September 2009 Investment Report

Equity and bond markets have registered advances every month since March ...

Equity markets registered a seventh consecutive month of positive returns, advancing 4.2% and 21.1% for September and the year-to-date period, respectively. The quarter ending September 30 was the best third quarter for performance since 1939. After reaching a low point on March 9, 2009, the Russell 3000 index, a broad index of U.S. equities, has advanced almost 57%. The index is now only 10% below its level of one year ago, which was just before the major downturn in the financial markets.

Credit markets also continued their strong performance. Investment-grade bonds issued by U.S. companies, measured by the Barclay’s Corporate Debt Index, advanced 1.7% for the month and 14.9% for the year. Riskier credit instruments, such as non-investment-grade bonds, also continued to perform well.

The General Board has continued to follow its long-term, disciplined and diversified investment strategy of not attempting to predict the future direction of the U.S. and world stock and bond markets. We firmly believe that such an approach continues to be a prudent way to ensure participants’ retirement security.

… but the economy has a long way to go to be considered healthy.

With the economic recovery at a point of uncertainty as to whether or not it is sustainable, economists and investors have adopted the practice of scrutinizing each release of government statistics, hoping to ascertain the future direction of the economy. With each data release, debate ensues between two divergent viewpoints. One viewpoint claims that the market rally is simply a leading indicator of an established rebound in the domestic economy. A second viewpoint insists that a deeper recession looms, especially if the U.S. government curtails its stimulus programs, and that unfounded optimism fuels the current market rally. Unfortunately, macroeconomic indicators are subject to a large degree of volatility.

While certain sectors of the economy, such as housing, manufacturing and consumer confidence, appear to be gradually improving, positive economic indicators remain well below historic averages. For example, the number of initial jobless claims, which is reported weekly and measures the number of people who first file for unemployment benefits, has fallen 15% since its peak this past February. However, the 550,000 initial claims reported at the end of September is still well above the 350,000 to 400,000 average of the past decade. Also, while the rate of job losses has been declining since late 2008, the current U.S. unemployment rate of 9.8% is disconcerting. Finally, while the most recently reported second-quarter Gross Domestic Product (GDP) growth rate of -0.7% is a significant improvement over the -6.3% rate registered in the fourth quarter of 2008, the economy continued to contract in the second quarter.

Reliant on government support, the housing sector is sending mixed signals about a recovery …

The market seems to be in a pattern of reacting in an excessively negative fashion to the release of data that might foreshadow the reversal of prior positive trends. In the housing sector, existing home sales declined 2.7% after rising in July at the fastest rate in 10 years. Analysts seem to agree, however, that a near-term repeat of August’s existing home sales decline is unlikely and that the housing market is stabilizing. New home sales rose modestly to the highest level in 11 months. Housing inventory declined from 9.3 months to 8.5 months of available supply, with unsold inventory approximately 16% lower than a year ago. Housing affordability has improved dramatically, with prices nearly 30% lower than the 2006 peak. The rate of decline in prices is stabilizing, with July’s result indicating a year-over-year decline of 13.3%, the slowest decline since February 2008.

Two primary concerns dominate the discussion of a housing market recovery. First, housing experts worry about the growing number of homes in the process of foreclosure but not yet available for sale. Distressed properties accounted for about one-third of total home sales in August. The second concern centers on the far-reaching impact of government efforts to stimulate housing sales and the consequences if those efforts are scaled back. For example, the $8,000 tax credit to first-time homebuyers is due to expire in November. Congress is currently debating an extension. Also, the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Administration (“Fannie Mae”), once independent agencies but now under Treasury department control, issue securities backed by mortgages originated by financial institutions, such as banks and mortgage companies. Under a special $1.25 trillion authorization, the Federal Reserve Bank (Fed) became the largest purchaser of these agency mortgage-backed securities, having acquired nearly 80% of them in 2009. The Fed has expended about two-thirds of its authorization, which is scheduled to expire by year-end. Because of these factors, many believe that government-supported financing accounted for nearly half of all home sales in the summer of 2009. It is clear that without government backing, the housing market would be in a much deeper slump.

… as are manufacturing and consumer-driven sectors.

Domestic manufacturing production, as measured by the Chicago Institute of Supply Management (ISM) Index, was another economic indicator that reversed direction. The ISM survey of purchasing managers registered a result of 52.6 versus an expectation of 54. A result over 50 implies that both the manufacturing sector and the economy are expanding. However, focusing on a single month can be misleading. In the case of manufacturing production, the number remains about 14% below its peak and comparable to a level that prevailed 10 years ago. During the month, factory orders also declined. However, if one excludes the volatile category of transportation goods, specifically aircraft orders, factory orders actually improved 0.4%.

Consumer confidence is another indicator that has improved significantly from its record low recorded in February, although it is just half its historical average and well below the lowest levels of the 2001 recession. Consumer confidence, driven to some degree by job market prospects, fell in September to a level of 53.1. The market reacted negatively to this news as it anticipated a value of 57.

Retail sales improved 2.7% in August and received an artificial boost in the final month of the “Cash for Clunkers” government program. Excluding auto sales, August retail sales still posted a respectable 1.1% increase. Taking a longer historic view, retail sales have fallen to 2005 levels. Auto sales, while up 10.6% in August, contracted significantly in September with the expiration of the “Clunkers” program. By comparison, automotive sales in September were at an annual rate of 9.2 million vehicles versus August’s 14.2 million annual rate. Under normal economic conditions, automotive sales average an annual rate of about 16 million units. Sales for bellwether U.S. manufacturers, GM and Chrysler, decreased at least 40% in September.

The fixed-income markets benefited from an absence of inflationary concerns …

The Fed continues to hold rates at low levels, suggesting that inflation continues to be of little concern. The Core Consumer Purchasing Index (CPI) and Core Producer Purchasing Index (PPI), which are the key inflation indicators, remained benign, increasing 0.1% and 0.2%, respectively.

Strong interest from overseas investors, coupled with Fed purchases of Treasury and mortgage-backed securities, helped support bond prices. Corporate bonds performed well in the month (+4.7%) and quarter (+7.5%), while historically low Treasury yields kept mortgage and corporate interest rates at an attractive level. During September, corporations took advantage of favorable borrowing costs to raise more than $40 billion, the largest amount of debt issuance since early March. The yield on the 10-year Treasury note was 3.3% at the end of September after reaching a high of 3.9% in the third quarter. Driven by very low interest rates in more conservative fixed-income investments, such as money market funds, investors continued to pursue higher-yielding strategies and riskier assets. High-yield bonds returned 5.7% in September and 14.2% during the quarter, as measured by the Barclays U.S. Corporate High Yield index.

… including stable commodity prices.

Commodities prices rose modestly in the month, with the Dow Jones UBS commodity index gaining 1.6%. Commodity prices have been reasonably stable in recent months. Crude oil futures prices rose 1.2% in September, but oil has essentially traded around $70 per barrel since late May. Despite natural gas prices increasing 21.1% in September, a result of heightened expectations for colder winter weather, the commodity has traded in a $4 to $5 per million British Thermal Units (BTU) range since April. The price of copper was flat during September and has been stable around $2.80 per pound since July. Agricultural commodities retreated from yearly highs experienced in late May given forecasts for favorable harvests. Corn prices have traded in a $3 to $3.50 per bushel range since June. Gold, which is widely viewed as an inflation hedge, advanced 5.9% in the month and now exceeds $1,000 per troy ounce for the first time since February. The overall story for commodities suggests a relative pricing plateau—and perhaps uncertainty about the ultimate strength of the economic recovery.

Corporate merger activity continued to make headlines.

Corporate mergers and acquisitions activity was once again in the headlines during the month. Several large deals were announced, including Kraft’s bid for the U.K. confectionery manufacturer Cadbury, Dell’s acquisition of the computer services vendor Perot Systems and Abbott’s plan to buy the pharmaceutical unit of the Belgian company Solvay. Other news stories in September included President Barack Obama’s renewed push for reform of the U.S. health system, regulatory seizure of Chicago-based Corus Bank due to its excessive exposure to failing commercial real estate loans, a trade war with China over tire imports, the Pentagon’s endorsement of a troop “surge” to end the war in Afghanistan and the re-election of Angela Merkel’s center-right alliance in Germany.

Market Reaction

U.S. stock markets had another strong month and quarter of performance driven by an improving picture for corporate earnings and continued federal stimulus efforts. The Russell 3000 Index rose 4.2% for the month and 16.3% for the quarter ending September 30, bringing the year-to-date return to 21.2%. Large-company stocks advanced 4.1% for the month and 16.1% for the quarter. Small-company stocks, as measured by the Russell 2000 Index, advanced 5.8% for the month and 19.3% for the quarter. Stocks of companies in developing countries, which have produced outstanding returns in 2009, rebounded from weak performance last month to post a 9.0% increase in September and a 20.9% increase for the quarter. Stocks of non-U.S. developed countries climbed 3.8% for the month and 19.5% for the quarter. The dollar closed lower compared with the major trading currencies of the euro and yen. The dollar has deteriorated against both currencies since April due to concerns regarding the expanding U.S. money supply resulting from the U.S. government’s stimulus programs.

Investment Fund Review

Inflation Protection Fund

Fund September Q3 09 Year-to-Date
Inflation Protection Fund +1.9% +4.4% +10.7%
Barclays Capital Inflation Linked Index +2.1% +3.1% +8.6%
Difference -0.2% +1.3% +2.1%
  • The Inflation Protection Fund had positive performance in September as all strategies produced positive returns. Specifically, the diversifying strategies of inflation-linked bonds from international and developing countries and the U.S. Treasury Inflation-Protected Securities (TIPS) portfolio added the most value in September. The fund underperformed its benchmark by 0.2% for the month as stable commodity prices affected the performance of the fund’s commodities investment portfolio.
  • For the quarter, the fund strongly outperformed its benchmark, primarily due to the diversifying holdings of commodities and inflation-linked bonds from developing countries.
  • As a result of the solid quarterly performance for reasons mentioned above, the fund meaningfully exceeds its performance benchmark for the year.

Domestic Bond Fund

Fund September Q3 09 Year-to-Date
Domestic Bond Fund +2.8% +7.5% +14.5%
Barclays Capital U.S. Universal (ex MBS) Index +1.6% +5.6% +9.3%
Difference +1.2% +1.9% +5.2%
  • The Domestic Bond Fund outperformed its benchmark in September as investor sentiment continued to reflect a greater willingness to invest in credit-related securities. The fund’s allocation to investment grade and high-yield corporate bonds and emerging-market debt contributed positively to performance for the month. The fund also benefited from an increase in value of its positive social purpose investments. For the quarter, the fund remained meaningfully ahead of its benchmark due to an overweight exposure to non-U.S. Treasury sectors as investor demand for riskier investments continued to strengthen.
  • The fund maintains a positive year-to-date performance and significantly exceeds its benchmark due to the same reasons indicated above for the quarter.

Domestic Stock Fund

Fund September Q3 09 Year-to-Date
Domestic Stock Fund +4.4% +13.3% +17.6%
Russell 3000 +4.2% +16.3% +21.2%
Difference +0.2% -3.0% -3.6%
  • The Domestic Stock Fund ended September with a positive return, modestly outperforming its benchmark. Similar to last month, the weakest performance of the fund came from its private real estate and private equity investments. The fund benefited from its higher-than-benchmark allocation to small and mid-sized companies, which produced better performance for the month compared with large companies.
  • For the quarter, the fund lagged its benchmark due to negative contribution from the fund’s private real estate and private equity investments. The valuations of these nonmarketable investments typically tend to lag the performance of the public securities markets.
  • For the year, returns for the Domestic Stock Fund continue to underperform the benchmark due to valuation reductions in its private real estate and private equity holdings. However, nearly all of the fund’s 13 active public equity managers are outperforming their respective benchmarks, with eight managers surpassing their respective benchmarks by at least 5%.

International Stock Fund

Fund September Q3 09 Year-to-Date
International Stock Fund +5.5% +21.7% +44.5%
MSCI ACWI x US +5.3% +20.1% +38.5%
Difference +0.2% +1.6% +6.0%
  • The International Stock Fund produced excellent gains for September because of continuing optimism regarding the rebound in the economies of developing countries, such as Brazil and China. The fund performed in line with its benchmark for the month, outperforming by a modest 0.2%.
  • For the quarter, the fund also outperformed its benchmark. Stocks from developing countries contributed to above-benchmark performance due to continuing optimism of recovery in their economies.
  • The International Stock Fund remains the best-performing General Board fund for the year, exceeding its benchmark by a robust 6.0%. The fund’s diversifying strategies, including dedicated portfolios composed of stocks from developing countries, developed-market small-cap stocks and international public real estate securities, represented the largest contributors to outperformance. In addition, all active managers with the exception of one are outperforming their respective benchmarks.

Multiple Asset Fund

Fund September Q3 09 Year-to-Date
Multiple Asset Fund +3.9% +12.5% +21.2%
Composite Benchmark +3.6% +12.9% +20.2%
Difference +0.3% -0.4% +1.0%
  • For the month, the Multiple Asset Fund outperformed its composite benchmark, due to the strong relative performance of the Domestic Bond Fund.
  • For the quarter, the fund is slightly trailing its benchmark, primarily due to the underperformance of the Domestic Stock Fund.
  • For the year, the fund remains ahead of its benchmark, primarily due to the strong benchmark-relative performance of the International Stock Fund, Domestic Bond Fund and Inflation Protection Fund, though partially offset by the underperformance of the Domestic Stock Fund.

Balanced Social Values Plus Fund

Fund September Q3 09 Year-to-Date
Balanced Social Values Plus Fund +2.2% +10.2% +15.6%
Composite Benchmark +2.2% +10.2% +15.3%
Difference +0.0% +0.0% +0.3%


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