First Quarter 2002 Market Review

The American economy showed very good resilience, and many economists are increasingly optimistic.  Nonetheless, U.S. stocks struggled in the first quarter.  Good news on the economy was offset by such diverse concerns as hostilities around the world and the quality of reported corporate earnings. Non-U.S. economies remained weak, and non-US stock markets were mixed; developed international stock markets were flat generally, but emerging markets rose sharply.  Finally, U.S. mid- to long-term interest rates rose in response to the pick-up in economic activity, so that bonds also offered lackluster, mixed results for the quarter.  The table on the other side of this page summarizes data for the quarter (reviewed below) and past 12 months.

Equities Review

Reflecting increased investor conservatism, U.S. stock prices took a breather after a strong run-up in the fourth quarter of 2001.  The mixed results included weak performance of large capitalization, blue chip stocks, which dominate market indexes such as the S&P 500, Nasdaq, and Dow Jones Industrials, and hid solid performance by stocks of many smaller companies.  Additionally, shares of cyclical and inflation-sensitive companies, such as those in the consumer, basic materials, and energy sectors, rose during the quarter because of evidence of a recovering economy.  Gold and real estate assets performed particularly well given the renewed concern about inflation.  On the other hand, the higher-tech sectors traded lower after having risen so quickly during the fourth quarter.

International equities offered positive returns, although U.S. investors in foreign markets again were negatively impacted by appreciation of the U.S. dollar.  Against 19 currencies, the dollar appreciated .7% for the quarter.  Local currency returns in developed markets were about 2%, and the MSCI EAFE Index provided a quarterly gain of 1% in U.S. dollar terms.  Most of Europe’s markets were about unchanged, and many of the best performing countries were in the Asia ex-Japan region.  Emerging equity markets, meanwhile, soared behind renewed confidence about a global economic recovery as well as increased demand for the commodities and raw materials that many of these countries provide.  The MSCI Emerging Markets Free Index jumped almost 12%, in both local currencies and U.S. dollars.

Fixed Income Review

The developing strength in the domestic economy had a mixed influence on the U.S. bond market.  The speed of the recovery and the subsequent rise in commodities prices resulted in an upward shift in the yield curve.  Longer-term rates rose by about 0.40% (40 bps) to reach their highest levels in almost a year.  The lower bond values due to the increase in rates largely offset the interest yield so that the total return from taxable bonds was miniscule. The Lehman Brothers Government/Credit Index fell for the first time since the fourth quarter of 1999.  The improvement in the economy helped the relative performance of credit bonds, which outperformed Treasuries by almost 50 bps.  High yield bonds did especially well, outperforming Treasuries by over 200 bps.  Municipal bonds managed small positive total returns of .7% as measured by returns of mutual funds buying municipals nationwide.

Interest rates also rose outside of the U.S. with most markets reporting upward shifts in their yield curve of 25 to 50 bps.  While each country’s economic outlook varied, most developed markets remained concerned about inflation, particularly in response to the spike in energy and commodity prices.  Local currency returns were negative for almost every foreign government bond index.  The decline in most developed currencies versus the U.S. dollar resulted in even worse performance for U.S.  The Salomon Brothers World Government Bond Index decreased slightly in local currencies, and declined in dollar terms 1.9% because of depreciation of major foreign currencies versus the U.S. dollar.

* Mutual fund return data are from Morningstar.

**      Capitalization-weighted index of 500 very large U.S. companies.  The 500 are chosen to achieve a fair cross-section of U.S. industrial and service sectors.  Recent median capitalization of approximately $61 billion.

***     Lehman Brothers index of U.S. Treasury bond total returns (i.e., interest plus or minus change in

       price).  Bonds in index have intermediate maturity of about 4-7 years.  No mortgage-backed securities included.

d               Lehman Brothers index of U.S. investment grade corporate bond total returns (i.e., interest plus or minus change in price). Bonds in index have intermediate maturity of about 4-7 years.

#      Index of small U.S. companies.  Recent median capitalization of approximately $930 million. 

##      International stock index indicating return of large foreign companies of 20 major developed countries (Japan, UK, and Germany have the highest weightings).  Returns are converted to U.S. dollars.  No emerging market stocks are included.

###      Salomon Brothers index of total return of foreign government bonds issued by major developed foreign countries (Japan, Germany, France, and UK have the highest weightings).  Returns are converted to U.S. dollars.

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