February 2008 Investment Report

Equity markets continued to struggle in February, amid soft U.S.
economic data …

Investors remained anxious in February, as a flood of weak economic data continued to raise recession fears. Orders for durable goods, those goods designed to last at least three years, declined greater than expected and negated the positive December report. Within the report, non-defense capital spending excluding aircraft, a proxy for business capital spending, also declined. Another economic report that caused significant concern among investors was the Institute for Supply Management (ISM) Service Index. The index declined unexpectedly to 41.9, well below December’s reading of 54.4 and well below expectations of 52.5. (A reading below 50 indicates economic contraction.) The sharp contraction of the business services sector is cause for concern, since services make up the bulk of the economic activity in the U.S. The ISM Manufacturing Index also fell below 50 to 48.3, a sign of a slowdown in manufacturing in the U.S. In addition, housing continued to deteriorate, with sales of both new and existing homes continuing to decline. The surplus of homes for sale continued to exert downward pressure on home prices. Particularly troubling, however, was weak news from the labor market. The employment report released in February reflected a loss of 17,000 jobs, the first decrease in four years. Additionally, unemployment claims trended higher in the month, as actual unemployment claims outpaced expected claims. Under the weight of all this negative news and with recession concerns highly elevated, consumer confidence fell sharply in February.

… the potential for higher levels of inflation …

In addition to the worsening outlook for economic growth, investors were also introduced to another danger in February: inflation. Wholesale inflation, as measured by the Producer Price Index (PPI), leaped 1% in January on rising food, energy and drug costs. Consumer prices also advanced by more than expected, increasing by 0.4% in January. Additionally, oil soared above $103 per barrel, following supply concerns over unrest in Nigeria and increased demand as cold weather hit the Northeast. Oil ended the month at $102 per barrel.

… and reminders of problems in the financial industry.

More unpleasant news from the financial industry exacerbated selling pressure in the U.S. and world stock markets. In its quarterly earnings report, American International Group reported a $5 billion loss and took a big charge on the estimated market value of credit derivatives, reminding investors that the fallout from bad credit bets by Wall Street continues. In addition, investment analysts issued more downgrades on financial companies that would be affected by a consumer slowdown, such as credit card issuers like American Express. Even Federal Reserve Chairman Ben Bernanke reminded investors of potential risks in the financial industry. During congressional testimony, he warned that some small banks could fail due to the housing crunch. But news of a deal to rescue bond insurer Ambac, accompanied by reaffirmation by Standard & Poors of the AAA rating for Ambac and MBIA, was welcomed by investors who feared that ratings downgrades in the bond insurers would spur additional write-downs by financial institutions.

Following the weak economic data and increased inflation pressures, Mr. Bernanke signaled the need for further interest rate cuts to stimulate economic growth. Investors are expecting another ½% reduction in the federal funds rate at the scheduled March meeting. Under the expectation that interest rates would fall, the U.S. dollar weakened against most major currencies, falling to nearly $1.52 versus the Euro.

Market Reaction

The surge in crude oil prices and recession fears held back major equity indices in February. The S&P 500 declined 3.3%, the Nasdaq plummeted 4.9% and the Dow Jones Industrial Average fell 2.8%. International markets, however, rose in dollar terms in February, with an international index of stocks rising 3.1%. As investors became increasingly concerned with the state of the U.S. economy, they turned to the safety of U.S. Treasury securities, sending prices up and yields down. The 10-year Treasury yield ended February at 3.51%, down from 3.60% at the end of January.

Investment Fund Review

The Inflation Protection Fund, Domestic Bond Fund and International Stock Fund increased in value in February. The Domestic Stock Fund, the Multiple Asset Fund and the Balanced Social Values Plus Fund decreased in value, given the level of investor uncertainty in the market, which hurt stock returns. For the year, the two bond funds offered by the General Board have generated positive returns.

Inflation Protection Fund

Fund Feb Year-to-Date
Inflation Protection Fund +1.8% +5.2%
BCGI Inflation Linked Index +1.4% +5.1%
Difference +0.4% +0.1%
  • The Inflation Protection fund slightly outperformed its benchmark in February, due to the fund’s allocation to commodities, which performed strongly in the month on continued demand.
  • This was slightly offset by the fund’s allocation to international inflation-linked bonds, which underperformed U.S. inflation-linked bonds.
  • For the year, the fund has produced a strong return, due to the fund’s allocation to U.S. inflation-linked bonds and to commodities.

Domestic Bond Fund

Fund Feb Year-to-Date
Domestic Bond Fund +0.9% +1.8%
Lehman U.S. Universal (ex MBS) Index  -0.1% +1.2%
Difference +1.0% +0.6%
  • The Domestic Bond Fund continues to show a positive return for the month and for the year-to-date.
  • The fund outperformed its benchmark for the month and for the year-to-date, primarily due to its allocation to bonds denominated in currencies other than the U.S. dollar. Most foreign currencies have strengthened relative to the U.S. dollar, which has helped investment performance.

Domestic Stock Fund

Fund Feb Year-to-Date
Domestic Stock Fund -3.1% -8.5%
Russell 3000 -3.1% -9.0%
Difference 0.0% +0.5%
  • Along with the U.S. equity market in general, the Domestic Stock Fund declined in February, matching the results of its performance benchmark.
  • Several factors have contributed to the fund’s better-than-benchmark performance for the year. One such factor is the fund’s exposure to alternative investments (real estate and private equity), which have not declined along with the overall U.S. market. Additionally, the fund’s allocation to real estate investment trusts has not declined as much as the broader market. These positive contributions have been slightly offset by poor benchmark-relative performance by one of the fund’s growth stock managers.

International Stock Fund

Fund Feb Year-to-Date
International Stock Fund +3.4% -5.6%
MSCI ACWI x US +3.1% -6.9%
Difference +0.3% +1.3%
  • U.S. investors in the International Stock Fund benefited by the decline in the U.S. dollar, which turned negative local market performance into positive performance for dollar-based investors. Additionally, commodity-oriented underdeveloped markets performed strongly in the month benefiting from strong commodity prices.
  • For the year, the fund is outperforming its benchmark due to the funds higher allocation to underdeveloped markets and due to the fund’s portfolio of investments in smaller companies, private real estate, and the fund’s recent investments in international real estate investment trusts. Additionally, the fund’s investment managers are collectively performing better than their respective benchmarks.

Multiple Asset Fund

Fund Feb Year-to-Date
Multiple Asset Fund -4.0% -4.0%
Composite Benchmark -4.0% -4.6%
Difference 0.0% +0.6%
  • For the month, the fund matched the performance of its benchmark.
  • For the year, the fund is outperforming its benchmark, due to better-than-benchmark performance by all of the underlying funds.

Balanced Social Values Plus Fund

Fund Feb Year-to-Date
Balanced Social Values Plus Fund -2.3% -5.2%
Composite Benchmark -2.6% -5.4%
Difference +0.3% +0.2%

 

 
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