Given the action in overseas markets today and futures trading on U.S. markets, it is likely that we will see a substantial decline when trading resumes tomorrow.  European markets declined 5%-7% today, and S&P 500 Futures closed about 4.5% below Friday’s 1325 close.  Below are current thoughts:

Our 2008 market outlook called for first half weakness and elevated volatility as markets focused on recession fears, the housing and debt crisis, and a slowdown in corporate earnings.  We saw downside risk in the S&P 500 to 1250 – 1300, or down 10% – 15%.  The surprising point is we’ve nearly reached that target just three weeks into the new year.  Markets are on track for the worst start in history.

What is driving the rapid declines in equity markets?  Market psychology has turned on a dime, expecting the worst.  There has been no economic news released in recent days suggesting the economy is materially weaker than what most thought coming into 2008.  In fact, the market has ignored seemingly positive news – such as President Bush’s proposed $150 billion stimulus package, and Fed Chairman Bernanke’s pledge to “take substantial additional action as needed to support growth”.

While the markets increasingly price in an economic recession in the U.S., the data is mixed.  Some of the recent data suggest a high risk of recession, or even that one has already begun.  The unemployment rate has risen from 4.4% to 5%, including a rare 0.3% rise in December.  Measures of manufacturing activity point to a downturn, and retail sales were soft in December.

However, not all of the economic news has been weak.  We have watched closely the data on employment and incomes for signs of a recession.  Weekly claims for unemployment insurance have been low and remain well below recessionary levels.  Monthly payroll employment growth, though tepid, remains positive and is not consistent with the sharp declines seen in a recession.  Consumer spending has slowed but remains positive, and spending on business equipment was up in Nov/Dec.  The economic calendar is very light this week, but next week we’ll get the advance report on 4th quarter GDP, January payroll employment, personal income, and the ISM manufacturing index.  These reports will be a good gauge of where the economy is heading.

What are the implications for our investment strategy?  First, this market correction has been global in scope with precious few places to hide, so our moves in the fourth quarter to boost high quality, defensive holdings in the portfolio have helped only marginally.  However, in recent days we have seen more intense selling in riskier areas such as emerging markets.  Second, while we would prefer to raise additional cash, now is not the time to do so.  Overseas trading today smacked of panicked selling, a trap long-term investors should avoid.  Finally, this type of market environment typically creates excellent buying opportunities, so we will be watching for signs of bottoming action.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.