Anticipation mounted in October as the market continued to price in expectations for a second Fed Funds rate cut. As anticipated, the Fed met those expectations with their October 31 announcement of another quarter percent cut.

Despite oil prices that are pushing $100 / barrel and continued uncertainty in the credit and housing markets, the equity market overall has remained resilient. Year-to- date most domestic indices have posted double digit returns, with the exception of small cap stocks which continue to lag. Small caps dominated the domestic equity performance in October. International equities have continued to outperform domestic equities, both over the last month and year-to-date, aided by the falling Dollar.


Source: PMFA

Market volatility intensified again in October after receding throughout September. Sub-prime related write-offs in the financial sector and softness in overall corporate earnings were the primary contributors. With the majority of companies in the S&P 500 having reported third quarter earnings, the potential for a year-over-year decline in earnings for that index appears increasingly likely.

VIX - CBOE S&P Market Volatility Index – 1-Year Change

Source: Yahoo Finance

Fixed income investment returns were also positive in October. Most notably, emerging market currency performed well, posting a return of 3.44% for the month pushing its year-to-date return to nearly 15.0%.


Source: PMFA

Alternative investments bounced back during October as well. Commodities specifically have benefited from the falling dollar, a surge in gold, and high energy costs.

Source: PMFA

Economy

GDP

The advance estimate for Q3 2007 GDP growth was an annualized rate of 3.9%, well above consensus forecasts. The average growth rate over the last four quarters is 2.6%, within the Fed’s range of expectations.

Concerns of weakening consumer spending in light of housing, rising energy costs, and credit worries dissipated in October. Consumer spending, which represents over 70% of GDP, was a primary contributor to the strong GDP growth for the quarter, at 3.0%. Other sources of growth were from net exports and government spending. Robust export growth coupled with some slowdown in import growth has offset some slowing in domestic demand thanks to the weakening dollar.

Consumer Spending vs. Real GDP - Quarterly % Change


Source: PMFA, Bureau of Economic Analysis (BEA)

As nominal GDP has slowed over the last year, corporate profits have declined as well. Third quarter earnings are projected to contract slightly from the corresponding period in 2006.

Nominal Gross GDP vs. S&P 500 Operating EPS

Source: Schwab, Factset

Inflation

The Consumer Price Index (CPI) increased 0.3%, while Core CPI increased 0.2% for the month of September. The 12-month trailing core PCE Deflator was unchanged at 1.8% in September, remaining within the Fed’s implied target range.

Source: PMFA, BEA, Bureau of Labor Statistics (BLS)


The Producer Price Index (PPI) increased 1.1%, largely due to the 8.4% increase of gasoline prices during the month. The PPI is typically more volatile than other inflation indices; however, core PPI remains in line with other core inflationary measurements.

Inflation Indices – 12-Month % Change
Source: PMFA, BLS

Interest Rates

At their October 31 meeting, the Fed announced a quarter percent cut in its funds rate, dropping it to 4.5%. In their statement the FOMC affirmed, “After this action, the upside risks to inflation roughly balance the downside risks to growth.”

Based on their comments, the likelihood of additional rate cuts has decreased, but the possibility remains. The Fed reiterated that they will “act as needed to foster price stability and sustainable economic growth.” Clearly, the Fed remains in a difficult position given lingering inflationary pressures in the face of a slowing economy and no apparent near-term relief in sight in either the credit markets or housing.

Source: Federal Reserve Bank of Cleveland

Longer term Treasury yields declined marginally. The ten-year Treasury yield closed October slightly lower than the prior month at 4.5%.

Ten-Year Treasury Yield - as of November 2, 2007

Source: Yahoo Finance

Short-term rates increased in October, but have since slipped lower following the Fed Funds rate cut. The one-month Treasury yield increased 0.6% during the month to 4.0%. Over the last three months, the yield curve has shifted to a more normally sloped term structure.

Treasury Yield Curve History
Source: PMFA, U.S. Treasury

Currency

The dollar sold off further in October against a broad group of currencies of major US trading partners, as illustrated by the Broad Dollar Index. Recently, the Federal government completed a study related to the depreciation of the dollar and its effect on foreign investors and foreign exports.

Based on their findings, prices have generally remained constant in the US, as foreign companies allowed their profit margins to erode in order to maintain market share. As the dollar has fallen relative to other currencies, US exports abroad have become increasingly more attractive, benefiting US net exports.

Broad Dollar Index vs. Net Exports

Source: PMFA, U.S. Treasury, BEA

Employment

The national unemployment rate for October remained constant at 4.7%. The pace of job creation doubled expectations and reached 166,000 for the month, the highest monthly rate of growth since May.

Nonfarm Payrolls & Unemployment Rate - Monthly Net Change
Source: PMFA, BLS

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other source believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from Plante Moran Financial Advisors for investment advice regarding your own situation.