Oil hitting $100 a barrel, the Dow falling 225 points in a day, political upheaval in Pakistan, a presidential election year and, of course, the great real estate plunge and credit crunch of 2007. It’s the kind of news that makes investors uncertain at best.

So, what’s the outlook for 2008? Where are the opportunities to grow and protect your wealth? Are the fears of recession overblown? Cincy asked several local experts to share their insights in a Q&A roundtable format.

The participants are: John Augustine, chief investment strategist for Fifth Third Private Bank; David C. Brooks, investment manager for Wealth Management Group of Park National Bank; Mark J. Busher, vice president and director of investments for PNC Wealth Management in Cincinnati; Rick Daeschner, audit principal for Rippe and Kingston, CO PSC; Philip C. Finn, first vice president, investments, and senior financial advisor at Merrill Lynch; Jason Jackman, director of fixed income for Johnson Investment Counsel, Inc.; Matthew McCormick, portfolio manager, Bahl & Gaynor Investment Counsel; Nicholas P. Sargen, chief investment officer, Fort Washington Investment Advisors Inc. (Western & Southern Financial Group); Garnet Wahlund, director of Cincinnati Investments Council.

It may be an understatement to say many people have anxiety about the American and global economic outlook. What kind of strategies are you advising to calm your clients’ fears?

AUGUSTINE: We believe that investors should be especially attuned to their outcome objectives as financial markets continue to be volatile in the face of credit market concerns, and as rising energy prices put combined pressure on the U.S. and other developed-market economies. This includes long-term growth investors using this pullback in stocks to add to the “growth” portion of their portfolios. which include emerging markets. Income-oriented investors can prudently diversify into corporate bonds, municipal bonds and preferred stocks that fit their risk tolerance. Clients oriented toward preservation of principal can consider short-term, high-quality corporate or municipal bonds, or cash equivalents — but understanding yields will be dropping. Volatility can create opportunity.

BROOKS: Diversification is typically stated by financial advisors as the key for an individual to build wealth. How to diversify correctly is the tricky part. Properly diversifying a portfolio for especially uncertain financial times such as these is a function of selecting asset classes which are “negatively correlated” with one another.

To put it another way, an individual needs to invest in asset classes which move opposite to one another, not in tandem. The asset classes which I suggest an individual investor select for the year 2008 are large multinational stocks, small-cap value stocks, intermediate government bonds, commodities with an emphasis on gold, international stocks with exposure to Asia, especially China, and real estate. These four assets can provide a solid return when properly blended together.

BUSHER: We are counseling our clients to avoid wholesale changes. We are educating clients that we invest to earn a return, and that returns are not linear. We are back to the basics of articulating risk and return objectives, and then prescribing an appropriate asset allocation.
DAESCHNER: A properly diversified portfolio should be able to weather the storm. Patience is also important, as timing the market is difficult to do. Individuals close to retirement should have a more conservative investment portfolio.

FINN: No one can predict what will happen in the stock market. We look at our client’s entire financial picture and use disciplines specific to each portfolio to help reduce risk and increase returns. We employ asset allocation techniques using stocks, bonds and cash equivalents based on the client’s goals. We also add investments that have a low correlation to the stock and bond markets to dampen portfolio fluctuations.
JACKMAN: We believe that the risks to the domestic economy are not fully reflected in the equity risk premium. Thus, we are advising clients to diversify a portion of their equity exposure into cash and fixed income. A substantial portion of our remaining equity exposure is directed toward international investments.

McCORMICK: We believe the U.S. consumer will focus more on needs versus wants as the economy slows. Thus, we think the best strategy is to invest in large, high-quality stocks that derive a substantial portion of their revenues from international operations and have a track record of earnings growth regardless of the economic environment.

Small caps underperformed large caps in 2007 for the first time in eight years. That trend should continue because small caps are traditionally reliant on U.S. economic growth. We also suggest under-weighting consumer discretionary stocks and over-weighting consumer staples.

SARGEN: Clients should establish a strategic allocation of stocks and bonds that they are comfortable with over the long term. We are maintaining allocations similar to current levels, as we believe stock and bond markets are fairly valued. Another important aspect is to be diversified in equity holdings by sector and geography. We believe an allocation of 15 to 20 percent in international equities is prudent.

WAHLUND: We align our strategies with the individual goals of our clients. We strive to build a diverse mix of investments with a flexible horizon. Exercising caution is part of this process to avoid experiencing the full volatility of the market. And reducing unnecessary risk certainly helps calm our clients’ fears.
 
For those who demand it, what kind of “safe haven” investing do you recommend? For example, is the peak for gold and other precious commodities anywhere in sight? What about the client who insists on dumping dollars for euros?

WAHLUND: Regardless of the market sector, education is an essential component of making sound investments. I provide and promote knowledge, but ultimately, if a client decides to pursue a less stable sector, I can only let them know they are opting for greater risk with less flexibility.

SARGEN: The best way to protect one’s portfolio in the current environment is by investing in high-quality bonds, as there is little risk of capital loss. Investing in commodities, currencies and gold could be risky if the global economy weakens in 2008.

McCORMICK: There is no such thing as a “safe haven.” But, there are some investments that are perceived to be safer than others. If a client is extremely risk adverse, I would recommend CD’s or short-term treasuries. However, this strategy also has some risk because these investments will not keep pace with inflation.

Commodities are sometimes viewed as a hedge against inflation or a harbinger of economic growth. And, it seems that commodities — especially gold and oil — have only gone up. The demand for gold and other precious commodities will continue as long as China, India, and other emerging markets maintain their torrid economic growth. Commodity prices may moderate slightly as U.S. economic growth slows. However, I do not anticipate gold at $400 or oil at $25 anytime soon.

Stocks have been, and will be, the best way to outpace inflation over the long term. A diverse portfolio of larger, high-quality stocks is probably the best investment for those investors who seek to surpass inflation and grow their portfolio with less volatility. These high-quality companies have many international components, and exposure to foreign currencies), and offer some insulation against further depreciation of the U.S. dollar.

JACKMAN: Bonds and cash are the ultimate safe haven investment classes for principal protection, income generation and protection from deflation. Commodity and non-dollar investments can provide valuable correlation benefits versus domestic equities for certain types of clients.

FINN: There are structured investments available that come with a guaranteed return of principal. These can be either tax-deferred or taxable depending on one’s situation.

BUSHER: If the markets of the last few months have taught investors anything, it is that there is no true “safe haven” investment. The treasury market, the “risk-free” asset, has exhibited volatility on par with that of equity markets. Several money market funds are on the verge of “breaking the buck,” so the risks of being too defensive may surpass the risks of maintaining a well-thought-out asset allocation.

BROOKS: I think the dollar will stabilize and even rise some in the near term. However the outlook for the dollar six to 12 months from now is still precarious. As far as “safe havens,” I like government bonds to appreciate in value as the overall stock market trends lower in 2008. I also still like the gold play; however, short-term, I think it comes under pressure. Late in 2008 I could see gold approaching a $1,000 an ounce.

AUGUSTINE: Safe-haven investing in volatile times is generally achieved by assets that have a maturity and very high credit quality. This can be achieved by Treasury, agency or municipal bonds, or CD’s — for savers. We would also advocate bonds rated AAA or AA in the corporate sector. The maturity of these investments would depend on the time horizon, and the risk-aversion of the individual investor.
We would not advocate moving into currencies or gold. The Euro has been the main attraction of investor interest, but is now arguably highly valued to the U.S. dollar, and fluctuates on a daily basis. Gold is a historical store of value, but has also seen a sharp increase in price to record levels recently.
Do you think we’re on the verge of a true recession in 2008, or just flirting with the edge of one?

AUGUSTINE: Though we fully understand the internal pressures on the U.S. economy, we remain with the belief that a recession will be avoided by a more aggressive monetary policy response, combined with overseas economic strength continuing to support U.S. exports — and supporting sagging corporate profits. However, if financial and credit markets don’t soon settle, if the price of oil stays over $100 per barrel, or if policymakers don’t come forward with more help, then U.S. economic growth could come to a halt.

Overall, we remain optimistic that moderate consumer spending and exports will support our domestic economy to be only in a “growth recession” early in 2008, and that the global economy will continue to move forward, led by emerging economies. In addition, we believe central banks in the slowing developed economies — like the U.S., U.K., EU and Japan — will act to defend their economies, as we have already seen rates being lowered in the U.S. and U.K. Long-term investors should use the high degree of pessimism in the initial stages of 2008 to diversify their portfolios to get ready for the potential opportunities 2008 will offer.

BROOKS: I think we will have a 50-50 chance of a recession in 2008. The financial sector is already in one, and in past recessions, financial stocks coming under pressure have hinted at a broader recession straight ahead for the entire economy. 

BUSHER: The U.S. economy is still flying, albeit barely above the treetops. Consumption is two-thirds of GDP, so the real key to staying out of recession is to keep the consumer spending. With unemployment hovering at 4.6 percent, the rationale is that an employed consumer will maintain a level of consumption to keep the economy just above stall speed. Employed consumers will also keep making their mortgage payments.

DAESCHNER: I believe we will not have a recession in 2008. This is due to the Federal Reserve cutting interest rates and continued growth in the global economy. Also, the economy remains rather strong, as there has not been a sharp rise in jobless claims. However, many economists predict a 40 percent chance of a recession.

FINN: The economy is divided. The consumer is facing mortgage problems as well as rising oil prices, which act as a “tax” on the consumer. Also, more and more taxpayers are facing the Alternative Minimum Tax (AMT), which results in more taxes being paid to the government.
On the other hand, many corporations are doing very well, especially those companies that export goods overseas. The weak dollar is helping their overall sales. With that said, Merrill Lynch’s North American economist, David Rosenberg, predicts there is over a 50 percent probability of a recession in 2008.

JACKMAN: If the economy is not already in recession, we believe it is likely to be in one by the first part of 2008. It is difficult to overstate the impact that the extension of credit has had on economic growth over the past several years. The subprime mortgage crisis has broadened into an outright credit crunch, weighing heavily on overall consumer spending capability. Although the decline may be small, we believe after an unprecedented string of 63 consecutive quarters of real consumer spending growth, the consumer will finally retrench to the point of economic contraction.

McCORMICK: Recession odds are rising. However, we feel strong corporate balance sheets and continued easing by the Fed should keep GDP growth positive. We are probably in a “mid-cycle slowdown” instead of a full blown recession.

It may feel like a recession to some as GDP and earnings growth slows to a trickle, costs continue to increase and the employment rate declines. However, the markets are forward-looking and usually about six months ahead of the economy. These mid-cycle slowdown periods have been positive for equities in the past and could actually be a great opportunity to move into high-quality stocks that have underperformed for the last several years and trade at reasonable valuations.

SARGEN: It’s a close call. We believe the risk of recession is about 40 percent, which is historically high. The most likely outcome, however, is a period of sub-par growth (1 to 2 percent) with strong export growth helping to offset weakness in housing.
WAHLUND: Factors are certainly pointing toward a recession, but how do we know for sure? The economists predict there will be one — and the banking and mortgage mess certainly set the stage. But it’s important to remember that, historically, three out of every 10 years have little to no growth, or have gone backwards. Assuming this pattern continues, the last four and a half years have been pretty strong, so there could be some setbacks over the next five years.
What effects do you see, in terms of investment portfolio decisions, from the declining dollar and the credit crunch?

WAHLUND: In this climate, I believe you’re asking for trouble by leaving all of your investments in equities. This is not a good time to focus on chasing returns or on market timing. I do not expect a lot of growth over the next three to five years, so the bond market should be strong. When making portfolio decisions, strategies centered on diversification will help the most.

SARGEN: The main risk now is a possible credit crunch that could tip the economy into recession. This environment argues for focusing on high-quality names. A weak dollar should benefit U.S. multinationals. The risk is a loss of confidence in the dollar that would trigger a rise in bond yields.

McCORMICK: Capital always goes where it is treated best. It is my judgment that investors will gravitate towards investments with strong international revenue streams and consistent earnings growth. Due to tighter lending standards, they will avoid smaller companies that are U.S.-focused, dependent on access to easy credit, and shun any companies that may have possible exposure to subprime investments.

JACKMAN: To mitigate the impacts of the macroeconomic environment, we have boosted allocation to cash and bonds and emphasized large, growth-oriented, multinational companies in our equity allocation. We are also significantly underweight in the financial stocks most impacted by the credit environment.

DAESCHNER: United States companies that export to foreign countries should benefit from the declining dollar. At some point, bank stocks will become attractive as a result of these stocks declining so much, as a result of the subprime mortgage fiasco and the housing market.
BUSHER: In this environment, investors should maintain a healthy allocation to international equities to hedge against a weak dollar. Additionally, domestic companies that derive a large share of earnings from abroad are a must for portfolios. Lastly, companies that don’t rely on the capital markets for funding should weather this dysfunctional credit environment well.

BROOKS: In terms of the credit crunch, I feel it is still too early to enter into owning financial stocks, however they are very short-term oversold, and could bounce some. Their value would be more enticing to me once further transparency is recognized with regards to their balance sheets. Given the overall lower trend for the dollar, I would be shifting assets to bonds and commodities early in 2008, and then shift those dollars back to equities using a dollar-cost average approach as equities move lower next summer, which I think they will.

AUGUSTINE: Think of the currency of a country as its stock price. The higher the value of that currency goes in relation to others, the more investors and businesses want to be in that country.
The Dollar Index fell 8 percent in 2007 to an all-time low for this 30-year old index. A lower dollar has several effects on an economy. It helps exports and overseas corporate profits repatriated to the U.S. It can increase inflation, as commodity prices and import prices move higher. It puts U.S. assets on sale to foreigners, with their stronger currencies. How Congress reacts to foreign buying of U.S. assets in a highly charged election year could affect financial markets. Credit is what drives capitalist economies. Without capital markets and banks providing credit, activity comes to a halt and prices move downward. In short, a credit crunch is deflationary and recessionary. Not good for Wall Street or Main Street.
Mideast and Asian banks are investing in U.S. and European financial institutions that suffered huge losses from the “subprime mortgage meltdown.” Is now a good time for your clients to invest more in these institutions, too? In the same sense, is now a good time to invest in devalued real estate?

AUGUSTINE: For individual investors, we believe there will be a time in 2008 to invest in financial sector companies, but we do not believe that time will come until market participants have a higher level of confidence that those “writedowns” have run their course. This could happen by mid-year if the Fed moves to a pro-economic growth policy and cuts its benchmark rate further. Currently, large institutions are moving into the financial sector, but often through the use of specialized preferred or convertible securities.
In addition, if borrowing costs move lower with the Fed, this could also create an opportunity to move the high levels of unsold home inventories in the U.S.

BROOKS: I think it is too early for financials and would stay away during the winter months. In terms of real estate, I like that play as we get later into 2008, as the stocks related to this area are looking ahead six to 12 months and will see light at the end of the tunnel before some investors do. Generally speaking, only speculators should venture into these arenas, however, for the downside risk exposure is still very high, relative to the possible return.

BUSHER: There is truly a tremendous long-term opportunity for investors in global financial institutions. The headlines of massive credit losses are obfuscating the profitability of diversified financials. Shaking out some of the weaker institutions is healthy and necessary for the global credit markets to return to functioning normally.

JACKMAN: We would not recommend investors move broadly into domestic or international finance companies at this time. Further substantial losses are likely for the fourth quarter and maybe beyond. However, some opportunities do exist in financial companies without direct exposure to investment losses whose valuations have been pulled down with the overall sector.

McCORMICK: It all depends on your time frame. Are Citigroup, Fannie Mae and Freddie Mac going to be around for five more years? My guess is: yes. Will housing eventually come back? Sure. However, that does not mean they are currently great investments or without risk. Nobody truly knows how or when the subprime debacle will be resolved. Fed cuts alone will not make these loans solvent. I would rather sleep at night, and avoid these and other stocks associated with subprime. I would also avoid devalued real estate until the current glut of unsold homes is diminished and demand increases.

Most investors will probably wait for more visibility before they buy these “investments.” My guess is “deep value” or “vulture” investors are starting to nibble at these banks that became greedy and made incredibly stupid loans to people who had no business buying homes. They are betting that the market has punished these companies enough. Current subprime fears are overblown, and they are buying these companies at substantial discounts. It is probably the same case with devalued real estate. You really have to do your homework, have a strong stomach, and a long time frame to invest in these currently distressed assets.

SARGEN: The sell-off in financial institutions probably has created some good long-term buying opportunities. That said, the more difficult task is identifying which institutions will recover; the lack of transparency makes that difficult to assess now, so we would hold off a while. Regarding real estate, we don’t see an improvement in residential housing until 2009. The best way to invest in distressed securities is to buy funds where managers have a proven track record in this area.

WAHLUND: I tell my clients there are two major guidelines for investing in financial markets or real estate: follow the buy low/sell high standard and know your risk threshold on the front end. In markets with no lateral movement, you have no place to go if the investment bottoms out, so you always want to have an exit strategy in place. Knowing when you should sell is critical.
The subprime mortgage mess, with global repercussions, has made more people aware of complex, multi-layered buying and selling of these bundled debts. Will this prompt more investors to seek more disclosure and transparency?

WAHLUND: I believe it will. But I also believe we need a little more common sense and a little less greed. Far too many people failed to read all of the forms when they signed their mortgage papers. But on the other hand, the banks and mortgage companies knew what they were doing. They extended millions and millions of subprime loans to people who couldn’t pay them and made records profits in the process.

SARGEN: We presume so. However, even with greater transparency, investors will need to do a better job understanding the risks of the underlying collateral and structures. Most importantly, they should know by now that they can’t rely on rating agency ratings alone to guide them.

McCORMICK: It already has. The market for subprime loans, collateral debt obligations — or CDOs — and collateral loan obligations — or CLOs — have simply gone away. Investors now believe all subprime loans are essentially worthless and have serious doubts about the solvency of “Alt-A” and “Jumbo” loans, as well.
Eventually, a loan’s value will be forced to be “marked to market,” meaning they are priced like any security — based upon its fundamentals, perceived risk and what the market will pay. They have been “marked to model,” where the investment house or bank estimates the loan’s worth based upon some theoretical valuation. These “mark to model” valuations are significantly optimistic and not based in reality. Warren Buffet calls this practice “mark to fantasy.” Many believe a massive reduction in these loan’s valuations is bound to occur. This will, of course, negatively impact these financial companies’ balance sheets and their stock’s price.

Banks have responded by tightening lending standards. Also, corporate spreads have widened. This makes it tougher and more expensive to get loans or capital, even when the Fed is lowering interest rates.

JACKMAN: Yes, we believe the current investment climate will lead to more transparency for investors. This is a distinct positive. A short-term negative of the current environment, however, is a sharp slowdown in the securitization process and the resulting dispersion of risk throughout the economy. Ultimately, securitization will return and be better and more transparent than before.

DAESCHNER: I think it will result in more disclosure. The subprime mortgage problem has resulted in people wanting more information as to where their money is invested. A lot of individuals have been investing in certain securities without knowing the associated risks.

BUSHER: I am not sure if this results in increased investor transparency, so much as investors increasing their risk premiums. Investors must and will demand higher levels of returns as they become more aware of the risks they are taking.

BROOKS: Yes, and it will be a good thing. Change is needed in this area and will be a benefit to investors long-term.

AUGUSTINE: Yes. It was investment banks, hedge funds and other institutional investors that bought much of the bundled debt. Not only will they require more transparency, but legislators likely will act to act force more transparency.
In that same vein, do you see a trend for typical investors, especially those with 401ks and similar retirement funds, to begin to question the value and safety of mutual funds, and the fees they charge?

AUGUSTINE: For the most part, mutual funds did a pretty good job navigating very treacherous fixed-income markets in 2007. We suspect these will continue to be the chief investment vehicle for 401k and IRA investors for the foreseeable future.

BROOKS: I think this is a stretch, for aside from some of the more complex CDOs and SIVs which the question above relates to, transparency is very good. The mutual fund industry does a good job with disclosures. Investors simply need to take the time to read all appropriate disclosures provided to them. So the need of more transparency should stop at the derivative level, and does not need to permeate further into other investment products.

DAESCHNER: Mutual funds remain an excellent investment choice for people to save for retirement. They allow for a diversified portfolio with limited funds. Fees are being questioned more and should be considered in evaluating mutual funds.

FINN: Mutual funds are attractive from the standpoint that an investor receives professional management and diversification by investing in them.

JACKMAN: Too many investors lack the information they need to be successful and tend to be trend followers, which can be a dangerous strategy. More disclosure and transparency would clearly be helpful to investors. To the extent investors begin to demand this information for their mutual fund providers, it is a positive thing.

McCORMICK: I doubt typical investors will question the value and safety of their mutual funds. They may question their results, especially if these funds have poor performance due to subprime exposure. Fees traditionally become more of an issue when investors become more sophisticated and involved with their retirement planning. Then they focus on returns, associated risks, costs, and alternatives like exchange traded funds (ETFs).

SARGEN: Investors are certainly better aware of risks in certain mutual funds than before. That said, it remains to be seen whether greater disclosure will ensure better decision-making by retail investors, who often chase past performance or high yields.

WAHLUND: It’s hard to say for sure because many employees do not have the information they need for a variety of reasons. In the retirement/401k market, the government is trying to help with initiatives like the recent “Pension Protection Act.” But the fact remains that employers are short on time and concerned with liability issues, so employees are often unaware of options that could save fees and potentially deliver better returns. We advise clients to bypass annuity-based 401k’s, which simply have to charge more fees, in favor of turnkey mutual-fund-based 401k’s. This option typically reduces fees and offers full disclosure.
To what extent do you think the presidential campaign year could affect equity and bond markets, and economies?

WAHLUND: If history can provide any indication of what lies ahead, we know that campaign years typically bring growth. We have a lot of factors to consider this time around, so proceeding with caution is prudent. There is a considerable degree of uncertainty that could affect the market.

SARGEN: The major issue that could affect equity markets is whether the program of Bush tax cuts will be allowed to expire in 2010 and be followed by tax increases. If equity investors anticipate this, the stock market could be vulnerable. Another major issue is whether the next administration will be more protectionist, which likely would be negative for financial markets.

McCORMICK: The market currently expects the Democrats to take control of the House, Senate and presidency. Most taxes will be increased if this scenario occurs, as every Democratic presidential candidate has vowed to increase capital gains, dividends, estate and, eventually, marginal tax rates to “pay for” additional spending. Additionally, free trade and pro-globalization are not popular topics at Democratic debates.

Investors may begin to react to a future Democratic administration earlier than November. This may cause some investors to sell stocks in order to reduce their taxes on capital gains. A recession in 2009 is likely if the Democrats succeed and subsequently raise taxes. Everything is up for grabs if the Republicans win the presidency or retain the Senate.

JACKMAN: On balance, we believe the presidential campaign rhetoric will be negative for the stock market. Talk of raising taxes on dividends and capital gains, if perceived to have a good chance of becoming policy, may weigh on the market. In addition, talk of raising the highest marginal tax bracket can have an impact on small businesses, which are responsible for a large portion of economic growth in America.
FINN: The presidential election cycle typically shows that the fourth year of a president’s term (2008) is a stronger-than-average period of performance in the stock market. In fact, according to the 2008 Stock Trader’s Almanac, the Standard & Poor’s 500 stock index has risen in the final seven months of every election year, except one, since 1950.

BUSHER: The fourth year of a presidential campaign t 
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