October 2007 Investment Report

Investment markets continue gains after initial rate cut …

Following the September 18th interest rate cut by the Federal Reserve, financial markets extended their recovery in October, although concerns remained. Investors continued to monitor economic and financial data in October, assessing economic growth and the potential for any negative repercussions from the credit freeze and the slowdown in housing. Wall Street seemed to be hoping for a moderate slowdown in economic growth; not enough for a recession, but enough to ensure more interest rate cuts by the Federal Reserve.

… although economic data released in October portrayed a somewhat weaker economy.

Initially, investors were excited by the September jobs report, released at the beginning of October, which showed 110,000 jobs added to the economy. Additionally, the Labor Department revised the August decline of 4,000 jobs to an addition of 89,000. More jobs typically translate into higher consumer spending, which would offset the expected impact to consumer spending felt by the slowdown in housing. News from the housing market continues to be negative as data released in October remained weak, as the inventory of existing homes for sale grew to a 20-year high average “for sale” period of 10½ months. The median home sales price also declined.

Market Reaction

After the Fed interest rate cut, equities soared in September and investors became less risk averse, especially compared to investor attitudes in August. The S&P500 Index advanced 3.7%, the Nasdaq returned 4.0%, and the Dow was up 4.1%. For the year, the stock indices remain strong with the S&P500 up 9.1%, the Dow up 13.3%, and the Nasdaq up 12.5%. International markets continue to outperform domestic markets year to date with a global index excluding U.S. stocks up 17.4%. Bonds have added 3%-4% since the beginning of the year.

Investors also watched for signs of inflation. Inflationary gauges were moderate as the Producer Price Index (PPI), a measure of wholesale inflation, was within expectations. The Consumer Price Index (CPI), a measure of inflation at the consumer level, was also within expectations. But, investors were more concerned with price increases in commodities, such as oil, and the weakening dollar, which makes foreign goods more expensive. Oil moved dramatically higher in October, reaching $92.96/barrel as a result of tight supplies and Iraqi approval for Turkey to pursue Kurdish rebels into Iraq, potentially disrupting oil supply lines there.

In addition to economic data, investors focused on financial data.

Investors have been attempting to forecast the impact of this summer’s credit crunch on the economy and on corporations. Investors paid particular attention to earnings reports from financial companies, particularly companies with the most exposure to subprime mortgage issues. Companies like Bank of America, Citicorp, E-Trade Financial, and Merrill Lynch did recognize significant losses during the month. As financial companies revealed more information about the impact on their financial condition and the impact of the subprime debacle, markets seemed to appreciate the information, even when the news wasn’t good. General consensus, however, is that there is more bad news to come.

By the end of the month, enough uncertainty was evident in the market that investors confidently predicted that the Federal Reserve would reduce interest rates by 0.25%. The Federal Reserve complied with expectations and lowered the Federal Funds rate to 4.5%. Lower rates help stocks by lowering borrowing costs; this is generally viewed as a way to stimulate the economy. However, in its accompanying statement, the Fed clearly cautioned that inflation risks are high, reducing the odds of another interest rate cut before year end. The Fed did acknowledge the slight improvement in the credit market, but said it would continue to monitor credit conditions.

Market Reaction

Despite the uncertainties in the month, equities recorded solid gains in October. The S&P500 advanced 1.6%, the Nasdaq returned 5.9%, and the Dow Jones Industrial Average recorded a slight gain of 0.4%. With a decrease in the federal-funds rate, the interest rate yield curve steepened in October. This means that the gap between short term and long term interest rates increased. For the year, the stock indices remain strong with the S&P500 up 10.9%, the Dow up 13.7%, and the Nasdaq up 19.1%. International markets continue to outperform domestic markets for the year with a global index excluding U.S. stocks gaining 24%, boosted by the weakening dollar. Bonds have added 3%-4% since the beginning of the year.

Investment Fund Review

All of the daily priced funds offered by the General Board increased in value in October. Five of the six daily priced funds outperformed their performance benchmarks in the month. The International Stock Fund was the only fund that performed worse than its benchmark. For the year, all funds, except the International Stock Fund, are outperforming their benchmark.

The Inflation Protection Fund rose 1.6%, surpassing its performance benchmark which gained 1.2%. The fund’s investment in commodities added to performance, as the price of commodities, like oil, continued to soar. Additionally, the fund’s recent exposure to inflation linked bonds of lesser developed countries also contributed to the fund’s excess performance. For the year, the fund has gained 8.6%, and is meaningfully ahead of its benchmark return of 7.6%. The excess performance is attributed to the fund’s allocation to commodities and emerging market inflation linked debt. These two strategies have respectively produced investment returns of 17.5% for the year and 12.5% since August. These gains were slightly offset by a negative contribution from the fund’s allocation to inflation linked debt of developed international countries which have not kept pace with the performance of U.S. government inflation linked debt.

The Domestic Bond Fund advanced 1.3% in October, exceeding its performance benchmark of 0.9%. The fund benefited from its allocation to fixed income securities issued in foreign currencies of both developed and lesser developed countries. The continued weakness of the U.S. dollar has benefited securities denominated in foreign currencies. As a result of the fund’s relative performance in October, it has completely recovered its benchmark comparative losses incurred in August and now slightly exceeds the fund’s benchmark return. For the year, the fund has gained 4.7%, ahead of the performance benchmark which gained 4.6%. Although the fund’s Affordable Housing mortgage portfolio continues to detract as a result of a reduction in value attributable to the subprime crisis, the fund’s exposure to foreign currency denominated debt has more than made up for the degradation of value in the affordable housing portfolio.

The Domestic Stock Fund gained 2.2% in October surpassing its benchmark return of 1.8%. The fund outperformed its benchmark due to its emphasis on stocks from small and mid-sized companies and excellent benchmark relative performance by most of the fund’s investment managers. For the year, the fund has gained 12.5%, ahead of its benchmark which has risen 10.8%. Several factors accounted for the fund’s better than benchmark performance. The General Board’s small and mid-sized company investment managers have added significant value compared to their respective benchmarks for the year. Additionally, the General Board’s investment in private real estate partnerships continues to positively add to the fund’s performance.

The International Stock Fund soared 5.0% in October, though it trailed its performance benchmark which advanced 5.6%. The major factor attributable to the underperformance in October is the less than market weight allocation to the Chinese market, which has continued its torrid ascent in 2007. For the year through October 31, the Chinese stock market has more than doubled. For the year, the fund has gained 23.6% compared to the benchmark return of 24.0%. The fund has benefited from its allocation to the stocks of companies domiciled in under developed countries and to its investment in international private real estate. The modest underperformance is primarily due to fees and to less than benchmark performance by the fund’s value manager and the fund’s emerging markets managers. Both emerging market managers hold less than a benchmark weight allocation to the Chinese market.

The Multiple Asset Fund gained 2.5% and outperformed its benchmark return by 0.2%. The out performance is primarily attributable to better than benchmark performance by the Domestic Stock Fund, Domestic Bond Fund, and the Inflation Protection Fund, though partially offset by the less than market performance of the International Stock Fund. For the year, the fund has gained 12.5% compared to its benchmark return of 11.5%. This excess performance is attributable to the better than benchmark performance by all the funds except the International Stock Fund.

The Balanced Social Values Plus Fund rose 1.9% in October, ahead of its benchmark which rose 1.8%. The equity portion of the fund added 2.6% in October, matching the fund’s benchmark, the Domini 400. The affordable housing loans added 1.0% in October. For the year, the fund has gained 10.2%, outpacing its performance benchmark by 1.5%.

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