September 2007 Market Commentary

“All is well that ends well.” Or is it? The see-saw nature of the market in the third quarter is arguably a fitting testament to that adage. The first half of the quarter evidenced the nosedive of major indexes due to the continued fallout in the subprime credit markets, oil prices hitting record highs and the dollar hitting a low against the Euro. Global markets took a beating as well, exemplifying their interconnectedness to the defaults in risky U.S mortgages. Things seemed to stabilize in the latter half of the quarter, and the market then recovered to end the quarter with respectable gains. The Federal Reserve helped in September with a half-percentage-point cut in its target short-term interest rate, while retail gasoline prices have remained below $3 a gallon despite the surge in crude-oil prices to more than $80 a barrel – relatively good news for consumers, who drive a big portion of economic growth.

Even though the quarter concluded on an optimistic note, can we safely say that the worst is behind us? The consensus on Wall Street is that the credit crunch will most likely play out through the rest of the year and into 2008.  The Fed’s decision to slash rates by half a percentage point was a bigger move than the market expected, and there appear to be contradictory concerns hinging on that decision. On the one hand, the Fed has reassured investors and made it easier for companies to borrow money in the capital markets, sparking a rally in stocks. However, many worry that the Federal Reserve's rate cutting could overheat the economy and spur inflation. Since the Fed's Sept. 18 rate cut, many inflation-wary investors have sold longer-term Treasury securities, pushing prices down and their yields up.

For the month of September, the S&P 1500, a broad measure of the U.S. equity markets, returned 3.57%, with large cap stocks and small cap stocks gaining 3.7% and 1.5%, respectively. At the sector level, energy stocks (+8.0%) and material stocks (+7.8%) posted the best returns, while on the downside, consumer discretionary stocks shed 0.9% and financial stocks rose modestly by 2.2%. Growth stocks outperformed value stocks across the broad market.

International markets enjoyed a rally for the month. The MSCI EAFE Index advanced 2.2% in local currency terms, and 5.3% in dollar terms; growth stocks outperformed value stocks. Among developed markets, the Pacific ex-Japan and Nordic markets posted the most impressive gains, advancing by 14.5% and 9.1%, respectively. The MSCI EAFE Small Cap Index advanced by 1.1%, while emerging markets posted impressive gains of 11.0%. The BRIC Index proved to be the best performer at 16.9%.

The fixed income markets were mostly flat for the month. The 10-Year Treasury ended at 4.5% down 53 basis points from the prior month. The 30-year Treasury yielded 4.8% at month end, unchanged from the prior month. The Lehman Aggregate Bond Index gained 0.8%. Government bonds also posted marginal gains of 0.6%, and corporate bonds returned 0.8%. Mortgage backed bonds followed suit with a return of 0.7%, while municipals did better at 1.5%. The high yield market gained 2.6%. International government bonds rose 2.9% for the month, as did TIPS at +1.3%.

Commodities ended the month on a positive note rewarding investors. The Dow Jones-AIG Commodity Index gained 8.0%, driven by rallies in wheat, silver and soybeans. Real estate, as represented by the Dow Jones - Wilshire REIT Index, was surprisingly positive at +3.9%.