October 2009 Investment Report

Equity markets record their first monthly decline since February …

U.S. and world equity markets fell in October, reflecting uncertainty over the strength of the economic recovery and the impact of declining government stimulus programs. In October, the Russell 3000 index, a broad index of U.S. equities, decreased 2.6%. Despite this modest reduction in value, the Russell 3000 has advanced 18.1% year-to-date and 8.1% for the one-year period.

Credit markets continued to perform positively in October. Investment-grade bonds issued by U.S. companies, measured by the Barclay’s Corporate Debt Index, advanced 0.6% for the month. Riskier credit instruments, such as non-investment-grade bonds and non-U.S. debt, were among the best performers in the fixed-income universe.

… as economic signals point to continuing improvement across consumer, housing and manufacturing sectors.

The economy continues to advance in a somewhat uncertain fashion. Most economists would agree that at a minimum, the economy has stabilized, although at lower levels of activity. Among the most welcome economic signals received at month-end was the U.S. report of Gross Domestic Product (GDP), which grew at an annualized rate of 3.5% after contracting for four consecutive quarters. Although the equity markets responded favorably to this report, it is important to keep in mind that the report represents the annualized improvement in GDP from the weak second quarter. Year-over-year growth remains negative, indicating the economy has not regained full strength. An additional disappointing announcement was the early November employment report, which reported higher-than-projected job losses and unemployment of 10.2%.

It is useful to examine the components of GDP growth in more detail. Consumer spending contributed the most, accounting for roughly two-thirds of the GDP increase. The “Cash for Clunkers” program, in turn, comprised about one-third of consumer spending. With the expiration of this one-time program in August, retail sales declined in September. The “silver lining” in the report was that total retail sales increased if one excludes the sales of automobiles. In addition, stimulus spending by the U.S. government, which peaked during the third quarter, contributed substantially to GDP growth. Stimulus directly and indirectly contributed about 1% to 1.5% to overall growth.

Contrary to recent trends, growth in residential investment also contributed to GDP growth. Spending on private residential construction climbed 3.9% in September. Publicly funded construction rose as well—a sign that government-driven infrastructure spending is occurring. The housing market is sending mixed signals of economic recovery, as new home sales in September declined 4% from August. However, existing home sales recorded 9% growth during the same period. This was likely driven by buyers attempting to take advantage of the soon-to-expire $8,000 housing tax credit. Given its success in supporting the rebound in housing, Congress appears ready to extend the tax credit program for first-time homebuyers and possibly expand it to include tax relief for non-first-time homebuyers.

Improvement in manufacturing inventories also contributed to GDP growth in the quarter. Domestic manufacturing production, as measured by the Chicago Institute for Supply Management (ISM) Index, increased. This represents the third straight month of growth and the highest level since April 2006. In an encouraging sign for labor markets, the ISM’s employment index rose for the first time in 15 months as manufacturers sought to recall workers or enlist temporary help. The rebound in U.S. manufacturing mirrored a surge in manufacturing activity around the world, as measured by global surveys of purchasing managers.

Companies that are able continued to prepare for an extended period of economic malaise.

An increasing amount of data suggests the economy is sorting out the “haves” from the “have-nots.” Among the “haves,” The Wall Street Journal recently reported that the largest corporations now hold more cash (11% of assets) than at any time in the past 40 years and have a substantial reserve to gird against any future liquidity problems. These corporations have benefited from improving interest rates and capital markets for debt issuance, and have undertaken significant cost-cutting efforts.

However, more than 100 banks have failed in 2009, representing just over $100 billion in assets. While bank failures typically occur among smaller banks, the recent bankruptcy filings and subsequent restructuring of third-party financing firms Capmark Financial and CIT Group suggest that these firms, although sizable, were not important enough within the financial system to warrant government support. As an important lender to businesses, CIT’s troubles point to a future challenging credit market, particularly for small business owners. Business bankruptcies are up 24% year-over-year from last October.

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

The Federal Reserve’s continuing view that the prospect for near-term inflation is benign appears justified based on September inflation data. Consequently, the yield on the 10-year Treasury note ended October at 3.4%—about the same level as in September. Although traditional U.S. Treasury securities continue to be the worst-performing fixed-income investment, this did not deter investors from collectively oversubscribing to a record government note auction of $123 billion during the last week of October. Paradoxically, inflation-protected Treasury securities were actually among the best-performing fixed-income instruments. This phenomenon is perhaps driven by long-term inflation concerns resulting from a weakening dollar and long-term worries about the magnitude of funding required to service a dramatically expanding government budget deficit.

In general, the interest rates at which corporations and banks can borrow have declined relative to U.S. Treasury rates. This is partially attributable to investor preferences for higher-yielding fixed-income instruments. Accordingly, corporate bonds, global bonds and high-yield bonds improved 0.6%, 1.8% and 0.9%, respectively, in October.

… despite a jump in commodity prices and U.S. dollar weakness.

After displaying relative stability for the third quarter, prices for most commodities advanced broadly in October. Crude oil rose almost 10% in the month to finish at $77 per barrel, but briefly touched $80 during the month. Gold hit a record high of $1,065 per troy ounce during the month. A broad-based index of commodities advanced 3.3% in October. Market observers have suggested that weakness in the U.S. dollar relative to major trading currencies was the primary cause of the strength in commodity prices, particularly crude oil. During the month, the U.S. dollar dropped to a 14-month low against a trade-weighted currency index, prompting Asian countries’ intervention to prevent the dollar from falling further.

Market Reaction

Despite reaching highs for the year in mid-October, the U.S. stock market declined for the month. The six-month stock market rally appears to have paused until investors can decide whether the pending gradual withdrawal of government stimulus will impair the nascent economic recovery. The Russell 3000 Index declined 2.6% for the month, bringing the year-to-date return to 18.1%. Large-company stocks declined 2.2%, but outperformed small-company stocks, as measured by the Russell 2000 Index, which retreated 6.8% for the month. International stocks declined less than U.S. stocks with stocks of companies in developed countries decreasing 1.3%, while stocks of companies in developing countries advanced 0.2% for the month.

Investment Fund Review

Inflation Protection Fund

Fund October Year-to-Date
Inflation Protection Fund +1.8% +12.6%
Barclays Capital Inflation Linked Index +1.2% +9.9%
Difference +0.6% +2.7%
  • The Inflation Protection Fund advanced 1.8% in October as U.S. Treasury Inflation Protected Securities were among the best-performing fixed-income instruments during the month. This was perhaps driven by investors’ concern over a weakening dollar and long-term worries over the magnitude of funding required to service a dramatically expanding government budget deficit. All strategies in the fund produced positive returns. The fund’s 10% allocation to commodities increased 7% and contributed to the better-than-benchmark performance, though this added value was partially offset by less-than-benchmark performance of the other two diversifying strategies in the fund.
  • The fund meaningfully exceeds its performance benchmark for the year because of the allocation to commodities and strong returns for inflation-linked bonds from developing countries.

Domestic Bond Fund

Fund October Year-to-Date
Domestic Bond Fund +1.2% +15.9%
Barclays Capital U.S. Universal (ex MBS) Index +0.5% +9.9%
Difference +0.7% +6.0%
  • The Domestic Bond Fund outperformed its benchmark as fixed-income markets benefited from an absence of inflationary concerns in October. During the month, investors demonstrated a preference for higher-risk fixed-income instruments compared with low-return, safer U.S. Treasury securities. As a result, higher-risk credit instruments, such as non-investment-grade corporate bonds and non-U.S. debt provided the best returns in the fixed-income universe. Similar to last month, the fund benefited from an increase in value of its positive social purpose investments.
  • The fund maintains a positive year-to-date performance and significantly exceeds its benchmark due its broad diversification across a variety of credit sectors and its below-benchmark weighting of U.S. Treasury securities.

Domestic Stock Fund

Fund October Year-to-Date
Domestic Stock Fund -2.7% +14.4%
Russell 3000 -2.6% +18.1%
Difference -0.1% -3.7%
  • All strategies in the Domestic Stock Fund produced negative returns for the month. The fund underperformed its benchmark due to its higher-than-benchmark allocation to stocks of small and mid-sized companies. The Russell 1000 Index of large company stocks declined 2.2%, whereas the Russell 2000 Index of small company stocks declined 6.8%. However, the fund’s investment managers collectively meaningfully outperformed their respective benchmarks to limit the fund’s benchmark relative underperformance to 0.1%.
  • For the year, returns for the Domestic Stock Fund continue to underperform the benchmark due to valuation reductions in the 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 seven managers surpassing their respective benchmarks by at least 5%.

International Stock Fund

Fund October Year-to-Date
International Stock Fund -0.4% +43.8%
MSCI ACWI x US -1.2% +36.8%
Difference +0.8% +7.0%
  • The International Stock Fund produced negative returns in October but nonetheless outperformed its benchmark. Stocks of companies in developed countries declined 1.3%, while stocks of companies in developing countries advanced 0.2% for the month. The fund’s diversifying strategies that focus on stocks from developing countries and international public real estate securities were the largest contributors to the better-than-benchmark performance.
  • The International Stock Fund remains the best-performing General Board fund for the year, and exceeds its benchmark by a very significant 7.0% margin. The fund’s diversifying strategies, including dedicated portfolios comprising 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 October Year-to-Date
Multiple Asset Fund -0.9% +20.1%
Composite Benchmark -1.2% +18.8%
Difference +0.3% +1.3%
  • For the month, the Multiple Asset Fund outperformed its composite benchmark, due to the relative outperformance of the International Stock Fund, Domestic Bond Fund and Inflation Protection Fund.
  • For the year, the fund remains ahead of its benchmark, due principally to the strong benchmark-relative performance of the International Stock Fund, Domestic Bond Fund and Inflation Protection Fund, though partially offset by underperformance of the Domestic Stock Fund.

Balanced Social Values Plus Fund

Fund October Year-to-Date
Balanced Social Values Plus Fund -0.7% +14.8%
Composite Benchmark -0.7% +14.6%
Difference +0.0% +0.2%


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