Fourth Quarter 2005 Market Review

November’s strong run up in stocks helped mutual funds to modest fourth-quarter returns despite Wall Street’s December malaise. International funds led the list of top performers for both the fourth quarter and the year. Specifically, the surge in the Tokyo stock market in December helped Japanese funds post significant returns during the period. On the fixed income front, U.S. and foreign bonds had weak results. Also, the fourth quarter saw an inversion of the benchmark Treasury curve in which the two-year note yielded more than the 10-year note – the first such occurrence in ten years.

Equities Review

During the fourth quarter, U.S. stocks gained about 2%. Within this return, materials stocks were among the best performers, as gold topped $500 per ounce. Meanwhile, financial stocks rose approximately 7% behind strong earnings reports from of the major financial service companies. On the other hand, energy slipped 8.5% as investors began to take profits and speculate on a leveling of energy prices. As was true for the full year, there was not much difference between the growth versus value or the small versus large segments of the market.

Foreign equities (both developed and emerging) gained about 7% in local currencies. Within the MSCI EAFE Index of large, developed country companies, there was some giveback in the energy sector while financials and materials did rather well. Foreign technology stocks also rose sharply (+15% on average) due in large part to gains from Japanese high-tech companies. Again, for U.S. investors, the rise in foreign developed markets was partially offset by the rise in the U.S dollar, which gained .7% during the period versus 19 currencies tracked by the J.P. Morgan Dollar Index. Appreciation versus the Euro, the Japanese Yen, and the British Pound was considerably higher and ranged from 1.5% to 3.9%. As a result, dollar-based developed country returns were reduced to 4.1% for the quarter.

In many emerging markets, wealth generated by commodity exports is helping to fuel economic growth and lift many non-commodity stock market sectors as well. Because the dollar did not appreciate on average against emerging market currencies, dollar based returns of about 7% matched those in local currencies.

Fixed Income Review

During the fourth quarter, U.S. bonds returned 0.6% as measured by the Lehman Brothers Aggregate Bond Index. The Federal Reserve’s Open Market Committee continued its series of interest rate hikes, to the extent that short-term rates were actually higher than longer-term rates: the inversion noted above. Within the bond market, higher-quality and shorter-duration bonds modestly outperformed lower quality and longer-duration bonds. For example, investment grade corporate bonds lagged Treasuries by about 30 basis points (.3%). Finally, the foreign bond markets fell, as evidenced by the Citigroup Non-U.S. World Government Bond Index, which indicated developed country bonds declined 2.6% during the quarter. This result was driven primarily by the rise in the U.S. dollar and mostly flat foreign yield curves. As was true for much of 2005, emerging markets' bonds offered rather strong returns during the fourth quarter.