2007: The Year of Living Dangerously

Last year will be remembered for many things, but calm investment waters won't be one of them.

One reason is that 2007 witnessed the widest range of performances among the major asset classes since 2000. On top was emerging market stocks, which soared by 36.5% in 2007. At the opposite extreme were REITs, posting a loss of 17.6% - the first down year for the asset class since 1999.

The spread from best to worst last year was a hefty 54 percentage points - the widest since 2000, proving once again that there's always plenty of opportunity (and risk) inhabiting the investment landscape in terms of the broad asset classes.

The fact that REITs finally succumbed to the laws of gravity after seven straight calendar years of gains may or may not signal what's coming in 2008. But if you compare the steep slide in REITs last year against the five-year bull market in emerging market equities that's still ongoing, one can see the outline of a rebalancing opportunity.

Then again, it's probably too early to make hasty, dramatic decisions for portfolio strategy. REITs, after all, defied gravity for seven years. The hope that they're now poised to rally after just one down year may be asking too much. Nonetheless, as a long-term proposition, taking a bit away from emerging markets and redeploying it to REITs looks eminently reasonably, at least at the strategic margins.

Still, your editor expects that additional bargains among the asset classes will surface as 2008 unfolds and volatility continues to rise. The crowd isn't sure if deeper economic troubles are coming, and so the odds for surprises look pretty good.

A BRIEF HISTORY OF TOTAL RETURNS AMONG THE MAJOR ASSET CLASSES

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Meanwhile, we can't help but notice a few intriguing trends that present themselves at the dawn of a new year. That includes the fact that commodities are also boasting five consecutive years of gains. This is the same for domestic stocks and equities in developed nations around the world. Who's willing to bet that all three will make it six in a row?

Alas, the recurring problem of recent years remains intact, namely: What looks attractive? Other than REITs, nothing was clobbered last year, and so there's plenty of debate as to which asset classes, if any, are poised for greatness in 2008.

That said, we're keeping our eyes on high yield bonds at the moment, in part because the asset class's yield premium over the benchmark 10-year Treasury is close to 500 basis points, which is the highest since 2003. Granted, that spread may not suffice if the economy goes into a recession this year, and junk defaults shoot up.

Perhaps the biggest challenge this year will be the declining yield in cash. Investors are no longer "paid to wait," and so the pressure's on to invest somewhere. As 2007 faded into the history books, our proxy for cash - the 3-month Treasury bill - only offered a yield of 3.36%, and is down sharply from 5.02% a year earlier.

Nonetheless, 2008 looks set to deliver opportunity for the savvy investor who's prepared to ignore the crowd. No, it won't be easy, nor will gratification come quickly. Indeed, winning the money game in the long run usually requires decisions with limited mass appeal in the short run. How many investors are willing, and able to endure such discomfort? If history's our guide, then relatively few. Therein lies opportunity.

With that in mind, bring on 2008!