August 2006 Investment Report
The markets rebounded in August after Israel and Hezbollah agreed to a cease fire, ending a month of violence. The markets worried that the conflict would affect oil supply if the violence began to affect other countries in the oil-rich region, particularly Iran, OPEC's second-largest oil producer and a backer of Hezbollah. Those fears raised crude oil to a record price of $78.40 a barrel on July 14, two days after the fighting started. Crude oil settled at $69.19 a barrel by the end of August.
The markets were tested when British Petroleum (BP) announced it was shutting down 16 miles of Alaskan pipeline for repairs. The pipeline accounts for 8% of U.S. oil production. Oil prices settled when BP later announced that it would be able to maintain half of its production and the repairs would not take as long as originally planned.
Fears of the season's first hurricane, Ernesto, subsided after it veered away from Gulf Coast oil refineries and was downgraded to a tropical storm. Weather forecasters are now predicting a milder hurricane season than originally expected. This means gasoline supplies should not face the same interruptions that drove up prices last year due to Hurricanes Rita, Katrina and Wilma.
The Federal Reserve leaves a key interest rate at 5.25% after …
… seventeen consecutive interest rate increases stretching from June 2004 through June 2006. The Federal Reserve has raised rates from a 46-year low of 1% to the current 5.25% in an effort to slow the economy enough to keep inflation under control. This was big news for the markets, as investors began to believe the Federal Reserve may be ending its rate hike campaign. The Federal Funds Rate, the overnight rate banks charge each other, stands at the highest point in more than five years. Higher interest rates slow borrowing and help moderate economic growth.
Home sales sluggish in 28 states …
… and are down 7% nationally, led by big drops in Arizona, Florida and California, states that had been enjoying red-hot sales during the housing boom of the previous five years. Sales of previously owned homes plunged to the lowest level in 2½ years, as the inventory of unsold homes climbed to a new record high. Construction of new homes fell to the slowest pace since November 2004. Economists watch the housing sector closely because it includes a number of key areas, including construction, mortgage lending, lumber, and makers of materials and supplies used in building homes. Economic observers are very concerned about the potential economic impact of the slowdown in home sales and home price appreciation. Many are concerned that the slowdown could adversely impact the U.S. and world economies.
Core inflation slowed in July …
… rising by just 0.2% after four straight months of 0.3% gains. Core inflation excludes food and energy and is the indicator most closely watched by the Federal Reserve. However, the Consumer Price Index, a key measure of inflation that includes food and energy, rose by 0.4% last month, double the 0.2% increase in June. Wholesale inflation was up by the smallest amount in five months in July, as falling food prices helped offset another rise in energy costs. The Federal Reserve will monitor inflation numbers carefully to determine if future interest rate hikes are needed.
Food service company Aramark was purchased …
… by a group of investors led by its chairman in a deal worth $6.3 billion. The deal continues a trend of public corporations being bought by private investors possibly indicating confidence these investors have in the economy.
Wal-Mart posts its first profit decline in a decade …
… as the world's largest retailer was forced to pay a hefty price for withdrawing from Germany, selling its stores there at a loss to a rival. Lower sales due to high gas and energy prices affecting customer pocketbooks were cited for the decline. The last time Wal-Mart saw quarterly profits fall was in 1996.
For the first time this year, all of the General Board's funds ended the month with positive year to date performance results. All of the funds offered by the General Board advanced more than 1% in August with particular strength in the funds that have exposure to the stock market. Additionally, the funds generally performed favorably compared to their performance benchmarks.
The Inflation Protection Fund (IPF) added additional gains to those earned in July with a 1.1% increase in August, but significantly underperformed its benchmark return of 1.8%. Interest rates declined as the prospect for continued Federal Reserve interest rate increases diminished. With the retreat of oil and other commodities prices, however, the fund's 10% exposure to commodities impaired performance compared to the benchmark. For the year, the fund has advanced 2.0% after the payment of investment management and fund administration fees. This result is 0.3% better than the fund benchmark return of 1.7%. Despite the August retreat in commodities prices, the fund's exposure to commodities has been additive to performance.
The Domestic Bond Fund (DBF) advanced 1.8% in August and exceeded it performance benchmark by 0.2%. The excess performance in August was attributable to the fund's exposure to emerging market debt denominated in local currency and the fund's less than market weight in U.S. Treasury securities. Bonds possessing exposure to credit risk performed better than U.S. Treasuries in August. For the year, the DBF has produced a positive 3.3% return and has meaningfully outperformed its benchmark return of 2.1%. The primary contributors to this excess performance is the aforementioned performance of the fund's emerging market debt strategy and the fund's contribution from international bonds denominated in currencies other than U.S. dollars. The dollar has continued to weaken this year.
The Domestic Stock Fund advanced 2.6% in August and outperformed its benchmark by 0.2%. The major factor contributing to the fund's excess performance is the portfolio's exposure to companies expected to grow earnings at a rate faster than the overall economy. When the fund's exposure to the various economic sectors is aggregated, the fund has a larger than market exposure to technology stocks and a smaller than market exposure to energy stocks. While this exposure has generally detracted from performance in 2006, energy stocks underperformed the broad market in August as a result of declining oil prices. For the year, the fund has gained 5.8% which very slightly exceeds the performance of its benchmark. The aforementioned underweight of energy stocks and overweight of technology stocks has impaired performance but is offset by the excellent returns of the fund's real estate investments.
The International Stock Fund advanced 3.1% in August and surpassed its performance benchmark by 0.3%. The excess performance is attributable to the fund's larger than market exposure to stocks from lesser developed (emerging) countries and better than market performance by four of the fund's six investment managers. The fund also benefited from its below market weighting to energy stocks, which fell as a result of declining oil prices. For the year the fund continues to trail its benchmark, though it is the best performing fund offered by the General Board on an absolute return basis. For the year, the fund is up 11.1% after payment of investment management and funs administration fees. However, the fund trails its benchmark, which has returned 13.9% for the year. This relative performance gap is attributed to poor performance of the fund's investment managers compared to their respective performance benchmarks. Throughout the year, the fund has had a less than market weighting in energy stocks, which have performed well and a greater than market weighting in technology stocks, which have performed poorly.
The Multiple Asset Fund gained 2.1% during August, but slightly underperformed the return of its performance benchmark by 0.1%. The less than benchmark performance is primarily attributable to the less-than-benchmark performance of the Inflation Protection Fund, though offset by better than market performance of the Domestic Bond, Domestic Stock, and International Stock funds. For the year, the fund has produced a return of 6.0%, which matches the performance of the benchmark. The relative performance of the Domestic Bond Fund has positively impacted the fund's performance and the relative performance of the International Stock Fund has detracted from performance.
The Balanced Social Values Plus Fund advanced 2.5% during the month and exceeded the performance of its benchmark return by 0.5%. The fund is positioned with an emphasis on smaller sized companies and companies with earnings growth that is expected to be faster than the overall market. These two factors positively influenced the fund's performance for the month. For the year, the fund is up 0.8%, but trails its benchmark return of 4.6% as a result of its emphasis on stocks expected to grow earnings faster than the overall economy.
Market Indices for August 2006
The S&P 500 was up 2.1% in August and is up 4.4% for the year.
The Russell 2000 was up 2.8% in August and is up 7.0% for the year.
The MSCI was up 2.5% in August and is up 12.2% for the year.
The performance data for these charts is based on price changes only and do not include the impact of dividend payments.