Equity Outlook for 2008

The fourth quarter of 2007 was a volatile one with broadly lower equity prices. Concerns swept through financial markets due to a broad downward re-pricing of riskier credit assets. Many financial companies were forced to write down large portions of their balance sheets amid investor concerns over housing-related debt. Additionally, the market expects a sharp drop in consumer spending due to continued declines in housing prices and pending resets in adjustable rate mortgages. Investors fear this will ultimately lead to a recession. As a result, the fourth quarter was negative for the domestic equity markets, led downward by Financial Services and Consumer Discretionary stocks -- two of the largest sectors in the S&P 500. Despite the weak fourth quarter, the market overcame significant headwinds and finished positively for the year.

Michael Pendergast, CFA
Chief Investment Officer,
Managing Director, Equity Investments

We expect the economy will avoid a recession in 2008. Although the market is already pricing in recessionary valuations, there are several forces that can prevent these expectations from becoming reality. Recent Federal Reserve and global central bank intervention has led to increased liquidity and lower interest rates, which should cushion the economy in the near to intermediate future; the Fed’s actions have shown its willingness to provide the U.S. economy with a soft landing. Additionally, while GDP growth should be stagnant through mid 2008, the second half of the year should show signs of recovery. US goods and services should experience greater overseas demand due to a weak US Dollar which will help offset economic weakness. Finally, there are no considerable signs of a widespread labor crisis, which is significant to consumer spending and confidence, thus we expect the consumer to be much more resilient than is widely expected.

HGK’s equity market outlook for 2008 calls for continued volatility in the near term and HGK is cautiously constructive on equities for 2008. Excluding the financial sector, corporate earnings should post a modest advance. Within the financial sector, it will take time for management to repair balance sheets and this difficult operating environment should result in limited growth prospects. Other sectors are poised to achieve modest earnings growth, especially those companies with significant foreign exposure that should benefit from a weak US dollar. Equity valuations within the large cap space are currently inexpensive. Large cap companies are still more attractively valued than small cap companies.

HGK is focused on companies with significant foreign exposure because they should see their revenue and earnings hold up relatively well in this environment. We are concentrating on those sub-industries, and companies that we expect to demonstrate above average revenue and earnings growth regardless of economic conditions. We continue to stress broad diversification among industry sectors, particularly given a period of heightened volatility. We continue to be bullish on the Healthcare sector, which is both attractively valued and positioned to post strong growth benefiting from demographic trends. Recently, we have increased our exposure to the Consumer Discretionary sector, as valuations are discounting near recession levels. At current levels these stocks are undervalued given even sub-par corporate performance. Any successes should lead to significant returns for the sector. While we were overweight in Energy for most of 2007, we have recently shifted our exposure to a slight underweight. Valuations have increased and earnings comparisons will be difficult. Finally, the recent share price declines in the Financial Services sector have made the group more attractively valued. Increased levels of loan losses and reserves, as well as the need to replenish their capital bases, will result in limited to no earnings growth. While the operating environment for these companies will be very difficult in the near term, the group appears to have little downside from current levels, even given limited growth prospects, and especially when buoyed by an accommodative Federal Reserve. HGK may look to selectively and gradually increase exposure to this sector as we move through 2008. As always, HGK will adhere to its value discipline.

Michael Pendergast, CFA
Chief Investment Officer,
Managing Director, Equity Investments