Market Commentary as of 3/31/08
Credit Crisis and Market Volatility Intensify
During the first quarter of 2008, stock price volatility reached record levels and the market indices turned in their worst performance in six years. The Fund entered the new year after having bested its S&P 500 Index benchmark by 15 percentage points in 2007, with half of the portfolio's holdings at or near their highs. Unfortunately, the credit markets reached near panic proportions during January and February as the sub-prime mortgage crisis spread throughout the fixed-income arena. Fears of recession became commonplace, raising further concerns about the state of future corporate earnings growth. The huge declines suffered initially by Financial stocks quickly spread to the Consumer Discretionary area, and then to other parts of the equity marketplace. Thus, the outperformers for 2007 sold off sharply, and the Fund lagged its benchmark by two percentage points during the quarter.
The bright outlook for global economic growth led us to overweight the Materials, Energy, Industrial, and Technology sectors during 2007 and on into this year. As talk of recession worked its way into the daily media, investors took profits in Industrials and Technology, hitting those stocks hard. Those areas were the two worst performing sectors for the Fund. Some of the best performers of 2007, such as MEMC Electronic Materials, Oracle, and Amphenol Corporation contributed to the tech decline. Jacobs Engineering, Danaher Corporation, and Parker Hannifin declined on the Industrials side. In contrast, Material and Energy stocks fared much better in contributing only slightly to the Fund's drop during the quarter. We continue to overweight all of these sectors, though we have sold some stocks whose fundamentals look less attractive going forward.
Financials and Healthcare names were among the losers during the quarter as well. Although the Fund was significantly underweight Financials—with an average stake half that of the S&P 500—there was no escaping the hefty declines within the group. By quarter end, only positions in Goldman Sachs and Affiliated Managers were still in the portfolio. Until we see signs of improving fundamentals, we do not intend to add to this sector. Fundamental setbacks in Schering-Plough and Waters Corporation caused the decline in the Healthcare arena.
The Dreaded 'R' Word
The question on most investors' minds as we enter the second quarter of 2008 is, "Has the U.S. economy entered into a recession?" Economists and statisticians will likely debate this question for months to come until all the data is in, but the more important issue is what will the reaction be among consumers, businesses, and the government to the current crisis and what are the investment implications?
The Federal Reserve Board, Congress, and the Administration are moving swiftly on numerous fronts to ease the housing debacle as well as put measures in place to prevent such financial dislocations in the future. Nevertheless, consumers are struggling under the burden of rapidly rising energy and food costs, and slower spending surely lies ahead. Business has also been slow to invest in this uncertain environment, and jobs are being lost. Putting it all together, we conclude that the recession call is a close one. From an investment point of view, the call probably does not matter. Ultimately, if the areas of strength (global) hold up and the areas of weakness (financial) stop deteriorating, all the talk will be about economic lift. It will take more time before the economy crosses that tipping point, though we believe we are in the late innings of the process.
Global Growth Is Down But Not Out
During the first three months of 2008, the market rallied, sold-off down to its January low, and then rallied again. In a way, this volatile trading pattern is what we hoped for in buying time for the actions by the Fed and others to take effect. The market's healing process is well along, and the key now is to watch how it absorbs any earnings disappointments or unexpected new credit problems. We are encouraged that many areas of the market—including cyclical consumer segments—are up in price and holding their gains, suggesting the market is expecting better business fundamentals down the road.
Our top-down analysis and bottom-up company research continues to favor overweighting those areas able to benefit from global growth and trade. As mentioned earlier, companies in the Materials, Industrials, Transportation, Technology and Energy sectors are particularly attractive. Healthcare remains a growth sector based on demographic demand, but we are increasingly worried that a move towards greater government involvement in domestic health issues will lead to relentless pressure on prices and profits for companies. Finally, while Financial and Consumer stocks show up in our work as oversold, we are not yet seeing a broad enough improvement in the fundamentals to suggest an aggressive investment here. All told, we see many attractive opportunities at today's stock prices and hope to look forward to portfolio gains over the remainder of the year.
Large-Cap Team
Optimum Investment Advisors
Note: Mutual funds that invest in growth companies may be more volatile than other funds because they are generally more sensitive to market moves.
The views expressed above are for informational purposes only and is not intended as investment advice. Since the date of the commentary, economic, market conditions and the portfolio manager's views may have changed.
As the fund is actively managed, the securities as presented do not represent the current or future composition of the portfolio.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.