First Quarter, 2009 Economic and Quarterly Commentary

Economic Conditions

We are now 15 months in to a deep recession that officially started in December 2007. This is already five months longer than the average recession since 1948. The GDP has declined by 6.3% in the fourth quarter of 2008, the biggest drop in 26 years, and likely fell again in the first quarter of 2009. Unemployment increased to 8.5%, and will likely continue to rise as long as output declines. Most economists have predicted the unemployment rate will hit at least 9-10% this year. Housing prices continued to plunge at a record pace and were down 19.4% for the 12-month period ending in January according to Standard & Poor's. Meanwhile housing starts fell 56% to a record-low annual rate of 466,000 over the same time period and are down 79% from the peak three years ago.

In the face of all this economic deterioration, the government continued to respond aggressively, first unveiling a plan to create a public-private fund for troubled bank assets, then approving a $787 billion economic stimulus bill and releasing details of a $50 billion foreclosure mitigation plan, and lastly by expanding its support for the credit markets by promising to buy hundreds of billions of dollars of treasury bonds and launching programs to support securitized markets for consumer and small business loans. It is clear that the government's primary goals are to stimulate consumer spending and stop the deterioration in home prices. The decline in housing prices and increase in foreclosures may not be over, but perhaps the three year plunge may be nearing an end if one considers mortgage rates, new inventory levels, the affordability index as well as government incentives. Stabilization in this area will be critical to initiate improvement in consumer attitude and spending. Further, although the first quarter GDP decline is likely to be similar to the previous quarter, the composition of that decline, namely a sharp reduction in inventory and a small increase in consumption, points to an improved second quarter.

The breadth and scope of the rapid reduction in economic conditions has obviously been difficult for everyone to deal with. However, one can also reasonably argue that the situation is creating a very solid base. Clearly, companies do not want to plan on another fiscal year like 2009. They are adjusting costs, inventories and pricing in a fashion to show improvement going forward. Whether or not you believe there is pent up demand, if and when the consumer comes back to spend, it will not be against the home equity of their house or via a junk credit card offer. Balance sheets for companies and individuals are probably better than they have been in years. Clearly, the government will need to reign in spending down the road, but some growth in the economy should go a long way to alleviating the difficulty of that task. To sum up with cliches, we do not propose to make a silk purse out of these conditions, but do believe there could be at least some bronze linings to some of the clouds we have seen.

Just as we may have reflected a glimmer of hope, we now must dampen that as we turn our attention to a more detailed discussion of the equity markets.

Equity Markets

It was more of the same in the first quarter of 2009, as all domestic asset classes and investment styles fell again and money continued to move out of equity funds and into cash and fixed income funds. Growth outperformed value; with mid and large cap growth showing the better relative performance declining 3.4% and 4.1% respectively. Small cap value was the worst performing sector during the quarter, declining 19.6%. Financials were once again the worst performing industry, with major industrials not far behind.

Developed international markets also fell across the board, with a continued strong dollar exacerbating these losses. The lone bright spot was emerging markets, which held its own by returning a positive 1.0%. Meanwhile real estate continued to plunge, falling another 31.9% during the quarter. It's hard not to think at this point that the worst case scenario is priced in to REITs, but further declines are always possible until some signs of stability become evident. The recent bankruptcy filing of General Growth Properties, the second largest U.S. mall owner, is a sign of the times, although this was almost a foregone conclusion and had been priced in to the stock price for some time.

Like the economy at large, equity markets may have started to show signs of stabilizing and bottoming. Volatility, as measured by the CBOE, fell from a peak of 80.9 in 2008 to 44.1 as of March 31, 2009. This is still much higher than average volatility of 20.7, but has come down drastically. Furthermore, all major valuation measures of the S&P 500 index are below their 20-year averages, and international P/E ratios are even lower than the S&P 500 on both an absolute basis and when compared to their long-term averages. Investment grade corporate bond yields remain near all-time highs as the market anticipated significantly higher levels of defaults than we have seen thus far to date. While further defaults are likely, we continue to believe that investors are being more than compensated for this default risk at current yields. Lastly, as a percentage of the capitalization of the U.S. stock market, money market funds (cash) reached 41% in January 2009. To put this in perspective the previous peak was 27%, reached in early 2003 after the 2000-2002 bear market. This means that there is a lot of money sitting on the sidelines right now that could bolster stock performance when the U.S. economy stabilizes and investors become more optimistic about owning stocks.

The quarter and 12-month period returns for the indexes that we benchmark our model growth component against are shown in the table below.

Benchmark Sector


3 Month Return

12 Month Return

Large-capitalization Domestic

S&P 500



Mid-capitalization Domestic

S&P 400



Small-capitalization Domestic

Russell 2000



Developed International Mrkts




Emerging International Mrkts




Real Estate Investment Trust

DJ Wilshire REIT



Global Real Estate Investment Trust

Morningstar Global REIT