears that the government was overturning the country's secular laws worried investors. Turkey fell over 38% with help from a sharp drop in the lira. Latin America was the best-performing region in the quarter, down only 1.39% as currency gains and rising commodities boosted mining companies and other raw materials producers. Brazil fell just under 5% while Mexico advanced by a similar amount, a somewhat surprising outcome given its close connection with the U.S. economy. RUSSELL INVESTMENTS Copyright© Russell Investments 2008. All rights reserved. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. Russell Investments is the owner of the trademarks, service marks, and copyrights related to its indexes. The Russell logo is a trademark and service mark of Russell Investments. Unless otherwise noted, the source in this material is Russell. 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. 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, credit, repurchase and reverse repurchase transaction risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield ("junk") bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to subprime mortgages. 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 based, 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, tax laws and interest rates all present potential risks to real estate investments. Fund investments in non-U.S. markets can involve risks of currency fluctuation, political and economic instability, different accounting standards and foreign taxation. Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems, which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than U.S. and longer established non-U.S. markets. 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. 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 or its affiliates. Federal funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. Gross Domestic Product (GDP) is the market value of the goods and services produced by labor and property in the United States. Lehman Brothers Aggregate Bond Index is an index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used to create any financial instruments or products or any indices. The MSCI information is provided on an "as is" basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the "MSCI Parties") expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure developed market equity performance in 21 developed market countries in Europe, Australasia, and the Far East. MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. 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. Russell 1000® Growth Index measures the performance of those Russell 1000® Index securities with higher price-to-book ratios and higher forecasted growth values, representative of U.S. securities exhibiting growth characteristics. Russell 1000® Value Index measures the performance of those Russell 1000® Index securities with lower price-to-book ratios and lower forecasted growth values, representative of U.S. securities exhibiting value characteristics. Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, representative of the U.S. small capitalization securities market. Russell 2000® Growth Index measures the performance of those Russell 2000® Index securities with higher price-to-book ratios and higher forecasted growth values, representative of U.S. securities exhibiting growth characteristics. Russell 2000® Value Index measures the performance of those Russell 2000® Index securities with lower price-to-book ratios and lower forecasted growth values, representative of U.S. securities exhibiting value characteristics. Russell 2500™ Index measures the performance of the 2,500 smallest companies in the Russell 3000® Index, representative of the U.S. small to medium-small capitalization securities market. Russell 3000® Index measures the performance of the 3,000 largest U.S. securities based on total market capitalization. S&P 500® Index is 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). Standard & Poor's Corporation is the owner of the trademarks, service marks and copyrights related to its indexes. Treasury Bills (T-bills) are short-term debt securities issued by the U.S. government with maturities of usually one year or less. Securities products and services offered through Russell Financial Services, Inc. (formerly Russell Fund Distributors, Inc.), member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. First used April 2008 RFD 0170			Investment Products LifePoints Funds Russell Funds Separate Accounts   Printer friendly version of this page Send feedback or comments Site Search

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