Russell Provides Mid-Year Update on Economy and 'Eight for 08' Forecast : Oil Prices Cause Largest Area of Concern for Outlook

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Russell Investments’ chief investment strategist, Ernie Ankrim, has released a mid-year update on his 2008 outlook for the economy: “Eight for ‘08.” Looking to the year’s final two quarters, Ankrim suggests that there are still surprises ahead, but that risk should begin to be rewarded as the remainder of the year rolls out.

That kid down the street is sure growing

"Patience and investment discipline are going to be the most valuable commodities an investor can have right now," said Ankrim. "The dramatic, and by some measures, unprecedented, run-up in oil cannot be explained by supply-and-demand dynamics. I am seeing a performance chasing mentality. Today's high oil prices seem suspiciously similar to the underweighting then overweighting of technology stock, REITs and offshore equities over the last twenty years. Investors need to stay diversified and avoid the temptation to react to short-term market volatility."

Revisiting his eight forecasts for 2008, Ankrim provided the following updates:

1. We'll move from meltdown to liquidity: Continued uncertainty and subprime write offs early in 2008 will likely give way to more transparency, and finally liquidity for structured investments. Some terrible pain aside, the markets should celebrate this development and the removal of the uncertainty as we head into the second half of the year.

Update: Stresses continue on financial institutions' balance sheets and in housing finance, but some transactions are taking place.

2. The "dead cat" won't bounce: Housing prices continue to decline through the first half of 2008. Although the size of declines moderates heading into 2009, with few exceptions, home prices show no signs of rising.

Update: The S&P/Case-Shiller Home Price Index year-to-date numbers through April have declined, supporting this forecast.

3. "Big stocks don't cry": Large, internationally diversified companies should continue to outperform their smaller, domestically oriented siblings in the U.S. equity market for the second year in a row.

Update: While the large caps, measured by the Russell 1000® Index, started the year with a slight advantage, small cap stocks, measured by the Russell 2000® Index, have won since the Fed's Bear Stearns intervention, mainly because the financial stress being felt has been harsher in large caps than small caps in the financial sectors.

4. Uncle Sam "cowboys up": Better trade numbers, continuing slower domestic growth, international investment in-flows, and expected monetary and fiscal restraint should put an end, for now, to dollar exchange rate declines.

Update: All these factors have been correct (save the expectation that the Euro Central Bank would have begun cutting its lending rate). However, the dollar has continued to decline due to the fact that, for the most part, the U.S. is currently weaker than the rest of the globe, which means we're more likely to have inflation problems than others, which in turn, puts pressure on the dollar.

5. "That kid down the street is sure growing": Tighter monetary policies begin to take their toll on developed economies (U.S. and non-U.S.). While this global slowdown takes some steam out of developing economies – their growth rates will likely slow only slightly.

Update: This has happened as forecast. If we look at 2007/2008, we've seen estimates range from 65 – 80 percent of growth in global production that comes from smaller GDP countries. Although the entire globe is slowing down in economic activity broadly, the U.S. is starting from a lower base.

6. "High prices = no inflation?" Commodity prices are likely to remain high, but both commodity and broader price level inflation should remain contained. Although some commodities show modest declines (e.g., oil stays under $100 for the year) few if any high costs are passed on through to the retail level as global competition continues to limit firms' pricing power.

Update: Oil futures climbed to $140 on June 30 and gasoline prices reached over $4.50 as many areas of the U.S. indicate. At the same time, core inflation hasn't accelerated yet. The run-up in oil prices was unexpected but the inflation numbers are as predicted.

7. "The sun will come out tomorrow": Optimistic outlooks for the economy in 2009 should cause earnings multipliers on equities to rise ahead of the anticipated positive developments. This would cause equity returns to approach the mid-to-upper teens even while '08 earnings grow at a slow pace.

Update: Consumer confidence is weak and demand for investment safety reigns; however, there are still six months left.

8. "We'll make it up on volume": While home prices remain weak, and despite continuing financing problems in early '08, homebuilder stocks could bounce back before the year is done. Declines in the price for land, material and labor would allow the market to see the end of a three-year tunnel for this group and valuations could improve dramatically by year end.

Update: The S&P Homebuilders Index was up 28% by April 3 this year. However, by June 30, the index had fallen dramatically, leaving the index down 25% year-to-date. This sector is quite volatile, but could still end the year much higher.

About Russell

Russell Investments provides strategic advice, world-class implementation, state-of-the-art performance benchmarks and a range of institutional-quality investment products. With more than $211 billion in assets under management as of June 30, 2008, Russell serves individual, institutional and advisor clients in more than 40 countries. Russell provides access to some of the world's best money managers. It helps investors put this access to work in corporate defined benefit and defined contribution plans, and in the life savings of individual investors.

Founded in 1936, Russell is a subsidiary of Northwestern Mutual Life Insurance Company and headquartered in Tacoma, Wash. Russell has principal offices in Amsterdam, Auckland, Johannesburg, London, Melbourne, New York, Paris, San Francisco, Singapore, Sydney, Tokyo and Toronto.

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Kerstin Parkel
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