After three difficult years for the economy and equity markets, Wall Street found itself contending with war in Iraq and other international uncertainty (e.g., North Korea, SARS). Waiting dominated the market mood, but just beneath the surface has been the fear of being left behind, which contributed to short, sharp moves in the market over the last quarter. With war worries at the front of investors' minds, stock prices fell, resulting in a 3.2% decline in the Standard & Poor’s 500 stock index. Non-U.S. economies remained weak, and non-U.S. stock markets also declined. The long bull market in bonds lost momentum, but bonds still managed positive returns for the period. The table on the other side of this page summarizes data for the quarter (reviewed below) and past 12 months.

Equities Review

Although the year opened on notes of optimism, with stock market gains in early January, those hopes faded as the U.S. marched toward war. The Dow Jones Industrials fell 3.6%, about in line with the 3.2% decline in the S&P 500. While markets generally struggled, some sectors and stocks recorded gains. Technology shares and some Internet stocks enjoyed a quiet rebound after exhibiting sharp losses for most of the past three years. Their rebound produced a positive return of .42% for the NASDAQ Composite. Health and real estate specialty funds provided modest positive returns. Large-cap growth funds outpaced large-cap value and small-cap portfolios. Overall, the average diversified U.S. equity mutual fund lost 3.4%, a bit worse than the S&P 500.

Overseas markets experienced volatility and weakness in the first quarter of the year, generally drifting lower in the first two months and then surging in the beginning of March, only to decline again by the close of the quarter. The U.S. dollar lost value against other developed country currencies, ending the quarter down 3.4% versus 19 currencies tracked by the J.P. Morgan Dollar Index. In spite of considerable currency gains for U.S. investors, the MSCI EAFE Index experienced a quarterly loss of 8.2% in U.S. dollar terms.

Fixed Income Review

The flow of investor funds for the quarter was erratic, mirroring the wild swings of stock prices, but overall remained heavily in favor of fixed income investments. After an interlude in the fourth quarter of 2002 when stock funds outperformed bond portfolios, fixed income funds again pulled ahead in the first three months of this year. U.S. taxable bond funds returned an average of 2.1% for the quarter. The Lehman Brothers Intermediate Government/Credit Index exhibited an overall increase of 1.5%. Yields from U.S. Treasuries, the world’s safest investments, fell modestly over the quarter and reached four-decade lows as investors flocked to government securities amid the global debate preceding the outbreak of war. All of the spread sectors offered positive excess returns (returns over Treasuries) during the first quarter; corporate bonds, especially those rated below investment grade, were particularly strong. High-yield bond funds had a 5.4% average return in the first quarter, their second strong quarter in a row. The average return for intermediate-term municipal funds was a modest .9% for the quarter, reflecting investor concern about budget woes, California being just one example.

The Salomon Brothers Non-U.S. World Government Bond Index rose 2.8% in U.S. dollars during the third quarter.  The lower gain in non-U.S. bonds relative to the U.S. market was a function of more benign rate drops in other countries and a negative return from Japanese bonds because of the dollar's strength.