World markets review Fourth 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: Credit crisis engulfs the global economy The end of 2008 could not come soon enough. Over the course of the year, an alarming and unprecedented series of events transformed the financial landscape and dramatically impacted credit conditions. Against this backdrop, the U.S. economy suffered its most harrowing conditions in decades. The demise of Lehman Brothers had enormous ramifications for short-term credit markets, cutting off credit for banks and companies and pushing up borrowing rates sharply. As the crisis intensified, trust in the credit markets collapsed and the cost of credit protection for financial institutions soared. In the space of only a few weeks, the crisis of confidence spread far beyond the U.S., toppling banks from Iceland to the euro- zone and beyond. Meanwhile, U.S. economic conditions deteriorated as the quarter progressed, with housing, retail sales, and manufacturing data all coming in worse-than-expected. Corporate profits plunged, and the auto manufacturers warned of imminent collapse. Job losses accelerated, bringing the unemployment rate to 7.2% at year-end. Overseas, Japan and the euro-zone were already in recession and China showed signs of rapid cooling. The International Monetary Fund (IMF) projected that growth across the developed and emerging markets would slow below 2% for the first time since 1991. In an effort to stem the crisis, the Federal Reserve and Treasury mounted an all-out effort to ease the credit crunch and stabilize the economy. By quarter-end, the Fed had slashed the federal funds target rate to an all-time low of between 0% and 0.25%. In addition to a $750 billion bailout program, the Fed and Treasury engineered other initiatives that provided for the purchase of commercial paper from companies and guaranteed the debt of selected of bank and finance companies. Furthermore, the Fed created new lending facilities to improve conditions in the mortgage and asset-backed markets. President-elect Barack Obama pledged a massive fiscal stimulus program, now under debate by Congress. From Europe to Asia, numerous central banks and governments also cut interest rates and announced fiscal stimulus programs. While Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson came under fire various times, credit conditions did improve somewhat by year-end. Interbank lending rates fell and bond spreads narrowed. Mortgage rates came down significantly. Other relief to consumers came from sharply lower commodity prices as global demand slowed. Oil prices, over $140 in July, ended the year near $44 and contributed to a sharp drop in consumer prices and inflation pressures. These conditions helped stem the free-fall in global markets and sparked strong rallies in late November. But is the worst over? In our view, probably not, given the severity of the housing market decline, the overleveraged economy, rising unemployment and the ease of contagion in the interconnected global financial system. Still, the massive efforts of central banks and governments around the world will be felt in 2009. An eventual bottoming in the U.S. housing market will help reestablish values for the toxic mortgage-backed securities that triggered the financial crisis. In the meantime, investors may start to look beyond the bad headlines and refocus on fundamentals and the longer-term prospects for companies. But after the epic drama of 2008, sentiment remains fragile and continued high volatility is likely. Index returns   Month ending December 2008   Quarter ending December 2008   Year to date 2008 Russell 1000® Index   1.60   -22.48   -37.60 Russell 2000® Index   5.80   -26.12   -33.79 Russell 2500™ Index   5.43   -26.25   -36.79 Russell 1000® Growth Index   1.81   -22.79   -38.44 Russell 1000® Value Index   1.39   -22.18   -36.85 Russell 2000® Growth Index   5.42   -27.45   -38.54 Russell 2000® Value Index   6.15   -24.89   -28.92 Barclays Capital U.S. Aggregate Bond Index   3.73   4.58   5.24 Russell Developed ex-U.S. Index (USD)   5.45   -21.85   -44.19 MSCI EAFE Index Gross (USD)   6.02   -19.90   -43.06 Russell Emerging Markets Index (USD)   6.62   -28.99   -55.55 MSCI Emerging Markets Index Gross (USD)   7.83   -27.56   -53.08 U.S. stocks: Market meltdown caps a brutal year U.S. stocks fell sharply during the first part of the quarter as the ongoing credit crisis and deteriorating economic data threatened more bank collapses and intensified pressures on consumers and companies. Forced selling by hedge funds, financial institutions and others contributed to the sell off. With dizzying volatility along the way, the Russell 3000® Index fell more than 36% by late November with the financials sector down more than 50%. However, the government's rescue of Citigroup and promise of aid for the auto companies, Treasury and Federal Reserve actions, and prospects of a large fiscal stimulus package helped improved investor sentiment. From its November 20 low through year-end, the Russell 3000 rallied more than 22%, with financials up almost 36%. Still, the Russell 3000® Index ended the quarter down 22.80%. Financials took the largest toll on the index, hurt by their exposure to distressed mortgage securities, dependence on short-term credit and excess leverage. Bank of America and Citigroup fell almost 59% and 67%, respectively. The materials, consumer discretionary, and technology stocks were also hit extremely hard on the back of grim corporate earnings announcements and the poor economic outlook. Traditionally defensive utilities, telecoms, consumer staples, and health held up best in the quarter. While there was little difference in the performance of growth and value styles, large capitalization stocks fared better than small caps as investors found greater comfort in companies such as AT&T, Verizon, and the large oil companies. Exxon Mobil and Chevron benefited from their record-low stock prices and opportunities for improvements in refining margins as oil prices plunged. But elsewhere in the energy sector, falling energy prices pushed down oil service stocks such as Schlumberger and Halliburton sharply. The Russell 3000® Index ended 2008 down 37.31%, its worst year ever. Putting the meltdown in greater historical perspective, the Dow Jones Industrial Average and S&P 500 fell just under 32% and 37%, respectively, their worst declines since the 1930s. U.S. bonds: Credit market chaos continues to favor treasuries Risk aversion drove the credit markets in the fourth quarter amid continued tight credit conditions and deteriorating economic data. Although at times rapid-fire policy actions by the Fed and Treasury resulted in some unintended dislocations, conditions did improve somewhat in November and December. Even so, spreads for investment grade, high-yield and other credits ended 2008 well above long-term average levels. Investors' continued desire for safety pushed Treasury prices higher and yields down to historic lows across the maturity spectrum The 2-year Treasury yield fell from 1.96% to 0.76%. The Fed's plan to buy mortgages and possibly even longer-dated Treasury debt helped push the 10-year yield from 3.83% to 2.12%. Within the Barclays Capital U.S. Aggregate Bond Index, Treasuries returned 8.75%. Agencies and mortgage-backed securities returned 6.10% and 4.34%, respectively, boosted by the Fed's intent to purchase agency debt and mortgages. Investment grade corporate bonds also recovered, returning 3.98%. In contrast, asset-backed and commercial mortgage-backed securities (CMBS) fell 6.82% and 13.52%. High-yield and emerging market debt (sectors not included in the index) rallied in December, yet ended the quarter down 17.88% and 9.31%, respectively. These losses pushed spreads against Treasuries to historic highs, reflecting fears of rising defaults. 2008 was one of worst years in credit market history, with sector returns spanning a high of 13.74% for Treasuries to a low of -20.52% for CMBS. Investment grade corporates fell almost 5%, their worst result since 1974, with spreads over Treasuries tripling. High yield and emerging market bonds fell 26.16% and 14.75%, respectively. Due to the enormous dispersion in returns, investors with any underweights to Treasuries suffered an unusually difficult year. Non-U.S. stocks: Economic tsunami hits Japan (All returns are in U.S. dollars unless otherwise noted.) After sharp declines in the third quarter, non-U.S. markets were further pummeled as the credit crunch broadened its global reach and pressured overseas economies. Yet non-U.S. markets fared slightly better than the U.S. in the fourth quarter. For the full year, however, they underperformed U.S. stocks for the first time in seven years. The financials sector plunged more than 30%, materials and consumer discretionary both fell over 20%, while telecoms, utilities and health care declined only by single digits. MSCI Europe fell 22.74%, with Germany and France slightly outperforming the region compared with larger than 40% declines in Ireland and Norway. In the U.K., telecoms and health care managed to deliver positive returns, offsetting some of the huge sell offs in banks such as Royal Bank of Scotland and Barclays. Nevertheless, extreme weakness in the pound sterling pushed the U.K.'s local market return from under -9% to more than -26% in U.S. dollars. The Bank of England and British government took aggressive action over the quarter, cutting the benchmark interest rate to a 53-year low of 2%, and partially nationalizing or engineering takeovers of banks. The ECB also reduced interest rates aggressively, bringing its key rate to 2.5%. MSCI Pacific Basin fell a relatively modest 13.81% with help from currency gains. Rising risk aversion and the continued unwinding of leverage and carry trades pushed the yen to a 13-year high against the U.S. dollar, causing Japan to outperform all other developed markets in the quarter and year. Yet the yen's surge added enormous pressure to Japan's export-driven economy. Toyota announced its first operating profit loss in the company's 70-year history as yen strength eroded profits on overseas sales. Despite limited exposure to mortgage-related securities, Japanese banks also fell sharply on concerns of rising bad loans and securities losses. The Bank of Japan cut interest rates to 0.1%, while the government also announced a package of fiscal stimulus measures to support the rapidly weakening economy. Elsewhere in the region, Hong Kong and Australia fell over 18% and 26%, respectively. Emerging Markets: World of pain (All returns are in U.S. dollars unless otherwise noted.) Emerging markets suffered even greater routs as risk aversion spiked and commodity prices and currencies collapsed. While markets rallied strongly near year-end with help from interest rate cuts, fiscal stimulus plans, IMF short-term lending programs and the Fed's extension of currency swap facilities, 2008 brought a remarkable run of gains to an end. Down over 53% in 2008, the MSCI Emerging Markets Index gained over 420% from 2003 through its October 2007 high. Energy and materials, which make up approximately 30% of the index, fell over 30% and 40%, respectively. Latin America, highly dependent on commodity earnings and trade with the U.S., fell almost 34%. Brazil declined over 37%, pulled down by hard-hit commodity producers and banks, but also due to an over 20% drop in the real against the U.S. dollar. Europe, Middle East and Africa (EMEA) fell 33.74% with Russia down over 51% on a combination of falling oil prices, weak banks, high exposure to foreign debt and political concerns. The end of easy credit availability also pummeled regional neighbors with large current account deficits, including Hungary and Turkey. Asia fell 21.51%. China lost just over 11% in the quarter though ended the year down over 50%. Reduced demand from the U.S. and Europe triggered a rapid decline in exports, and declining property values and rising unemployment further pressured China's economy. Despite interest rate cuts and an almost $600 billion stimulus plan in the works, the IMF predicted that Gross Domestic Product (GDP) growth would slow to below 8% next year, the level China considers necessary to maintain jobs and stability. India suffered a greater loss, falling almost 30% to end 2008 down more than 60%. Hit hard by the global downturn and December's terrorist attacks in Mumbai, India's government also cut interest rates and pledged fiscal support. 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 2009. 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. Barclays Capital U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. Dow Jones Industrial Average: Price-weighted average of 30 actively traded blue chip stocks. 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): The market value of the goods and services produced by labor and property in the United States. 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: 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). 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. 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., member FINRA, part of Russell Investments. For information on the Financial Industry Regulatory Authority, go to www.finra.org. First used January 2009 RFS 09-1372			Past commentary 3rd 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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