Second Quarter 2008 Market Review

Financial markets first rose, then fell precipitously over the second quarter. Equities declined significantly across all market capitalizations and sectors in both U.S. and foreign markets. Unlike last quarter, most bond sectors did not prove to be the safe haven of positive returns generally sought by investors during challenging equity markets. Bond returns were predominantly negative though not abysmal. The Fed maintained its fed funds and discount rates during the quarter after aggressively lowering rates through the first quarter. The U.S. dollar stabilized and slightly strengthened based on U.S. export strength, the Fed’s cessation of its rate reduction program, and growing economic weakness overseas, especially in Europe.

Equities Review

Global equities advanced sharply from April through mid- to late-May, then dramatically retreated; returns varied greatly across styles, sectors and capitalizations. U.S. small-cap stocks outperformed large-caps for the first time since the first quarter of 2007 as the Russell 2000 Index of small cap stocks returned .6% and the S&P 500 Index of large cap stocks declined 2.7%. Growth stocks significantly outperformed their value counterparts, which were weighed down by their financial exposure. The Russell 3000® Growth Index returned 1.5%, while the Russell 3000® Value Index dropped 5.2% for the quarter. Performance varied notably by sector, with energy, utilities, materials, and technology stocks returning 20.4%, 7.7%, 5.8%, and 2.8%, respectively. The worst performing sectors were financials, consumer discretionary, industrials and consumer staples which returned -16.6%, -8.1%, -6.9%, and -5.5%, respectively. As measured by funds’ results, natural resources returned 19.3% while real estate declined 6.9%.

Foreign stocks declined as well with returns similarly varying greatly by style and sector. Unlike recent quarters, broad-based dollar weakness did not occur, and as a result, returns in local currencies did not benefit when converted into U.S. Dollars. The U.S. dollar was essentially flat, up a modest .5%, during the quarter versus 19 mostly developed country currencies tracked by the J.P. Morgan Dollar Index. The MSCI EAFE Index of foreign developed markets declined 2.3% in U.S. dollars. Weakness was spread throughout Europe and most of Asia, but Japanese stocks rebounded after experiencing a dismal first quarter. The MSCI Emerging Markets Index returned -0.8% for the quarter in U.S. Dollars and exceeded local currency results to some degree due to some continued dollar depreciation.

Fixed Income Review

Bonds also declined at the start of the quarter, before partially rebounding in June. The Lehman Brothers U.S. Aggregate Index returned -1.0% for the quarter. Returns also varied across sectors and quality. Lower-quality bonds bounced back from a difficult first quarter, while higher-quality and international fixed securities reversed course from the prior quarter, experiencing losses. Yields rose across the yield curve, particularly on the shorter end of the curve, as investors priced in higher rates to counter increasing inflation expectations. Partly offsetting, yield spreads contracted as bargain-hunting investors returned to riskier assets. Foreign bonds also declined during the period due to a combination of modest strength in the U.S. Dollar and the anticipation of interest rate hikes from the European Central Bank to fight inflation.