World markets review Third 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: Recession looms as crisis of confidence reshapes the financial landscape In the aftermath of the Bear Stearns collapse in March, credit conditions initially improved through aggressive Federal Reserve actions. Unfortunately, conditions deteriorated again as banks resumed their reluctance to lend and as companies and consumers found access to credit more difficult. Yet as the second quarter progressed, runaway oil and other commodity prices pushed inflation to center stage, threatening the economic health of developed and emerging markets alike and triggering interest rate hikes around the world. In the third quarter, attention turned back to credit markets. With astonishing speed and drama, events in September dashed any hopes for a quick economic recovery and changed Wall Street as we know it. Along the way, global stock markets experienced extreme volatility and declined sharply across the world. Broadly speaking, September's key events originated from extraordinary losses in mortgage-related securities and complex credit derivatives. These precipitated a crisis of confidence among extensively linked firms. In rapid succession, a number of the country's largest financial institutions tumbled. Fannie Mae and Freddie Mac, mortgage giants that own or guarantee almost half of the mortgages in the U.S. were taken over by the government. Lehman Brothers, formed in 1850 and a survivor of the Great Depression, filed for bankruptcy. American International Group (AIG), the world's largest insurance company, was also rescued by the government with an $85 billion loan in exchange for an almost 80% stake in its business. Merrill Lynch, wanting to avoid Lehman's fate, agreed to be acquired by Bank of America. Washington Mutual, the largest U.S. mortgage lending company, was seized by the government while J.P. Morgan Chase (the recent purchaser of Bear Stearns) bought its branches and assets. Goldman Sachs and Morgan Stanley, with share prices plummeting and fears rising, embraced capital injections from Warren Buffett and Japanese bank Mitsubishi UFJ Group and changed their legal status from investment banks to bank holding companies. Against this backdrop, the country's oldest money market fund "broke the buck" as its holdings in Lehman paper lost value. This caused havoc in the money and commercial paper markets and essentially brought credit markets to a halt. Working around the clock in September, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson presented a $700 billion bailout plan for financial institutions. On Monday, September 29, the House of Representatives voted to reject the bill, triggering a 778-point decline in the Dow, its largest one-day point loss ever. Eventually, both the House and Senate approved a revised version of the bill, but only after much tension and uncertainty in the markets. The U.S. economy grew at a 2.8% rate in the second quarter, but third quarter data indicated weaker conditions as the impact of the tax stimulus faded. Housing news continued to be poor, retail and auto sales fell, job losses spiked in September and the unemployment rate edged up to 6.1%. Slowing growth abroad and cautious consumers and businesses at home threatened corporate profit forecasts. There was some good news, however. Oil prices dropped from almost $150 to near $100 levels. Meanwhile, other commodity prices also fell sharply and the dollar staged an impressive recovery after years of decline. These reversals will ease inflation and pressures on businesses and consumers alike. Credit conditions remained tough overall, although mortgage rates eased considerably following the Fed's takeover of Fannie and Freddie. Still, the financial crisis, now a global condition, will keep markets volatile and economies fragile in 2009 and perhaps well beyond. As we enter the fall, investors hope that the bailout plan, likely interest rate cuts, and other actions by governments and central banks around the world will thaw the credit freeze and enable the engines of economic growth to keep running. Index returns   Month ending September 2008   Quarter ending September 2008   Year to date 2008 Russell 1000® Index   -9.53   -9.35   -19.50 Russell 2000® Index   -7.97   -1.11   -10.38 Russell 2500™ Index   -9.94   -6.72   -14.29 Russell 1000® Growth Index   -11.58   -12.33   -20.27 Russell 1000® Value Index   -7.35   -6.11   -18.85 Russell 2000® Growth Index   -11.30   -6.99   -15.29 Russell 2000® Value Index   -4.69   4.96   -5.37 Lehman Brothers Aggregate Bond Index   -1.34   -0.49   0.63 Russell Global Developed ex-U.S. Index (USD)   -14.89   -21.27   -28.59 MSCI EAFE Index Gross (USD)   -14.42   -20.50   -28.91 Russell Emerging Markets Index (USD)   -18.03   -26.94   -37.40 MSCI Emerging Markets Index Gross (USD)   -17.49   -26.86   -35.37 U.S. stocks: Wall Street's meltdown batters stocks The third quarter started on a fairly positive note as better-than-expected earnings from some of the largest financial institutions raised hopes that the worst was over for the beleaguered sector. Financials rallied sharply after being battered in the first half of the year. But in September, worsening credit market conditions and the remarkable progression of bailouts, bankruptcies, and takeovers pummeled stocks. With wild swings along the way, the Russell 3000® Index fell 8.73% during the quarter, bringing its year-to-date return to -18.81%. From its October 2007 high, the Russell 3000 Index had fallen by over 23% as of September 30. While there were few places to hide during the quarter, there were unusually large return dispersions in terms of capitalizations, sectors, and styles. Energy and materials stocks fell sharply as oil and other commodity prices declined. Technology also sold off as growth expectations for the global economy eased. Defensive sectors such as consumer staples and health care benefited in this environment. Surprisingly, financials also fared well on a relative basis as gains among regional banks and diversified financials such as Bank of America, J.P. Morgan Chase, and Citigroup offset huge declines in Freddie Mac, WaMu, and Lehman Brothers. Large cap stocks performed worse than small caps, pulled down by financial and energy stocks such as AIG, ExxonMobil, and Schlumberger. Apple was also a notable underperformer on expectations that consumer spending would slow going forward. Though volatile in September, small caps held up relatively well as sharp rebounds among financial stocks offset weak technology issues. In a reversal of second quarter trends, growth stocks underperformed value by a sizable margin, pulled down by weakness in energy and technology. On the other hand, gains ranging from 38% to 60% from J.P. Morgan, Wells Fargo, and Bank of America supported value stocks. U.S. bonds: Credit market chaos (Performance is stated in total returns unless otherwise noted.) Investors will likely remember September as one of the worst periods in credit market history. Despite aggressive maneuvers by the Treasury and Federal Reserve, the avalanche of collapsing financial institutions raised fears to the point where borrowing and lending virtually ground to a halt. Investors fled to the safety of U.S. government Treasuries, pushing the 3-month yield to near zero towards quarter-end. Yields fell across the maturity spectrum, especially at the shorter end as expectations rose for another interest rate cut before year-end. The 2-year Treasury yield fell to 1.97%, down 66 basis points over the quarter. The 10-year note ended September at 3.83%, down 16 basis points during the quarter. Within the Lehman Brothers Aggregate Bond Index (now owned by Barclays Capital), Treasuries returned 2.30%. Mortgage-backed securities returned 1.87%, supported by the government's takeover of Fannie Mae and Freddie Mac. But other results were dismal. Investment-grade corporate bonds returned -7.80%, pulled down by extreme weakness among the financial institutions sub-sector and softening conditions in the global economy. The volume of investment-grade bonds issued in the quarter fell 68%. Asset-backed and commercial mortgage-backed securities returned -3.72% and -5.83%, respectively. Outside of the Lehman Aggregate, the extended sectors of corporate high yield and emerging market debt returned -8.89% and -5.80%, respectively. High yield spreads rose to 1000 basis points for the first time since 2002. Non-U.S. stocks: Financial crisis spreads to europe (All returns are in U.S. dollars unless otherwise noted.) The spreading credit crisis and further evidence of economic slowdowns in Europe and the Pacific Basin contributed to broad sell-offs that were intensified by currency fluctuations. The MSCI EAFE Index fell over 20% in U.S. dollars while losing 12.95% in local currency terms. The euro and British pound lost over 10% each against the dollar. In contrast, the yen held steady during the quarter as rising risk aversion caused investors to unwind carry trades. The materials and energy sectors lost over 30% each as oil and other commodity prices plunged. Industrials and technology were also hit hard while relatively healthy Japanese banks gave support to financials. As in the U.S., health care and consumer staples were the most defensive sectors and value stocks fared better than growth stocks. Japan, down over 17% in both U.S. dollars and yen, came under pressure as the global slowdown curbed exports to the U.S. and Europe. Elsewhere in the region, Hong Kong sold off sharply in concert with China. Australia lost over 26% as falling commodities and credit concerns pushed down its currency, materials, and financial stocks. Europe fell 20.97% (-11.3% in local currency), with declines ranging from just over 13% for Switzerland to over 40% for Norway's energy-heavy market. The major markets of France, Germany, and the U.K. fell between 18% and 21%. Although years of restructuring and cost cutting have improved the health of German industry, a key business sentiment index fell to its lowest level in more than 15 years. The widening credit crisis threatened a number of financial institutions and the European Central Bank (ECB), Bank of England and others worked with the Fed over the quarter to inject liquidity into the financial system. The U.K. government facilitated the acquisition of mortgage lender HBOS by Lloyds TSB. Just after quarter-end, the Dutch government took over Belgian-Dutch bank Fortis. The ECB at last signaled the possibility of an interest rate cut by year-end, even as inflation pressures remain elevated in the eurozone. Emerging Markets: Investors retreat from risky assets (All returns are in U.S. dollars unless otherwise noted.) Emerging markets also fell dramatically during the quarter as the combination of falling commodity prices, slowing global growth, rising geopolitical tensions with Russia, and the spreading financial crisis further pummeled asset prices. Currency declines exacerbated the rout, despite substantial efforts by a number of central banks to defend their currencies. The MSCI Emerging Markets Index fell almost 27% in U.S. dollars while losing more than 20% in local currency terms. All sectors declined, with the energy and materials sectors down between 36% and 41%, respectively. With half of its index concentrated in materials and energy stocks, Latin America was the worst-performing region, down 32.57%. Brazil fell 37.87% (24.65% in local currency). Europe, the Middle East, and Africa (EMEA) fell 28.53%. Russia provided the most spectacular declines within EMEA as tougher credit market conditions, falling oil prices and the war with Georgia pushed down its market by 45.26%. Trading was suspended for two days in September after Russian shares suffered their steepest one-day fall in more than a decade. Subsequently, President Medvedev announced a $120 billion rescue package, including share purchases, injections of cash into banks to boost liquidity, and tax cuts for oil companies. Despite falling commodity prices, high inflation remains a concern in Russia and other EMEA markets. As world equity prices reeled, Asia fell 22.95%, with China and India down 25.22% and 13.93%, respectively. Slowing exports, declining property values and plunging stocks prompted a surprise interest rate cut and other measures to bolster China's market, including the purchase of bank stocks by sovereign wealth funds. Battered by soaring oil prices earlier in the year, India fared better in the third quarter as commodity prices retreated. Note: All equity sector returns are based on Global Industry Classification Standards (GICS) to allow for consistency between overseas and U.S. equities. 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. 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. The Russell Global Developed ex-U.S. Index measures the performance of developed market securities in the Russell Global Index outside of the United States, based on market capitalization. The index includes approximately 4,800 securities and covers 46% of the investable global market. The Russell Global Index is constructed to provide a comprehensive and unbiased barometer for the global segment and is completely reconstituted annually to ensure new and growing equities are reflected. The Russell Emerging Markets Index measures the performance of emerging market securities in the Russell Global Index, based on market capitalization. The index includes approximately 2,800 securities and covers 20% of the investable global market. Securities products and services offered through Russell Financial Services, Inc., member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. First used October 2008 RFD 08-1074			Past commentary 2nd quarter 2008   Investment products LifePoints funds Russell funds Separate accounts   Printer friendly version of this page Send feedback or comments Site Search

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