February 2009 Investment Report

World stock markets continued negative trends in the month …

Adverse stock market conditions observed in January continued through February, with discouraging economic and financial news weighing heavily on the U.S. and world stock markets. President Obama entered the White House in late January and immediately confronted one of the most severe economic challenges ever to face an incoming administration. While he and his team’s accomplishments during the first several weeks included the announcement of a $790 billion stimulus plan, discussions to acquire “toxic” bank assets, plans to provide mortgage relief to homeowners and the unveiling of a $1.36 trillion federal budget, these actions did little to calm the hypersensitive financial markets. U.S. equity markets as measured by the S&P 500 declined 10.5% in February, and the Dow Jones Industrial Average recorded its weakest February performance in 76 years, declining 11.7%.

… amid more troubling economic data.

The preliminary results for the fourth quarter 2008 Gross Domestic Product (GDP) indicated a steep decline of 6.8% in the nation’s output. During the month, the Federal Reserve (Fed) sharply downgraded its prognosis for the economy with an unemployment forecast of 9% by year-end, although this seemed understated, since February’s unemployment rate was 8.1%, the highest in 26 years. In addition, the Fed forecast a GDP contraction of between 0.5% and 1.3% for 2009. Job losses matched January’s decline of 650,000 and significantly influenced development of the administration’s fiscal stimulus package legislation. The U.S. has lost 4.4 million jobs since the recession began in December 2007.

January retail sales were actually up by 1% from December when adjusted for seasonal and other variations, yet still down almost 10% year-over-year. Analysts attributed the increase to deep merchandise discounts and seasonal factors after weak holiday sales. Consumer confidence, a reliable indicator of future retail behavior, declined 33% to an all-time low since the index began in 1967. Automobile sales continued their collapse, falling from an annualized 9.6 million to 9.1 million units. At the current pace of sales, it would take almost 30 years to replace the existing U.S. automotive fleet. Both wholesale and business inventories continue to be drawn down, mirroring declines in factory orders, durable goods orders and industrial production. All of these indicators are pointing to declining health of the manufacturing sector.

The Obama administration has endorsed the view that rescuing the housing industry is essential to economic recovery. On February 18, the administration announced the $75 billion Homeowner Affordability and Stability Plan, which aims to help some 4 million homeowners facing foreclosure by providing mortgage payment reduction programs. The plan also is designed to provide refinancing options to those 27% of homeowners (and 40% holding mortgages not issued by a federal agency, such as Fannie Mae) who owe more on their mortgages than the underlying value of their property. In February, the housing markets showed little signs of stabilization, with all major indicators declining. One bit of good news was that existing home sales month-over-month were down 5.3%, while the decline in housing starts were down 16.8%—suggesting that supply may finally be lining up with demand. Home prices were down about 19% year-over-year as measured by the most recent Case-Shiller data.

Inflation indicators reversed trend in the month, with both consumer and producer price indices edging higher for the month of January. This, along with the anticipated high levels of debt issuance by the U.S. government in coming months and years, may have contributed to longer-term U.S. Treasury yields rising during the month. Commodity prices, with the exception of gold, declined modestly in the month, despite intra-month volatility. Crude oil futures prices, as an example, traded at $46 per barrel at the beginning of the month, dropped to $37 and rebounded to $44 at month’s end amid pronouncements by oil producers on the need to reduce supply to counter falling demand and establish a higher, stabilized price level.

Government stimulus efforts and banking sector health continue to be the central focus of the financial markets.

The Obama administration and its efforts to combat the spreading impact of the recession were in the spotlight during the month following the announcement of several major stimulus initiatives. In addition to the Homeowner Affordability and Stability Plan, other notable measures include the expansion of the Term Asset-Back Lending Facility (TALF)—a new bank bailout plan—and, most importantly, the passage of the Obama plan for stimulating the economy. After much debate, Congress passed the stimulus package on a vote split along party lines. The primary components of the plan include infrastructure spending to help create jobs, tax breaks for businesses to restore confidence, tax breaks for workers to strengthen consumer spending and increases in entitlement programs, such as health insurance for the unemployed and food stamp benefits. Skepticism regarding the plan’s effectiveness arose over concerns that the impact of the stimulus spending would not occur soon enough to mitigate the recession and that the job creation elements of the plan were not particularly efficient. Funds for the previously established TALF plan were expanded to potentially $1 trillion to increase loans to consumers and small businesses and relaunch frozen securitized debt lending markets.

Another initiative promoted by the new administration was the so-called Public-Private Investment Fund. This was a reintroduction of the Bush/Paulson plan to have the government purchase distressed investments directly from banks. The market reacted negatively to the lack of details surrounding the fund, particularly how the government and the private sector will cooperate to set a price for the troubled assets.

Finally, in late February, President Obama introduced his 2009 budget, which included the following priorities: higher taxes for upper-income brackets; reduced defense spending coupled with an effort to withdraw American forces from Iraq over the next 18 months; and increased spending on health care, renewable energy and foreign aid.

Despite government stimulus programs, stocks of companies in the financial sector continued to perform poorly for a variety of reasons. Emphasizing the need for stricter oversight of financial firms, President Obama issued a controversial proposal requiring firms accepting TARP funds to limit executive pay to $500,000 per individual. Additional government intervention in the banking industry surfaced late in the month with the announcement that the government would increase its stake in Citigroup to 36%.

In the fixed-income sector, longer-maturity (greater than one year) U.S. Treasury interest rate yields rose in the quarter. Insufficient access to funds is appearing among the public as well as the corporate sector. Many states and municipalities are projecting significant budget shortfalls as tax revenues are forecast to decline in the wake of the recession. The corporate sector, however, has seen a modest improvement in lending availability through expanded commercial paper markets and the ability to issue longer-term bonds. Since the beginning of the year, blue-chip U.S. companies, such as Cisco Systems, General Electric Capital, AT&T and ConocoPhillips have sold almost $80 billion of investment-grade bonds.

Market Reaction

As indicated, the markets continued to decline during the month due to financial sector worries and skepticism about the various Obama stimulus plans. For the month, the Russell 3000 Index declined 10.5%, and the Dow Jones Industrial Average hit a 12-year low on February 27 of 6,952. Large company stocks—down 10.3%—modestly outperformed small company stocks—down 12.1%. International stocks performed slightly better than U.S. stocks, with the broad international index (MSCI ACWI ex-U.S.) down 9.2%. Stocks from developing countries (emerging markets) declined 5.6%, but they outperformed developed markets, which declined 10.2%. In the currency markets, the dollar strengthened against the Euro (+1.1%), the pound sterling (+1.5%), and the Japanese yen (+7.8%). The pound’s weakness may have been partially attributable to the Bank of England lowering its key interest rate to a record low of 1%. The European Central Bank (ECB) was expected to follow and lower its short-term borrowing rates as well. The U.S. trade balance has continued to decline with lower oil prices, but exports and imports across the world have declined with the global economic slowdown. In other stories, two additional investment frauds, Stanford bank and the Westridge hedge fund, came to light, suggesting that the SEC was stepping up enforcement in the wake of Congressional criticism.

Investment Fund Review

Inflation Protection Fund

Fund February Year-to-Date
Inflation Protection Fund -2.3% -2.8%
Barclays Capital Inflation Linked Index -1.9% -1.1%
Difference -0.4% -1.7%
  • The Inflation Protection Fund underperformed its benchmark in February, primarily as a result of the fund’s diversification into inflation-based strategies other than U.S. Treasury Inflation Protected Securities, specifically a 7% allocation to commodities. The Dow Jones AIG-Commodity Index fell 4.4% in February. The fund’s investment in international and emerging market inflation-linked securities also contributed to underperformance as the U.S. dollar strengthened compared to most other countries’ currencies.
  • For the year, the fund is significantly underperforming its benchmark for the same reasons cited above. The fund’s commodities investments have declined nearly 11% since the beginning of the year. The fund’s investments in inflation-linked bonds from emerging markets have declined 3.8%. Despite this very disappointing performance, the General Board continues to adhere to its philosophy of building broadly diversified funds and believes that such a strategy will prove to benefit its participants in the long term.

Domestic Bond Fund

Fund February Year-to-Date
Domestic Bond Fund -1.4% -1.7%
Barclays Capital U.S. Universal (ex MBS) Index -1.1% -2.1%
Difference -0.3% +0.4%
  • The Domestic Bond Fund declined 1.4% in February, although with varied performance across the different sectors. Longer-term (greater than one year) U.S. Treasury interest rates reversed direction and increased during the month, due to possible concerns that U.S. debt will grow to unprecedented levels as a result of the government’s massive stimulus efforts. Spreads widened on credit and high-yield debt, reversing trends of the previous month. Benchmark-relative performance was impaired by the fund’s lower-than-benchmark exposure to high-quality U.S. Treasury securities.
  • For the year, the fund remains modestly ahead of its benchmark. Sectors that have outperformed the fund’s benchmark, the Barclay’s U.S. Universal index (excluding mortgage-back securities), include higher-risk debt, as historically high-spread differentials tightened relative to Treasury securities. International bonds have underperformed as a result of dollar strength and the fund’s holdings of positive social purpose investments supporting affordable housing and community development projects. Despite sector underperformance in some cases, several managers outperformed their respective benchmarks, including the fund’s high-yield debt, global bond and emerging debt managers.

Domestic Stock Fund

Fund February Year-to-Date
Domestic Stock Fund -7.7% -15.0%
Russell 3000 -10.5% -18.0%
Difference +2.8% +3.0%
  • The Domestic Stock Fund declined significantly in February, but meaningfully outperformed its benchmark, primarily as a result of outperformance by several of the fund’s active managers and positive contributions from the fund’s private real estate and private equity investments.
  • For the year, the Domestic Stock Fund has lost 15% of its value. However, 12 of the fund’s 15 active managers are ahead of their respective benchmarks, with eight managers surpassing their respective benchmarks by three percentage points.

International Stock Fund

Fund February Year-to-Date
International Stock Fund -7.9% -15.8%
MSCI ACWI x US -9.2% -17.0%
Difference +1.3% +1.2%
  • The International Stock Fund also fell significantly in the month, but managed to outperform its benchmark by 1.3%. This outperformance was due to a less severe decline in stocks of companies from developing (emerging) countries compared to the performance from stocks from developed countries and benchmark outperformance by all of the fund’s active managers.
  • For the year, the fund has lost almost 16% of its value, but has outperformed its benchmark. All but one active manger are outperforming their respective benchmarks. Two managers, one in and one in developed markets, have each outperformed their respective benchmarks by three percentage points for the first two months of 2009.

Multiple Asset Fund

Fund February Year-to-Date
Multiple Asset Fund -5.3% -10.0%
Composite Benchmark -7.1% -12.4%
Difference +1.8% +2.4%
  • For the month, the fund outperformed its benchmark, due to outperformance in the Domestic and International Stock Funds.
  • For the year, the fund remains ahead of its benchmark, due to the strong relative performance of the Domestic Stock Fund, International Stock Fund and Domestic Bond Fund.

Balanced Social Values Plus Fund

Fund February Year-to-Date
Balanced Social Values Plus Fund -6.6% -10.1%
Composite Benchmark -5.7% -10.5%
Difference -0.9% +0.4%


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