The global stock market rout that was “made in China” has gotten a bit of a reprieve of late but I believe the rapid descent of
markets here and abroad is still causing jitters. We saw more of that today.

Either way, the bottom line for us is that very little of a fundamental
nature has changed—either in terms of the markets and the economies
here and abroad, or in terms of corporate earnings—that we didn’t already know was happening months ago: the fact that we’re
seeing a slowdown across the board.

That doesn’t mean recession.

It simply means a slowing. You don’t go from 40 miles per hour in a car straight into reverse. (If you did, you’d probably drop
your transmission—or worse, and that’s called a wreck.) You slow down. But a car that was going 40 and slows down can still roll
forward for a very long time. I think the economy is going to continue to roll ahead, though the occasional speed bump is going to take some
momentum out, and unless we see a reason to push down on the gas or come to a downhill, we’ll just mosey along for a while.

Is it possible the economy could speed up again? Absolutely. One thing that could do that would be rebuilding of inventories. Inventory depletion
was one reason fourth-quarter GDP was so punk. Rather than build more stuff, companies sold what they had on the shelves. They may still be
doing that now, as the first quarter of 2007 doesn’t appear to be picking up much momentum. But eventually, inventories must be replenished,
and we might just see that happening in the next quarter or two.

The five-day selling spree that ended with last Tuesday’s rally had some nasty repercussions for some Vanguard funds. Precious Metals & Mining lost
11.1%, as there was no flight to the supposed safe haven of gold, but rather a flight away from most commodities and precious metals. Emerging
Markets Index was down 10.5% over the period, and REIT Index dropped 8.5%. Small stocks were big losers, and big stocks were smaller
losers. But of course, everything went down.

Despite recent rallies, it could go down again. As I’ve said, I would not be at all surprised by a 10% decline from the market top,
which would put the Dow at about 11,500 and the S&P 500, which has yet to surpass its March 2000 high, at about 1,315 or so. Of course,
we’re not very close to that right now, so I’d expect continued big swings, meaning more of the volatility that we hadn’t
seen for a long time until just this past week or so.

Why You Need to Diversify Overseas

I want to comment briefly on the now increasingly common thought that international diversification is losing its oomph and that, because
global markets are operating in such lockstep, it almost doesn’t matter if you diversify overseas or not. Hogwash! While the day-to-day
market moves, particularly of late, have seen quite synchronous movements between Asian, European and U.S. markets, and over long, long periods
it’s also clear there’s greater correlation, the fact is that the correlation between foreign and domestic markets has actually
decreased over the past few years when looked at it on a rolling three-year, or 36-month, basis.

Just take a look at Total Stock Market and Total International Index. Over the past three years, these two funds’ correlation
has run about 60%, which is significantly less than it was in mid-2005, when the markets were much more closely correlated. Over the past five
years, the same broadening benefit of diversification can be seen. It’s when you look over 10-year periods that you can see how markets
have become more closely correlated. But even then the correlation has moved to about 65%, not nearly 100%.

What this means is that you and I can benefit from diversification overseas when markets are not correlating, and will benefit less when they
are moving in greater lockstep—and we can adjust our allocations to these markets over time to take advantage of the shorter-term phenomenon.
In fact, that’s what we’ve done with our foreign investments, taking less risk and earning greater returns over time than simply
plugging our money into a Total Stock Market or 500 Index type of fund.