December 2008 Investment Report

Market anxiety eased …

The extreme market declines in October and November abated in December. The federal government’s Troubled Asset Relief Program (TARP), along with efforts by the Federal Reserve to lower interest rates, appeared to be showing modest success. U.S. equity markets continued their late-November rally with positive performance in December. International markets rebounded even more strongly with mid-single digit increases for the month. Mortgage rates declined after indications that the government would be willing to purchase some delinquent loans and work with struggling homeowners to restructure payment terms to help them stay in their homes.

… although the economy continued to deteriorate.

Despite better news on the financial front, economic reports offered little comfort. Final Gross Domestic Product for the third quarter of 2008 corroborated the government’s preliminary report that the economy contracted at a rate of a 0.5%. This, in turn, confirmed what many people already suspected—that the U.S. is squarely in a recession. Reports regarding non-farm employment revealed losses in jobs for the 11th consecutive month. As a result, the unemployment rate rose to a 15-year high of 6.7%, with some economists projecting an eventual 8% rate (or even higher) by the end of 2009.

Consumer confidence resumed a negative trend in December. Not surprisingly, retail sales (excluding auto and gasoline sales) were down 4% year-over-year through the Christmas holiday season, despite attempts to attract shoppers with aggressive price-cutting. In a telling sign of difficult times, even online e-commerce sales were down 2%—as compared with a 22% increase in 2007. Auto sales continued to spiral downward, falling 13% from November. One positive outcome of poor auto sales was that auto manufacturers were able to convince the U.S. government to lend them $17 billion to forestall filing for bankruptcy. In addition, GMAC, the primary auto loan-financing arm of General Motors, was awarded bank holding status and also given $6 billion of government aid from TARP. The impact of dwindling retail sales began affecting a broad variety of manufacturers and suppliers of goods and services. Domestic factory orders have declined for three consecutive months, and global manufacturing output is estimated to have declined at a 15% annualized rate in the fourth quarter.

Housing markets again showed no indication of bottoming, with the primary indicators—existing and new home sales and housing starts—down from the previous month. With the promise of government support, fixed-rate mortgages are now available at approximately 5%, so housing may soon begin to recover.

With the continued fall in commodity prices and weakening demand, inflation has receded into the background as an issue of concern for the Federal Reserve. Crude oil futures prices reached a low of approximately $30/barrel during the month, before rallying on news that OPEC would enact production cuts to match falling worldwide demand. Weak commodities demand claimed a casualty in the bankruptcy filing of petrochemical producer LyondellBasell Industries.

Government focus on unfreezing credit markets may be having an effect.

With most inflation indicators down amid the signs of a weakening economy, the Fed lowered its target for its overnight rate to a range of 0% to 0.25% in December; the rate has dropped 4 percentage points since the beginning of 2008. In early January, President-elect Barack Obama provided more details on what has become an $800 billion fiscal stimulus package, including $300 billion of tax-cut measures for individuals and small businesses that would be enacted over the next two years.

Despite the equity market recovery, pricing behavior in U.S. Treasury securities suggested that investors were still prioritizing risk of loss of principal over potential investment return. The 10-year Treasury bond ended the month yielding near 2%, which is close to the lowest rate ever. Investment-grade corporate bond yields declined during the month of December, but the difference between corporate bond rates and U.S. Treasury bond rates did not compress, as Treasury yields also declined.

Market Reaction

As previously noted, the markets’ downward trend of the previous two months was reversed in December. The Russell 3000 Index appreciated almost 2%. Small-company stocks performed better than large-company stocks, with the Russell 2000 Index of small companies up almost 6% for the month. The domestic real estate securities (REIT) market continued to see extreme volatility by registering a nearly 18% gain—and yet still ending the year down almost 40%. A primary reason cited for this market’s volatility was the trading activities of certain real estate exchange-traded funds that borrow heavily. International stocks outperformed U.S. stocks, with stocks from developed countries up about 6% and stocks from developing countries up just over 8%. In the currency markets, the dollar actually reversed its appreciating trend against the Euro, and continued deteriorating against the Japanese yen, possibly as a result of the last Fed interest rate cut and concern about the impact of massive U.S. government spending on rescue programs. Another notable story during the month was the uncovering of the Bernard Madoff fund fraud, which was called the largest Ponzi scheme in history. It has been reported that potential investor losses could be as much as $50 billion. Finally, at the very end of the year, conflict erupted between Israeli troops and Palestinian Hamas forces on the Gaza Strip.

Investment Fund Review

Inflation Protection Fund

Fund December Year-to-Date
Inflation Protection Fund +5.3% -7.7%
Barclays Capital Inflation Linked Index +4.8% -1.7%
Difference +0.5% -6.0%
  • The Inflation Protection Fund outperformed its benchmark in December, primarily as a result the fund’s diversification into inflation-based strategies other than U.S. Treasury Inflation Protected Securities. However, the main detractor from performance was the fund’s 10% allocation to commodities. After declining 16.8% in November, the Dow Jones AIG-Commodity Index fell 4.5% in December due to a continuing rapid decline in the price of oil. As a result of the global economic contraction, the demand for all types of commodities has declined significantly. Global investors’ risk aversion has negatively affected nearly all asset classes other than U.S. government-issued debt.
  • For the year, the fund significantly underperformed its benchmark for the same reasons cited above. The fund’s commodities investments have declined nearly 53% since the beginning of the year. The fund’s investments in inflation-linked bonds from developing countries declined about 15%. Despite this very disappointing performance, the General Board continues to adhere to its philosophy of building broadly diversified funds and believes that this strategy will benefit its participants in the long term.

Domestic Bond Fund

Fund December Year-to-Date
Domestic Bond Fund +4.7% +1.4%
Barclays Capital U.S. Universal (ex MBS) Index +5.1% -0.7%
Difference -0.4% +2.1%
  • The Domestic Bond Fund advanced 4.7% in December, though the performance difference among the various fixed-income segments was significant.
  • U.S. Treasury interest rates continued to decline as a result of global risk aversion leading to price improvements for these securities. Additionally, higher-quality, investment-grade bonds’ performance improved as investors realized that prospective returns from high-quality bonds were very attractive. Even below-investment-grade bonds produced positive performance as investors appeared willing to consider modestly raising their risk tolerance. The two best-performing segments in the Domestic Bond Fund were high-grade corporate bonds and international bonds. After several months of strengthening relative to foreign currencies, the dollar weakened. Only one of the Domestic Bond Fund’s strategies produced negative performance in the month. Despite the broad dispersion among the various elements of the fund, the Domestic Bond Fund just marginally underperformed the performance benchmark.
  • For the year, the fund meaningfully outperformed its benchmark and gained 1.4%. Only about 30% of bond mutual funds produced a positive return in 2008. The fund’s better-than-benchmark performance is primarily due to returns generated from the fund’s positive social purpose investments supporting affordable housing and community development projects. The fund’s investments benefited from a one-time adjustment to the pricing methodology for valuing the fund’s holdings. Additionally, the performance of the fund’s core bond manager, PIMCO, has meaningfully surpassed its performance benchmark. These two positive contributors, however, were offset by the fund’s lower-than-benchmark holdings of U.S. Treasury securities. As with the Inflation Protection Fund, the Domestic Bond Fund is broadly diversified by holding below-investment-grade bonds and international bonds from both developed and developing countries. The global economic crisis has resulted in virtually all non-U.S. government bonds underperforming U.S. Treasury securities.

Note: Following the failure of Lehman Brothers in September, the rights to publish the Lehman Brothers fixed-income indexes were purchased by Barclays Capital. All Lehman indexes have been rebranded “Barclays Capital.”

Domestic Stock Fund

Fund December Year-to-Date
Domestic Stock Fund +0.9% -34.5%
Russell 3000 +1.9% -37.3%
Difference -1.0% +2.8%
  • The Domestic Stock Fund attained positive performance in December as all equity sectors advanced from the lows experienced in the prior months. The fund underperformed its benchmark in December. The underperformance is primarily attributable to a reduction in value of the fund’s private real estate investments. The negative contribution from a reduction in private real estate values was partially offset by the fund’s larger-than-market exposure to stocks of small and mid-sized companies.
  • For the year, the Domestic Stock Fund declined significantly, losing nearly 35% of its value. Compared with its benchmark, the fund benefited from the benchmark-relative performance of its small and mid-sized company managers, which have collectively outperformed their benchmarks. The fund has also benefited from its exposure to private real estate and private equity, despite the year-end write-down of private real estate fund values.

International Stock Fund

Fund December Year-to-Date
International Stock Fund +7.5% -46.6%
MSCI ACWI x US +5.9% -46.0%
Difference +1.6% - 0.6%
  • The International Stock Fund rebounded in November with positive performance and also outperformed its benchmark by 1.6%. The outperformance is primarily due to the fund’s greater-than-benchmark exposure to stocks from developing countries and excellent benchmark-relative performance of two of the fund’s investment managers.
  • For the year, the fund has lost almost half of its value and has performed slightly worse than the performance benchmark. Although individually, the fund’s managers have performed better than their respective benchmarks, the fund’s higher-than-benchmark weighting in stocks from developing countries and its diversification into international real estate securities both negatively contributed to its benchmark-relative performance.

Multiple Asset Fund

Fund December Year-to-Date
Multiple Asset Fund +4.0% -26.1%
Composite Benchmark +3.8% -28.0%
Difference +0.2% +1.9%
  • For the month, the fund modestly outperformed its benchmark as the outperformance of the International Stock Fund and Inflation Protection Fund overshadowed the underperformance of the Domestic Stock Fund and Domestic Bond Fund.
  • For the year, the fund outperformed its benchmark due to the strong benchmark-relative performance of the Domestic Stock Fund and the Domestic Bond Fund, though this was partially offset by the significant underperformance of the Inflation Protection Fund.

Balanced Social Values Plus Fund

Fund December Year-to-Date
Balanced Social Values Plus Fund +0.8% -20.3%
Composite Benchmark +0.8% -20.2%
Difference    0.0% -0.1%


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