Investment Performance: Selected Rates of Return

• Equity Index Returns
• Fixed-Income and Other Index Returns

Investment Performance: Long-Term Equity Trends

• Large Growth Stocks vs. Large Value Stocks
• Small Growth Stocks vs. Small Value Stocks
• Large Stocks vs. Small Stocks
• Foreign Stocks vs. U.S. Stocks

Investment Performance: Fixed-Income Data

• Steepening Yield Curve
• Continued Widening of Credit Spreads
• Sharp Widening of Yield Spreads for Non-Treasury Sectors
• International vs. Domestic Bonds

The Economy: Key Indicators

• GDP
• Inflation
• Fed Funds Target Rate
• Unemployment

To discuss any of the content in this Synopsis, contact your Segal Advisors investment consultant or the nearest Segal Advisors office.

Quarterly Highlights: Noteworthy Developments

Segal Advisors finds the first quarter (Q1) 2008 developments discussed in this section to be noteworthy for institutional investors.

JP Morgan’s Proposed Merger with Bear Stearns

On March 16, 2008, under the supervision of the Federal Reserve, Bear Stearns signed a merger agreement with JP Morgan Chase & Co. under which JP Morgan would assume the counterparty risk and exercise management control over Bear Stearns, pending shareholder approval. This occurred following a tumultuous week in which investors became concerned about trades entered into with Bear Stearns, Bear Stearns cash position fell sharply, and the Fed made a series of unprecedented moves culminating in JP Morgan’s agreement to merge with Bear Stearns. Fed Chairman Ben Bernanke stated that there most likely would have been “severe consequences” to the default of Bear Stearns, leading to a possible systemic financial crisis.

Bear Stearns Stock Price for the Six Months Ending 3/31/08

Source: Bloomberg

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Drop in Consumer Confidence

Rising gas and food prices, weaker job prospects, credit conditions and slumping housing values continued to erode consumer confidence during Q1 2008. Although the consumer price index (CPI) is not showing significant inflationary pressure, consumers fear that inflation is on the rise. Consumer confidence, as measured by a Conference Board survey, fell in March, down from February, as shown by the line in the graph below. Another indicator of declining consumer confidence is the fact that the percentage of survey respondents who planned to take a vacation in the next six months fell to a 30-year low.

Sources: The Conference Board, Econoday.com and Moody's Economy.com

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Quality and Liquidity Issues in the Municipal Marketplace

During Q1 2008, a number of issues arose in the municipal bond market as a result of rating downgrades (and prospective downgrades) of the monoline bond insurers (i.e., insurers that operate a single line of business), which are summarized in the adjacent table. Credit uncertainty led to an increase in short-term borrowing costs for auction rate securities (ARS) and leveraged municipal bonds players. This included closed-end bond funds and hedge funds, which relied on the credit enhancement. Concerns surrounding the monoline bond insurers remains primarily focused on their exposure to credit issues in the taxable bond market.

Source: S&P, Moody's & Fitch

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The Rising Cost of Food

In Q1 2008, the trend of increasing international food prices continued, and even accelerated. The rising cost of food is being felt around the world. The prices mainly reflect changes in demand, as people in China and India are consuming more grain and Western countries are converting cereals into fuel. The rapid increase in wheat and rice prices has resulted in purchase restrictions, protests and riots in some countries. Pressure is also being felt at some of America's largest food firms, as they continue to struggle due to increased ingredient costs. Firms are changing packaging and recipes to defend themselves against rising costs.

Sources: S&P GSCI and US Department of Agriculture

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Investment Performance: Selected Rates of Return

This page focuses on Segal Advisors’ observations on the relative performance of selected indices. All of the graphs on this page show rolling three-year return deviations from March 1982 through March 2008. These graphs demonstrate the importance of diversification over the long term. Changes are expressed in terms of basis points (bps). As a reminder, 10 bps equals 0.1 percent.

Equity Index Returns

Q1 2008 Equity Index Returns

* For 10-year performance, gross returns are provided.

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Fixed-Income and Other Index Returns

Q1 2008 Fixed-Income and Other Index Returns

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Investment Performance: Long-Term Equity Trends

This page focuses on Segal Advisors’ observations on the relative performance of selected indices. All of the graphs on this page show rolling three-year return deviations from March 1982 through March 2008. These graphs demonstrate the importance of diversification over the long term. Changes are expressed in terms of percentages and/or basis points (bps). As a reminder, 10 bps equals 0.1 percent.

Large Growth Stocks vs. Large Value Stocks

After seven consecutive years of outperformance by the Russell 1000 Value (R1000V) Index relative to the Russell 1000 Growth (R1000G) Index, the R1000G was ahead of the R1000V at the end of Q1 2008 on trailing one-year (+925 bps) and three-year (+30 bps) time periods. The graph below compares the rolling three-year returns for both indices. Since the inception of these indices in January 1979, the R1000V has increased 13.6 percent and the R1000G has increased 11.4 percent, a difference of +220 bps.

Source: Russell Investments

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Small Growth Stocks vs. Small Value Stocks

The Russell 2000 Value (R2000V) Index outperformed the Russell 2000 Growth (R2000G) Index in six of the last 10 calendar years. However, the R2000G outperformed the R2000V at the end of Q1 2008 for the trailing one-year (+800 bps) and three-year (+140 bps) time periods. The graph below compares the rolling three-year returns for both indices. Since the inception of these indices in January 1979, the R2000V has increased 14.5 percent and the R2000G has increased 9.6 percent, a difference of +492 bps.

Source: Russell Investments

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Large Stocks vs. Small Stocks

Consistent with seven of the last eight calendar years, in which the the Russell 1000 (R1000) Index outperformed the the Russell 2000 (R2000) Index, the R1000 was ahead of the R2000 at the end of Q1 2008 for the trailing one-year (+756 bps) and three-year (+110 bps) time periods. The graph below compares the rolling three-year returns for both indices. Since the inception of these indices in January 1979, the R1000 has increased 12.7 percent and the R2000 has increased 12.3 percent, a difference of +42 bps.

Source: Russell Investments

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Foreign Stocks vs. U.S. Stocks

Foreign stocks, as measured by MSCI’s Europe, Australasia, and Far East (EAFE) Index outperformed the S&P 500 Index in seven of last 10 calendar years, including the last six in a row. The graph below compares the rolling three-year returns for both indices. Since January 1979, the S&P 500 increased 12.7 percent and the EAFE increased 10.4 percent, a difference of +177 bps.

Sources: Morgan Stanley Capital International and Standard & Poor’s

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Investment Performance: Fixed-Income Data

This section focuses on selected fixed-income data and Segal Advisors’ commentary.

Steepening Yield Curve

In an effort to fend off a recession and bolster confidence in the financial markets, the Fed eased the Fed funds rate, the interest rate that banks charge other banks to loan their balances at the Fed, again in March by cutting its target for the Fed funds rate by 75 bps to 2.25 percent at the March 18, 2008 Federal Open Market Committee (FOMC) meeting. In total, the Fed aggressively cut its target for the Fed funds rate by 200 bps in Q1 2008 from 4.25 percent to 2.25 percent. As a result of this Fed activity and ongoing forward-looking concern about inflation, the Treasury yield curve steepened significantly, as shown in the graph below. The difference between two-year and 30-year Treasury yields jumped to +271 bps on March 31, 2008 from +140 bps at year end 2007.

Source: U.S. Treasury

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Continued Widening of Credit Spreads

For the third consecutive quarter, credit spreads continued to widen. During Q1 2008, credit spreads widened by +83 bps and ended March 2008 at +338 bps. The highest spreads have been since the end of the 2002. See graph below.

Although corporate defaults remain low, in light of deteriorating market fundamentals, the Moody's 12-month corporate default rate rose modestly to 1.5 percent.

Source: Moody’s Economy.com

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Sharp Widening of Yield Spreads for Non-Treasury Sectors

Yield spreads on non-Treasury sectors widened sharply in March 2008, which, in some cases, were all-time highs. Due to forced liquidations of mortgage issues and asset-backed securities (ABS) by Carlyle Capital and Thornburg Mortgage, among others, the option-adjusted spread (OAS) on mortgage-backed securities (MBS) and ABS were pushed to +121 bps and +402 bps, respectively. Concern in the finance sector, especially about the cash position of broker-dealers, pushed spreads in that sector to all-time highs as well (+330 bps). The OAS on the Lehman Aggregate Index (+135 bps) was also a new record, as shown in the following graph:

Source: Baird Advisors using Lehman Brothers data

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International vs. Domestic Bonds

International bonds continued to significantly outperform domestic bonds during Q1 2008:10.9 percent vs. 2.2 percent. The significant underperformance resulted in domestic bonds trailing international bonds across all annualized periods studied. Most notably, international bonds now outpace domestic bonds — 7.4 percent vs. 6.0 percent — for the 10-year annualized period. See the following graph:

Performance of U.S. Bonds vs. International Bonds: Rolling Three-Year Return Deviations, March 1982—March 2008

Sources: Lehman Brothers and Citigroup

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The Economy: Key Indicators

This section focuses on selected fixed-income data and Segal Advisors’ commentary.

GDP

As shown in the below graph, Q1 2008 gross domestic product (GDP) advanced at a 0.6 percent annualized rate, which was the same rate of growth as seen in the fourth quarter of 2007. Over the past 12-month period, real GDP increased 2.5 percent a year. A buildup in inventories and strong exports helped to drive GDP growth. However, that growth was offset by a weakened housing market, decreased business investment and a pullback in consumer spending. Growth in inventories was a result of slowing demand, which could possibly lead to a decline in GDP during the second quarter of 2008. Consumer spending, which makes up 70 percent of GDP, rose 1.0 percent in Q1 2008, the weakest increase since the second quarter of 2001.

Sources: Moody’s Economy.com and The Wall Street Journal

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Inflation

As shown in the graph below, the CPI rose by 4.0 percent in March on a year-over-year basis, 3.1 percent on a three-month basis, and by 0.3 percent from February. The core index, which excludes food and energy prices, increased 2.4 percent (year-over-year) during Q1 2008, which was a tenth of a percentage point increase over the previous month. Lower labor costs and decreased consumer spending inhibited businesses' ability to pass on production costs to consumers.

CPI: Percentage Change Year over Year

Source: Bureau of Labor Statistics

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Fed Funds Target Rate

In response to weakening economic conditions, the FOMC decided to cut the target rate by 75 basis points to 3.5 percent at an emergency meeting on January 21, 2008. At the scheduled January 29, 2008 meeting, the FOMC agreed that economic conditions had deteriorated since the previous meeting, and lowered the rate by an additional 50 basis points, to 3.0 percent. On March 10, 2008, the FOMC voted to offer a Term Securities Lending Facility, allowing primary dealers to exchange highly rated assets for Treasuries. On March 18, 2008, the FOMC reduced the target rate by 75 bps, to 2.25 percent, again citing further weakening in the economy and ongoing problems in the financial markets.

Source: Moody’s Economy.com

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Unemployment

As shown in the graph below, the unemployment rate increased to 5.1 percent in March, marking the highest rate since September 2005, as the number of unemployed workers exceeded the number of labor force entrants. Payroll employment declined by 232,000 jobs in Q1 2008 as job growth in professional, technical, health care and food services continued to be offset by job losses in construction, manufacturing and retail.

Source: Bureau of Labor Statistics

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