Market Review
Third Quarter 2011

Stock returns fell sharply during the third quarter after posting modest losses during the second quarter. Investors focused on the European debt crisis, disappointing U.S. economic data, and the political stalemate surrounding the U.S. debt ceiling. Quality bonds were a safe haven, and U.S. fixed income returns were generally good. The U.S. dollar strengthened against most developed and emerging market currencies, depressing returns of emerging market bonds and all categories of foreign stocks for unhedged U.S. dollar investors. Unhedged investments in bonds of foreign developed countries were barely in the black for the quarter for the same reason.

Equity Review

U.S. stocks fell across all asset classes during the third quarter. Investors' preference for large-cap stocks over their small-cap counterparts continued as investors became more risk adverse. The Russell 1000 (large cap) and Russell 2000 (small cap) indexes returned -14.7% and -21.9%, respectively, for the quarter. Growth stocks outperformed value stocks. The Russell 3000 Growth and Russell 3000 Value fell 13.9 and 16.6%, respectively, for the quarter. Finally, defensive sectors such as utilities and consumer staples were the best performers, falling 6.3% and 9.3%, respectively. Economically sensitive sectors such as energy, industrials, and materials plunged 21.8%, 24.6%, and 22.3%, respectively.

International stocks continued to underperform their domestic counterparts due to economic uncertainty, the ongoing sovereign debt issues in peripheral Europe, and the strengthening dollar. As in the first and second quarters, foreign developed countries stocks outperformed emerging markets stocks as concerns about inflation, the retreat of commodities prices, and other macroeconomic issues continued to reduce investors' appetite for the emerging market's growth story. The MSCI EAFE Index of developed countries and MSCI Emerging Markets Index lost 19.0% and 23.2%, respectively, for U.S. dollar investors. The results across developed regions were similar to U.S. stocks. In local currencies, the MSCI Europe Index fell 17.6%, the MSCI Japan Index declined 11.5%, and the MSCI Pacific Ex-Japan Index lost 15.1%.

As noted, the dollar strengthened during the quarter. It rose 5.7% versus 6 currencies tracked by the U.S. Dollar Index (euro, British pound, Canadian dollar, Swiss frank, Swedish krona, and Japanese yen). The greenback also strengthened 5.8% versus 25 emerging market currencies tracked by the MSCI EM Currency (USD) Index. For the quarter, currency losses amplified foreign stock losses for unhedged U.S. dollar investors.

Fixed Income

Fixed income performance was mixed for the quarter. The broad U.S. market, as represented by the Barclays Capital (BarCap) U.S. Aggregate Bond Index, rose 3.8% for the quarter. Quality (or the lack thereof) drove relative performance as investors sought "safe harbors" in U.S. Treasuries and agency bonds despite their low yields. Illustrative of the risk dichotomy, the Barcap Government Index and BarCap U.S. Corporate High Yield Index returned 5.9% and -6.1% for the quarter. The Barcap Long-Term U.S. Treasury Index soared 24.7%, mostly from price appreciation, as the 30-year Treasury bond yield fell from 4.38% to 2.90% over the quarter. Foreign bonds generally underperformed their domestic counterparts due to lower interest rate decreases coupled with currency losses. The Citigroup Non-U.S. World Government Bond Index (developed markets) and JPM Emerging Markets Bond Index of unhedged performance returned 1.0% and -2.1%, respectively, for the quarter.

Third Quarter 2011 and Nine Months Year-to-Date
Table of Stock and Bond Returns
     

Period Return to 9/30/11 *

 
      Third
Quarter 		  Nine Months Ending 9/30/11
U.S. Stocks
S&P 500 Index** -13.9% -8.7%
Average Diversified U.S. Equity Mutual Fund -17.9% -12.7%
Russell 2000 Index # -21.9% -17.0%
Sector Mutual Funds
Technology -16.2% -13.0%
Health -14.0% -1.1%
Communications -16.1% -11.1%
Financial -21.9% -22.8%
Real Estate -14.9% -6.6%
Natural Resources -24.1% -22.8%
Foreign Stocks
MSCI Europe, Australasia & Far East (EAFE) Index ## -19.0% -15.0%
MSCI EAFE Local Currencies -15.7% -15.6%
Average Diversified International Stock Mutual Fund -20.5% -17.1%
Regional/Specialty Mutual Funds
Europe -23.8% -18.9%  
Japan -8.2% -10.5%  
Diversified Pacific/Asia except Japan -20.6% -21.9%
Diversified Emerging Markets -22.8% -23.3%
Alternative Strategies
Average Long-Short Fund -8.5% -7.8%
U.S. Bonds
Barclays Capital Intermediate Gov't Bond Index*** 3.2% 5.4%
Barclays Capital Intermediate Credit Index ð 0.9% 4.2%  
Intermediate Municipal Bond Mutual Funds (National) 2.5% 6.3%
Intermediate Municipal Bond Mutual Funds (CA) 2.6% 6.3%
High Yield Bond Mutual Funds -6.6% -2.6%
Foreign Bonds
Citigroup Non-U.S. World Gov't Bond Index ### 1.0% 5.7%
J.P. Morgan Emerging Bond Index #### -2.1% 2.6%
       
* 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 $45.0 billion.  
*** Barclays Capital 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.  
ð Barclays Capital 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 $832 million.  
## International stock index indicating return of large foreign companies of 21 major developed countries (Japan, UK, and Germany have the highest weightings). Returns are converted to U.S. dollars. No emerging market stocks are included.  
### Citigroup 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.  
#### J.P. Morgan index of total return of debt instruments issued by 13 emerging markets countries (Argentina, Brazil, and Chile have the highest weightings). Returns are converted to U.S. dollars.  
   
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