May 2006 Investment Report

Inflation Worries Weigh Down Markets

Stocks declined in May amid inflation fears and more Federal Reserve rate hikes. Inflation, pushed by gasoline prices, experienced its highest increase in three months.  For the current year, inflation is rising at an annual rate of 5.1% compared to 3.4% for 2005. Core inflation, which excludes energy and food products, is the data Federal Reserve views closely when making interest rate decisions. The 12-month trailing core inflation rate registered 2.1%, exceeding the Federal Reserve's comfort range of 1% to 2%. For the current year, core inflation is on pace to exceed 3% and could signal additional rate hikes to control inflation. The fear is that that energy costs are now creeping into the prices of everyday goods and services, reducing consumer purchasing power and slowing down the economy. This would leave the Fed to balance a slowing economy along with higher inflation, which makes the markets very cautious.

Housing data points to a slowing economy …

… with the number of new housing permits dropping 7.4% and existing home sales dropping 2%. Low interest rates have driven up demand and price for housing over the last five years, creating what some feel is a housing bubble. This has economists concerned because of the amount of economic activity associated with housing. Many homeowners have accessed their home equity through borrowing and would be hurt by falling prices. In addition, new housing creates jobs and injects money into the economy.  Economists are watching for signs whether the housing bubble will burst or is headed for a soft landing.

Oil prices remain at record highs …

… because of geo-political concerns. Prices spiked in May due to terror attacks disrupting production in Nigeria and uncertainty over Iran's nuclear ambitions. Prices climbed to $76.72 a barrel before dropping to $72.89 a barrel when Iran gave assurances it would not cut oil production. With the summer driving season underway, the markets will closely monitor supplies.  If demand remains high, look for further hikes in oil prices.

Federal Reserve boosts key interest rate to 5% …

… marking the 16th increase in two years and the highest level in more than five years. The funds rate, the interest that banks charge each other, stood at a 46-year low of 1% when the central bank began raising rates in June 2004 to keep inflation under control. However, the Fed's rate hikes have raised the borrowing costs for millions of Americans on everything from adjustable rate home mortgages to auto loans. The Fed meets again on June 28-29, and if the prospect for inflation does not slow to the Fed's expectations, more rate hikes are imminent.

Former Enron execs convicted …

… of conspiracy to commit securities and wire fraud in one of the biggest business scandals in U.S. history. Jurors determined that former Enron executives Kenneth Lay and Jeffrey Skilling repeatedly lied to cover a vast web of unsustainable accounting tricks and failing ventures that led Enron, once the nation's seventh-largest company, into bankruptcy protection in December 2001. The conviction closes the book on an era of corporate scandal that saw convictions against executives from WorldCom, Adelphia Communications and domestic diva Martha Stewart.

Fund Performance

Investment performance for the month of May was poor, with all but one of the General Board's funds declining in value both in absolute terms and relative to each fund's respective performance benchmark. International stocks were especially weak, particularly those from developing countries. Investor fear and uncertainty regarding the prospect of inflation in the U.S. and its perceived contagion impact on world economic growth has caused significant weakness in the world stock markets. Despite poor performance in May, four of the General Board's funds continue to exceed their respective performance benchmarks.

The Inflation Protection Fund (IPF) was the only fund to advance during the month and exceed the performance of its benchmark. The fund gained 0.5% for the month compared to a gain of 0.3% for the performance benchmark. Inflationary fears have driven investors to seek investments that protect against inflation. Once again, the fund gained ground compared to its benchmark as a result of its 10% exposure to commodities and the contribution from active management by the fund's global inflation protected securities investment manager. For the month, a basket of commodities held by the fund increased in value by 1.7%. For the year, the IPF has declined 1.0%. However, the aforementioned contribution from commodities and the active investment manager has resulted in a 0.9% improvement compared to the performance benchmark, which has declined 1.9%.

The Domestic Bond Fund (DBF) declined 0.5% during May, and its performance benchmark declined 0.1% due to inflationary concerns. The fund's less than benchmark performance is primarily attributable to the emerging market debt component, which fell 5.8% as investors sold due to concerns about the impact a perceived economic slowdown may have on emerging countries. These losses were partially offset by gains in bonds from developed countries denominated in currencies other than U.S. dollars, which benefited from weakness in the dollar. For the year, the DBF has a very slight gain of 0.1% and remains ahead of its benchmark, which declined 0.8%.  The primary contributors to this excess performance are the fund's contribution from non-investment grade and international bonds, which continue to benefit from the weaker U.S. dollar.

The Multiple Asset Fund declined 2.8% during the month and underperformed the return of its performance benchmark by 0.4%. The less than benchmark performance is primarily attributable to the less-than-benchmark performance of the two stock funds and Domestic Bond fund, and only slightly offset by the better-than-benchmark performance of the Inflation Protection Fund. For the year, the fund has produced a return of 3.6% and is 0.7% ahead of its performance benchmark The benchmark-relative performances of the Inflation Protection, Domestic Bond and Domestic Stock Funds have enhanced relative performance, though the relative performance of the International Stock Fund has detracted from MAF's benchmark relative returns for the first five months of the year.

The Domestic Stock Fund fell in value by 3.5% in May and underperformed its performance benchmark return of -3.2%. The fund has a higher-than-benchmark exposure to the stocks of small and mid-sized companies, which performed significantly worse than the overall stock market. The S&P 500 Index (comprised of stocks of large companies) declined 2.9%. However, the Russell 2000 Index (comprised of stocks of smaller companies) declined 5.6%. For the year, the fund has gained 4.1% and its benchmark has advanced 3.0%. The General Board's greater-than-market weighting in small and mid-sized company stocks has benefited the fund for the first five months despite the poor performance in May. Additionally, the outstanding results from the fund's exposure to private real estate has also contributed to the excess performance.

The International Stock Fund materially weakened in May and declined 5.7%, meaningfully below the performance of its benchmark, which declined 4.7%. The fund was negatively impacted by its exposure to stocks from developing markets, which fell 10.5% during the month. For the year, the fund is up 7.8% but now trails the benchmark return of 9.8%. The fund's relative performance has been negatively impacted by its exposure to stocks from emerging countries and less than benchmark performance by five of the fund's six investment managers.

The Balanced Social Values Plus Fund declined 3.8% in May and was worse than the -1.9% performance for its benchmark. The fund's exposure to companies with smaller sized companies and companies with earnings growth that is faster than the overall market negatively impaired the fund's performance. For the year, the fund has marginally advanced by 0.2%, but is less than the 2.0% return of its performance benchmark.

Market Indices for May 2006

sp0605 The S&P 500 Index declined 3.0% in May and is up 1.7% for the year.
russ0605 The Russell 2000 Index declined 5.6% in May and is up 7.1% for the year.
msci0605 The MSCI World ex-USA Index declined 3.0% in May and is up 1.7% 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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