Centara Connection

Market Update: Volatility Returns To Equity Markets

Mark Dossa, CFP®, Senior Portfolio Manager

Volatility returned to equity markets in Q1 of 2007 as investors faced a variety of negative events during the first three months of the year. Market movements of over 1% a day were common place, something we have not seen much of in the past few years.

January started off strong with the S&P 500 gaining 1.5%, as corporate profits remained in the double digit range. Equities then gave all the gains back and then some in February as markets suffered a meltdown on February 27th after the Chinese market plummeted 9% overnight. The S&P lost 3.5% on 2/27, the single biggest one day loss in four years. Stocks then rebounded in March with the S&P gaining 1.1% to finish the quarter with a paltry gain of 0.64% (almost all from dividends). The DJIA lost 0.87% on the quarter and the Nasdaq rose 0.26%.

The Fed decided to leave interest rates alone once again but sparked a rally when they took a more neutral stance on inflation. In their statement following the announcement, voting members discussed how inflation is under control and the economy is slowing but not by too much. The housing market proved to be a barrier to better gains as home prices and sales continued to drop. In addition, sub-prime lenders felt the heat from increased defaults and began declaring bankruptcy.

Crude oil spiked towards the end of the quarter after dipping into the mid-$50’s a barrel earlier in the year. Increased tensions in the Middle East, due to Iran’s taking of British soldiers in “international waters,” was much to blame. Higher crude prices could lead to a bump in inflation that is already staying stubbornly high. This, in turn, could keep the Fed from reducing rates – and that is not what the markets want to see happen.

Bonds, as reflected in the Lehman Brothers Aggregate Index, gained 1.50% on the quarter as investors fled equities into the relative safety of debt instruments. With corporate profits slowing to a predicted pace of less the 5%, bonds could play a key role in portfolio performance for 2007.

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