Investors Look Back On 2007
Kurt Brouwer January 4th, 2008
The year 2007 was a wild and rather woolly year for investors. Many ups and downs. The stock market finished up for the year although it slid late in the year (and that slide has continued in the New Year). Here is a quick reprise of the year in an oddly-titled piece from the Wall Street Journal (registration required):
Dazed and Confused (Wall Street Journal, January 3, 2008, Tom Lauricella)
‘After last year, you can’t blame mutual-fund investors for feeling a little dizzy.
Stock markets around the globe spent the early part of 2007 still booming, though the U.S. bull market that began back in 2003 looked increasingly frail even as stocks hit new highs.
By the second half of the year, big portions of the financial markets were in disarray. Some of the most widely held bank and Wall Street stocks were cratering amid fear of huge waves of mortgage defaults — and concerns mounting about risks in supposedly safe short-term-bond and money-market mutual funds.
“It was a tale of two markets,” says Marc Baylin, a portfolio manager at OppenheimerFunds Inc.
Still, for all the gloom in recent months, mutual-fund investors have some reason to cheer: Stock funds came out of 2007 in pretty good shape. Diversified U.S.-stock funds delivered a respectable 6.6% average total return for the year, according to preliminary figures from fund tracker Lipper Inc. That beats the return of the big-company Standard & Poor’s 500-stock index, which delivered 5.5%, including reinvested dividends.
A number of factors fueled those stock-fund returns. Early in the year, buyout firms used cheap debt to fund ever-bigger mergers and acquisitions. Tech stocks rebounded, at long last. And companies that supply developing markets rode a global economic boom.
But even as those positive trends were driving the market higher, the subprime crisis was starting to gather steam. And when it hit in full force, it wrecked the party. Even though the end result for mutual-fund investors was positive, the gains in 2007 lagged behind U.S. stock funds’ average 12.4% return for 2006 and the 14% average of the past five years.
What comes next?
…Despite the rough ride in the second half of 2007, fund managers think the tottering U.S. economy will manage to narrowly avoid recession with the help of lower interest rates. But until the outcome becomes clear, the roller-coaster ride could continue. “Until we get answers, we’re going to be in the broad trading range that we’ve been in,” says Robert Doll, global chief investment officer for equities at BlackRock Inc…
…Tech stocks were one reason growth funds outperformed. After years in the doghouse, tech companies benefited from strong economic growth world-wide and a wave of product introductions. And as the market went south, investors weren’t willing to wait for beaten-down value stocks to turn themselves around.
Meanwhile, portfolio managers may have something to cheer about in the running contest between actively managed funds and index funds. The ability to avoid such trouble spots as financial stocks led to better performance for many active managers when compared with index funds, which are stuck with fixed weightings of their holdings.
The Gathering Storm
But trouble was brewing in the bond market. Years of easily available credit were making some veteran fund managers nervous. Lenders had steadily eroded the standards for making home loans. Wall Street firms, in turn, had developed giant businesses packaging these loans into securities so complicated that they needed mathematical whizzes to help figure out the prices…
…For much of the early part of the year, fund managers expressing such concerns sounded a lot like Chicken Little, and their investors were falling behind. Perhaps the most notable voice in this camp was Bill Gross, founder and chief investment officer of Pacific Investment Management Co.
He had been betting that U.S. real-estate prices had reached bubble status and were headed for a collapse that would ripple through the economy. He filled the portfolio of his flagship Pimco Total Return portfolio with securities that would benefit from an interest-rate cut, anticipating that the Federal Reserve would have to step in to seek to lower rates to keep the economy on track. And he shied away from higher-yielding corporate bonds, viewing companies that issue these “junk” bonds as vulnerable in an economic downturn.
Through the early part of 2007, Mr. Gross looked dead wrong, and his portfolio was near the bottom of the fund rankings. In mid-May, he acknowledged that the timing of his call had been a “big mistake” — but he stood firm with his strategy.
All-Out Trouble
As the calendar ticked over into the second half of the year, the tide did shift. In May, signs of trouble were unmistakable among investors in the securities backed by low-quality, or subprime, mortgages. By June, with defaults and foreclosures of mortgages in the headlines, prices on these securities were collapsing.
For the most part, mutual funds had avoided the lowest-quality mortgage-backed securities well before the market cracked. But not all. Fidelity Investment’s Ultra-Short Bond Fund, for one, had held stakes in both low-quality and high-quality mortgage-backed securities…’
Given all the challenges we faced, the financial markets did well in 2007. Oil soared by more than 70%, the housing and mortgage industries slumped, unemployment ticked up as did inflation, yet stocks finished the year with a positive return. And, interest rates on high quality bonds went down. Nonetheless, that is small comfort for investors who focus on the short-term because most news is pretty negative right now.
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