Where Do We Go From Here?

George Hosfield, CFA, is Ferguson Wellman’s chief investment officer and chairs the firm's Investment Policy Committee. In addition, he is a member of the equity team with responsibility for management of the consumer discretionary sector on a global basis. He is a principal of the firm.

As of this writing, the S&P 500 is down 28 percent year to date and still falling. Though such levels are historically not the best times to reduce equity exposure, with evidence mounting that this will not be a typical correction, in the interests of capital preservation we are initiating trades that will not only reduce the allocation to equities but also position the remaining equity portfolio more defensively.

The inability of Congress to expeditiously pass an appropriately targeted “liquidity bill” was another step toward shaking the confidence of the credit markets. Coupled with unwillingness on the part of the European Central Bank (ECB) to cut interest rates, the chance of a synchronized global recession has become increasingly likely. At a minimum, the slowdown will persist well into 2009 or possibly 2010. Furthermore, any slowdown will probably be deeper than the current consensus expectations, and the subsequent recovery will likely be tepid. In a world where the U.S. has become the “best house in a bad neighborhood,” the dollar will likely appreciate further as foreign central banks ultimately shift toward easing their interest rates.

To be sure, we have been surprised by the magnitude of the market downturn related to the aforementioned events. However, it is not too late to make additional portfolio adjustments to reduce the market risk in our client portfolios while continuing to provide an opportunity to participate when the equity markets ultimately rebound. Specifically, we shall judiciously make the following aggregate portfolio moves:

• Further reduce the allocation to equities
• Within the equities that remain, diminish our exposure to the most cyclical sectors (energy, industrials, technology and commodities) and increase the allocation to defensive sectors (utilities, consumer staples and healthcare)
• Reduce the commitment to international equities relative to U.S. equities
• Within the international portfolio, reduce volatility by selling disproportionately more from emerging markets and cyclical sectors
• Position the proceeds from equity sales in cash and high-quality, short-term bonds.

Some of the portfolio adjustments outlined above have already begun, and over the coming weeks you can expect to see activity accelerate in a prudent manner. In other words, we will attempt to use any market rallies as an opportunity to implement these changes.

As always, please do not hesitate to contact me or your portfolio manager with any questions or comments.

Best regards,
George W. Hosfield, CFA
Chief Investment Officer