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Capital Markets Commentary
January 24, 2008

The U.S. economy proved to be resilient in 2007, despite the fact that the hoped-for “Santa Claus” rally never occurred in the final months of the year and equity markets formally entered a correction in late November. For the year as a whole, equity market indexes finished in the mid-to-high single digits: the Dow Jones Industrial Average returned 8.9%; the Standard & Poor’s 500 Index returned 5.5%; and the Nasdaq Composite returned 9.8%.

The past few months haven’t been as good. As of January 22, 2008 the S&P 500 is down almost 17% from its October 11, 2007 52 week high. Other US stock market indices fell in the same range.

The Federal Reserve lowered its benchmark interest rate by a quarter point to 4.25% in December, reflecting its concerns that tighter credit market conditions and housing turmoil could impact the broader economy, but disappointing some who were hoping for more significant easing by the Fed. The Fed’s emergency rate cut on January 22nd served to ease stock market fears somewhat, but, since the full impact of rate cuts is not seen in the economy for 9 to 12 months, it should have little or no broad economic effect in 2008.

The overriding risk to the US economy continues to be the credit crunch. No amount of Fed rate cuts can adequately address this issue. When large, money center banks curtail lending, even to credit worthy corporate borrowers, economic growth slows.

One of the brightest spots during 2007 was overseas markets. For the year, the MSCI EAFE and MSCI Emerging Markets Indexes gained 11.2% and 39.4%, respectively. The strong performance of international equities underscores the need for portfolio diversification, consistent with one’s risk tolerance and long-term investment objectives.

The fixed income market has been plagued by concerns about sub-prime mortgages and the creditworthiness of borrowers broadly. Spreads have widened in recent months, as the yield on the 10-year Treasury declined, coming in at roughly 4% at year-end. Some analysts are calling for the yield on the 10-year to decline further, especially if markets begin to factor in the risk of a recession.

In the equity markets, domestic growth stocks handily outperformed value stocks across all market-cap segments. The Utilities, Energy, and Consumer Staples sectors were the fourth quarter’s best-performing sectors, whereas the Financials, Consumer Discretionary, and Telecomm Services sectors were the biggest laggards.

Looking ahead to the rest of 2008, U.S. corporate profit growth is expected to weaken, but there are positive factors that could benefit the economy, such as full employment and moderate income growth. Unknowns that should impact the economy going forward are whether the housing market will continue to soften – making it more difficult for homeowners to tap equity – and whether higher energy costs – including the price of gasoline – will cause consumers to cut back.

As always, we urge our clients to remain patient and stay diversified. Please feel free to contact us about your portfolio or any other matter. We are always available to you and look forward to speaking with you soon.

Sources: Lockwood Advisors, Thompson Financial/ Vestek Systems, Lehman Brothers, MSCI Barra, CBS Marketwatch