By Martin E. Landry, CFA, CFP®, CIMA®, Senior Investment Analyst

Stocks reached new highs at the start of the fourth quarter of 2007 only to succumb to unsettling news of large write-downs in the value of sub-prime investments held by the major global banks. Volatility returned as dissonance between data showing a slowing domestic economy and rapidly rising oil and commodity prices rattled nervous investors. The financial fallout morphed into heightened worries about slowing global growth in November and equity markets corrected. Many areas slipped over 10% from their recent peaks before a faint rally appeared at month-end. December saw investors abandon those equity sectors viewed as vulnerable to a weakening economy with many jumping ship to grab U.S Treasuries as a safety net.

The year ended with stocks retracing much of the progress made during the summer; however, large-cap growth stocks suffered less. The broad U.S equity market as measured by the Russell 3000® Index slipped 3.34% for the fourth quarter but finished the year with a modest 5.14% gain. The large-cap oriented S&P 500® Index fell about the same during the quarter, down 3.33%, yet finished with a total return of 5.49% for the year. Returns from international equity markets outpaced U.S. stocks. The MSCI® All Country World ex-U.S. Index (Net), representing both developed and emerging international markets, slipped just 0.66% for the fourth quarter. It remained ahead of all major domestic indices for the year posting a 16.65% return.

The performance divergence between growth and value stocks widened further during the quarter. The large-cap oriented Russell 1000® Growth Index fell only 0.77% for the quarter outpacing the Russell 1000 Value® Index by over 5%. For the year, the gap in favor of growth ballooned to almost 12%. Much of the outperformance came from investors fleeing traditional value names such as large diversified banks and placing money into technology and consumer services companies such as Apple Computer and Google.

The small-cap oriented Russell 2000® Index lost 4.58% for the quarter, mostly due to slumping prices for stocks within the financial services and consumer discretionary sectors. For the year the Russell 2000® Index fell 1.57%; however, the divergence between growth stocks and value stocks was also significant (at over 16%).

Emerging market stocks, as measured by the MSCI® Emerging Markets Index, were one of the few areas within equities to experience a positive return for the quarter, returning 3.64%. Over the year, returns from such countries as Brazil, Russia, India and China helped push the MSCI® Emerging Markets Index up nearly 40%. Developed international stocks, as represented by the MSCI® EAFE Index, fell 1.75% during the quarter but were up 11.17% for the year. A weakening U.S. dollar accentuated returns for U.S. investors.

Investments in public real estate companies, including REITS, continued to fall amidst concerns over the widening effects of the crisis in the mortgage and financial markets. The Dow Jones Wilshire Real Estate Securities Index fell 13.68% for the quarter and ended the year down 17.66%. After large gains in the previous few years, their three-year returns are now back in line with broad market averages.

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