February 2006 Investment Report

Inflationary concerns hold markets in check

Though the economy grew at a lackluster pace in the fourth quarter of 2005, many economic indicators in January indicated a resurgence of inflation. The Gross Domestic Product (GDP), which measures all goods and services produced in the U.S., increased at a lower than expected rate of 1.6% after a healthy 4.1% increase in the third quarter. Economic growth was negatively influenced by high energy prices and the impact of Gulf Coast hurricanes. Still, a new year brings new economic hope. Indicators that point to a strong employment market and strong retail sales to consumers indicate the economy begins the year on a strong footing.

Retailers experience better-than-expected January sales …

… as consumers purchased goods and services with gift cards they received at Christmas and took advantage of warm weather to give retailers a better-than-expected month. Some analysts fear, however, that the consumer spending that has been responsible for nearly two-thirds of economic activity may soon dissipate. A government report issued in February indicated that Americans are actually depleting their savings in order to finance their spending. The last time Americans had negative savings rates was during the Great Depression.

Unemployment claims hit six-year low …

… as employers increase hiring in January and the nation's unemployment rate fell to 4.7%, the lowest since July 2001. Claims have been below 300,000 for four out of the past five weeks. The four-week average for claims is at the lowest level in 5 ½ years.

Worker productivity rises at the slowest pace since 2001 …

… the year the U.S. was in a recession, while labor costs rose by 2.4%, the biggest jump since a 4.2% increase in 2000. The combination of slowing productivity—the amount of output per hour of work—and rising labor costs was certain to attract attention at the Federal Reserve, which is worried that rising wage demands could trigger inflation problems in the near term. Since the mid-1990s, productivity has accelerated as the economy benefited from the growing use of high-tech tools such as computers and the Internet. When productivity rises, workers earn more, but increased labor costs do not affect the cost of the products and services sold by the company. However, lower productivity combined with increasing labor costs will inevitably lead to an increase in the price of goods and services and is considered inflationary.

Tighter labor markets may prompt the Fed to increase the interest rate …

… banks charge each other on overnight loans, to its highest point in nearly five years. New Federal Reserve Chairman Ben Bernanke may guide the Fed to issue at least one more rate hike on March 28 as the central bank tries to make sure that tighter labor markets do not trigger rising wage pressures that could push inflation higher. Changes to the Fed funds rate impact the prime rate, which determines for consumers the cost of borrowing money for car loans and credit cards.

Oil prices drop but influenced by global uncertainties …

… including militant action in Nigeria, an explosion at a major oil refinery in eastern Saudi Arabia and threats by Iran to enrich uranium, which could be used as fuel for atomic weapons. Global unrest overshadowed reports earlier in the month indicating an increase in domestic supplies of oil. High energy prices will continue to apply inflationary pressure and increase the trade deficit, both areas of economic concern. At month's end, oil prices were $64.09 a barrel, down from $68.28 a barrel at the end of January.

2005 U.S. trade deficit soars to an all-time high of $725.8 billion …

… with record trade deficits occurring with China, Japan, Europe, OPEC, Canada, Mexico and South and Central America. The deficit with China has become an especially contentious issue, as many believe it uses unfair trade practices and has gained a huge advantage over America by artificially depressing the value of its currency, which makes Chinese goods cheaper for American consumers and American products more expensive in China. The U.S. trade deficit with China rose to a record $201.6 billion last year, the highest deficit ever recorded with any country and 24.5% above the previous record of $161.9 billion set in 2004.

Fund Performance

The Inflation Protection Fund (IPF) declined 0.3% for the month and underperformed its performance benchmark, which was flat. In February, the General Board invested 10% of the fund in a diversifying strategy that invests in commodities. We believe that, long term, investing in commodities is a prudent way to protect participants from the impact of inflation. Commodities declined during the month of February and adversely impacted performance. The decline in commodity prices was slightly offset by gains attained by the General Board's active inflation bond manager. For the year, the IPF is down 0.3% and its performance benchmark is up a fractional 0.1%.

The Domestic Bond Fund (DBF) advanced 0.6% during February, and outperformed its benchmark return of 0.4%. As in January, the fund's performance was helped by its exposure to bonds from lesser developed countries and bonds in non-investment grade companies. This was partially offset, however, by the fund's exposure to bonds denominated in currencies other than the U.S. dollar. The dollar strengthened in February. For the year, DBF is up 1.2% and is handily outpacing the performance benchmark's return of 0.4%

The Multiple Asset Fund increased slightly by 0.1% during the month matching the return of its performance benchmark. The fund was helped by the returns of the Domestic Bond and Domestic Stock components, but hurt by the returns of the Inflation Protection and International Stock components. For the year, the fund remains comfortably ahead of its benchmark and is up 3.7% compared to the benchmark return of 3.0%.

The Domestic Stock Fund advanced 0.3% in February, ahead of its performance benchmark, the Russell 3000 Index, by 0.1%. Gains in the real estate holdings of the fund helped performance, though offset by losses in the fund's holdings of stocks in small/mid cap companies. For the year, the fund is up 4.4% and its benchmark is up 3.5%. The real estate holdings and small/mid company exposure are the primary drivers of better than benchmark performance.

The International Stock Fund reversed course from a solid January and fell 1.1% for the month of February. The fund underperformed its benchmark, which decline 0.3%. This is attributable to weakness in the Japanese stock market and weakness in companies that have recently experienced better than average earnings growth. The General Board's portfolio has a slight bias favoring Japan and stocks with strong earnings growth. For the year, the fund is up 6.4% and now slightly trails the benchmark return of 6.6%.

The Balanced Social Values Plus Fund declined 0.2% in February compared to a gain of 0.3% for its benchmark. This fund also has exposure to companies with earnings growth that is faster than the overall market, and growth stocks underperformed the market as a whole. For the year, the fund is up 2.9%, which is 0.5% better than the performance benchmark.

Market Indices for February 2006

sp0602 The S&P 500 was up 0.06% for February and is up 2.6% for the year.
russ0602 The Russell 2000 was down 0.35% for February and is up 8.5% for the year.
msci0602 The MSCI World ex-USA was down 0.46% for February and is up 5.8% for the year.

The performance data for these charts is based on price changes only and do not include the impact of dividend payments.

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