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R. Kevin O’Keefe, CIMA®, AIF® | Chief Investment Officer
Investors looked to 2008 for a fresh start following last year’s disappointing finish. But instead, the average U.S. diversified stock mutual fund turned the worst quarterly showing since the bear market of 2000–2002.

The average U.S. diversified stock fund lost 10.6% in the first quarter of 2008, according to Lipper Inc. That was worse than the 9.4% loss for the S&P 500 Index. International stock funds did not perform much better.

The U.S. stock market has now declined for five consecutive months despite repeated efforts by the Federal Reserve to lower borrowing costs and stimulate lending activity. The possibility that there may be more mortgage-related write-downs still ahead for the financial sector is weighing heavily on investors’ minds.

With stock fund losses so universal, the quarter was a sobering reminder of the value of bonds and money-market funds to help cushion the downside. Most investors can tolerate the volatility of a balanced portfolio. Portfolios invested entirely in stocks, however, are much harder to stick with during the bad times.

The current financial crisis has been compared to 1990–1991. That period also was characterized by massive layoffs on Wall Street and high anxiety about the stability of the banking system. Savings and loans were failing everywhere, and real estate prices slumped badly.

How did the stock market behave? Stocks bottomed in October 1990, which, we later learned, was the low point of the recession. The S&P 500 Index soared in November and never looked back. By the time the recession itself ended in April 1991, the Index had posted a 25% gain over a five-month period.

We are not blind to the risks in owning stocks, and we are not forecasting clear skies ahead. Jobs data, sagging consumer confidence, high energy prices, and the weak housing market are real problems. Despite the attention given by the nation’s business and political leaders, solutions may be elusive. And, past performance is no guarantee of future results.

But the stock market often pleasantly surprises. Case in point: There have been only six times in the past that the S&P 500 declined for five consecutive months. In those previous six such declines, the total return for the S&P 500 over the subsequent 12 months averaged 18.1% and, in three of the six instances, returns exceeded 30%. In only one instance was the index lower 12 months later.

The biggest rallies usually come when the outlook is bleakest. Yes, we just endured a terrible quarter. We could have said the same thing in October 1990 and at other times when the stock market was on the brink of a big rally.

Kevin O’Keefe serves as First Affirmative’s Chief Investment Officer. He is responsible for due diligence and monitoring of mutual funds and separate account managers, and leads First Affirmative’s Institutional Consulting Services Group.

Kevin O’Keefe serves as First Affirmative’s Chief Investment Officer. He is responsible for due diligence and monitoring of mutual funds and separate account managers, and leads First Affirmative’s Institutional Consulting Services Group.