Third Quarter 2008 Market Review

We’re providing an abbreviated review mainly because the sharp drop of the prices of global equities in early October has considerably overshadowed summer quarter results. After breakeven returns for the first two months of the quarter, U.S. stocks began a steep, broad decline in September which then accelerated in October. Stock prices in foreign markets weakened all quarter in line with deteriorating credit and economic news and the U.S. market sell-off, but were hurt further by currency losses due to a strengthening U.S. dollar. Unlike the typical bear market, 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 with the exception of U.S. governments as investors exhibited extreme risk aversion.


Equities Review

U.S. equities were down sharply for the quarter; the S&P 500 Index lost 8.4%. Negative returns were generally experienced across all styles, sectors and capitalizations. Real estate, finance, and health care were the exceptions, exhibiting either defensiveness in a classic sense or an oversold situation from prior quarters. U.S. small-cap stocks moderately underperformed large-caps, somewhat reversing prior quarterly outperformance and reflecting the perceived higher quality and safety of larger companies in tough economic times. The worst performing sectors by far were energy and other commodities. Both were affected by decreasing demand by consumers due to the global economic slowdown and previous bubble-like prices which also deterred consumption. As measured by funds’ results, natural resources lost 32.4% for the quarter.

Foreign stocks declined broadly and deeply as well. Unlike earlier years and the first quarter of 2008, 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 appreciated significantly, up about 6.0%, 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 13.6% in local currencies but a worse 20.6% in U.S. dollars. Emerging market currencies also weakened. The MSCI Emerging Markets Index returned -21.6% in local currencies but a worse -27.6% for the quarter in U.S. dollars.

Fixed Income Review

De-leveraging and the flight to quality were negative for most categories of bonds. The Lehman Brothers U.S. Aggregate Index returned -0.5% for the quarter, which was relatively strong compared with other bond indexes because it is heavily comprised of U.S. government bonds. Yields spreads rose across the yield curve as investors priced in higher rates to counter increasing crisis-related default risk. Lower-quality bonds had a particularly difficult quarter, losing 8.2% as measured by fund returns. Foreign bonds also declined during the period due primarily to currency losses reflecting the strengthening of the U.S. Dollar.