April 2008 Investment Report

Investors continue to assess the economic environment and watch first-quarter corporate earnings reports …

The month of April began with Investors focused on corporate earnings, eager to learn how businesses were faring in the uncertain, “recession-oriented” economy. Unexpected weak results from General Electric seemed to play on investors’ worst fears. A multinational conglomerate, such as GE, whose businesses span finance to health care, could be considered a “proxy” for the market as a whole and gave investors a preview of what was in store for the broader market. The weak results prompted a stock sell-off, as worries deepened that economic growth would slow more than expected. However, as the month continued and more companies reported earnings, investors became more hopeful and stock markets rebounded. Companies across various industries, including Google, Caterpillar and Honeywell, all reported strong earnings. This suggests that the economy may be approaching a turning point. As widely expected, losses were reported in the financial industry, as companies such as Citigroup, Merrill Lynch and JPMorgan Chase announced more credit-related reductions to asset values contributing to negative earnings results. Nevertheless, the collective actions of investors were positive due to optimism that negative adjustments to asset values could be finally nearing an end. As a result, financial stocks rallied, as investors became convinced that a catastrophic financial event would not derail the U.S. financial system.

… along with key economic data …

In contrast to the positive earnings announcements from companies, economic data released in April remained weak. The employment report reflected a decrease of 80,000 U.S. jobs in March, larger than expected, with additional downward revisions to prior months. The unemployment rate increased from 4.8% to 5.1%. The data revealed that the housing market in the U.S. continued to deteriorate, as the sales of both new and existing homes further weakened. The supply of homes available for sale once again grew, and home prices continued to fall. The conventional wisdom is that falling prices may be keeping potential home buyers from making offers until prices stabilize. With rising unemployment and declining home values, the outlook for consumer spending supporting economic growth continues to be dim. The U.S. Conference Board Consumer Confidence Index fell again, sliding 41% in the past year. Despite the poor economic data from housing, employment and consumer spending, the country’s Gross Domestic Product (GDP) actually rose by 0.6% in the first quarter of 2008, based on an initial estimate. Many analysts were expecting a decline in the output of goods and services, but additions to the nation’s inventory stock helped prevent the economy from contracting.

… and action by the Federal Reserve.

After reviewing recent economic reports, the Federal Reserve rate setting committee known as the Federal Open Market Committee continued on the path of reducing short-term borrowing interest rates by cutting the federal funds rate by 0.25% to 2.0%. Although widely anticipated by analysts, the cut was smaller than the recent interest rate cuts of 0.50% and 0.75% made by the committee earlier in the year. However, the accompanying policy statement unsettled investors as it indicated that the Fed may be nearing the end of its rate-cutting cycle. Rather than believing that the end of the rate reductions could have a positive impact, indicating that the economy was back on track and growing, investors realized that inflation may be a bigger risk that would keep the Fed from continuing further stimulus through rate cuts. The Fed’s string of lowering rates has had the adverse consequences of weakening the U.S. dollar and driving up commodity prices, which, in turn, have increased inflationary pressures. Thus, economic growth could continue to be weak, and inflation could continue to be a concern. However, the Fed may be unable to spur the economy through additional interest rate cuts.

Market Reaction

Overall, the positive shift in investor sentiment resulting from better-than-expected first-quarter earnings reports led to a positive return in stock markets. The S&P 500 advanced 4.9%, the Nasdaq rose 5.9% and the Dow Jones Industrial Average increased 4.7%. International markets also rebounded in April. A global index excluding U.S. stocks rose 5.7%. As investors became more upbeat, they shifted away from the safety of U.S. Treasury securities, sending bond prices down and interest yields up.

The rebound in April, however, wasn’t enough to completely reverse the year-to-date decline of the equity markets. For the year, the S&P 500 has declined 5.0%, the Nasdaq has fallen 8.8% and the Dow has retreated 2.6%. International markets remain negative as well, with a global index excluding U.S. stocks falling by 3.9% through the end of April.

The market’s disdain for corporate, asset-backed and other bonds with exposure to credit reversed in April after many consecutive months of increasing credit spreads relative to risk-free U.S. Treasury securities. Interest rates for U.S. Treasury securities increased during the month. For example, the 10-year U.S. Treasury Note yield ended April at 3.73%, up from 3.41% at the end of March. However, interest rate differentials for riskier bonds with exposure to credit narrowed. A widely used index of U.S. corporate bonds increased in value by 0.6% in April compared with a decrease in the index that tracks U.S. Treasury securities, which declined 1.7%.

Investment Fund Review

The Balanced Social Values Plus, Domestic Stock, International Stock and Multiple Asset funds increased in value in April, though all four have declined for the year. The Inflation Protection Fund and the Domestic Bond Fund declined in April, but both funds have generated positive returns for the year. The year-to-date returns for all of the General Board’s funds exceed each fund’s performance benchmark.

Inflation Protection Fund

• U.S. inflation-linked bonds declined as investors shifted from risk-free to higher-risk assets.
• The Inflation Protection fund significantly outperformed its benchmark in April due to the fund’s diversification into investments other than safe U.S. Treasury Inflation Protected Securities. The fund’s allocation to commodities and strong performance by the manager of the fund’s portfolio of inflation-protected securities in developing countries contributed to its better-than-benchmark performance. Commodities surged in April, as oil traded up to $119/barrel before retreating at the end of the month to $113/barrel.
• For the year, the fund remains ahead of its benchmark due to the fund’s 10% allocation to commodities and inflation-linked bonds from developing countries.

• The Domestic Bond Fund retreated slightly in April, underperforming its performance benchmark, but remains positive for the year. The fund’s allocation to non-U.S. bonds detracted from performance as non-U.S. bonds decreased relatively more in price and the U.S. dollar strengthened against foreign currencies. Additionally, the value of loans originated in the fund’s Positive Social Purpose Investment Program declined in value as a result of an increase in interest rates for U.S. Treasury securities, which is a key element of determining the fair market value of the program’s loans.
• For the year, the fund is substantially ahead of its benchmark, reflecting the one-time adjustment to the pricing methodology for valuing the fund’s holding of positive social purpose investments. Complete details of this change can be found at www.gbop.org/sri_funds/DBFunitpricechange.asp.
• Additionally, the fund has benefited from excellent performance of its active core bond manager and the performance of the portion of the fund invested in foreign currency bonds, which has benefited from the decline in the U.S. dollar.

• The Domestic Stock Fund advanced in April as a result of the strength in the U.S. stock market. The fund slightly underperformed its performance benchmark due to the fund’s allocation to private equity and private real estate investments. At the end of April, the value of these investments remained about the same as they were at the beginning of the month. The General Board only adjusts the value of these investments after it receives quarterly financial statements from fund managers.
• For the year, the fund remains ahead of its benchmark due to the fund’s allocation to public real estate investment trusts along with private real estate and private equity.

• The International Stock Fund advanced in April as a result of the positive performance of the world’s stock markets. The fund underperformed its benchmark due to its allocation to small-company international stocks, which did not perform as well as large-company international stocks. Additionally, the fund’s value manager meaningfully underperformed its benchmark (although the manager’s portfolio remains ahead of its benchmark for the year).
• For the year, the fund is outperforming its benchmark due to strong stock selection by several of the fund’s active managers, particularly the manager of international growth stocks and the manager of smaller capitalization stocks.

• For the month, the fund underperformed its benchmark due to less-than-benchmark performance by the International Stock Fund.
• For the year, the fund is outperforming its benchmark due to better-than-benchmark performance by all of the underlying funds, particularly the Domestic Bond Fund.