2007 turned out to be tumultuous year of transitions as greed got swept away by fear in the midst of a subprime meltdown that marked the abrupt end of an economic boom powered by an era of cheap credit, innovative financing and price stability. Despite numerous warning signs that a crisis was imminent, investors chose to not heed those signs and some ended up paying a very high price.
In this toughened environment of cash shortages, tighter lending standards and commodity led inflation, homebuilders and financials suffered most, the former as a result of a huge and growing backlog of unsold homes and the latter as a result of huge exposure to toxic subprime paper. The consumer discretionary sector was next in line as fear spread to households, prompting consumers to hold back on nonessential purchases, squeezing profit margins already hit by rising raw material prices.
A rapidly deteriorating economic environment prompted central banks to intervene on several occasions, injecting much needed liquidity into the system. The calming effect was temporary, however, as the root problem was not being addressed.
As signs and anticipation of a marked economic slowdown hit the U.S. the decoupling theme gained importance as the rest of the world did not show any signs of weakness. Emerging markets in particular, benefiting from stricter monetary and fiscal discipline, large foreign reserves, foreign direct investments and the formation of a distinct middle class, seemed somewhat more resilient and less dependent on the gyrations of the U.S. business cycle.
The current economic crisis, like many before it did produce opportunities. The lack of transparency in subprime related mortgage backed securities and growing fear of inflation and that the market was heading for a recession prompted investors to seek the safety of treasuries and inflation protected securities, sparking a huge rally. On the equity side, sectors such as healthcare, consumer staples and information technologies also thrived for different reasons.
On the currency front, the dollar's value kept eroding, hit by the economic deterioration and anticipation of greater divergence in interest rate differentials.
