The domestic equity markets demonstrated their resilience during a month buffeted by liquidity concerns in the credit markets. The threat that the meltdown in sub-prime mortgages could deteriorate into a “credit crunch” prompted the Fed to intervene. They initially responded by adding large amounts of liquidity to the market, followed by their surprise announcement on August 17 of a 0.5% cut in the discount rate to 5.75%.


Source: PMFA

By reducing the rate that they charge banks to borrow money, the Fed addressed the mounting liquidity concern and provided at least some temporary relief. After their intervention, equity market volatility that had been unparalleled in the preceding four years receded and the domestic equity market rebounded.

VIX Market Volatility Index – as of September 5, 2007

Source: Yahoo Finance

Through August 15, the S&P 500 Index had declined by 3.2%. In the two subsequent weeks, responding to the Fed’s intervention, the S&P 500 Index surged 4.9%. Given the lingering uncertainty in the markets and increasingly conflicted economic data, we expect that market volatility is likely to continue in the short-term. Moving into 2008, we anticipate that the U.S. Presidential election may also lead to increased volatility, as investors react to the candidates’ specifics about their respective plans.

International markets were not as resilient in August, as the MSCI EAFE reported negative returns for the month, despite outperforming the U.S. market year-to-date.


Source: PMFA

The bond market bounced back in August as investors sought shelter from the increased volatility in equities. The yield on the 10-year Treasury fell from 4.78% to 4.54% during August, while the 3-month T-Bill yield fell from 4.96% to 4.01% for the month on aggressive investor purchases of short-term issues.


Source: PMFA

The July return for the CSFB Tremont Hedge Fund Index was 0.0%. Preliminary indications for August are that broadly diversified funds of funds declined 1-2% for the month due to the significant disruptions in the credit market and overall market volatility.

Economy

GDP

The preliminary estimate for Q2 2007 GDP growth was revised upward to a strong 4.0% annualized rate. The average growth for the first half of 2007 was revised to 2.3%, within the Fed’s previously projected range of 2-3%.

The upward adjustment was a result of revised increases in business investment and net exports. Along with government spending, these factors helped to offset softness in consumer spending during the second quarter.

Quarter-to-Quarter Growth in Real GDP

Source: Bureau of Economic Analysis (BEA)

EMPLOYMENT

The unemployment rate for August was unchanged at 4.6%, although job creation softened considerably. Nonfarm payrolls declined by 4,000 jobs in August, while June and July payrolls were revised downward as well. The average monthly rate of job creation over the past three months has been nearly 100,000 lower than that of the first five months of 2007. Job growth slowed to a pace last experienced in the third quarter of 2003 as the economy was still emerging from recession.


Source: PMFA, BLS

INFLATION

The Consumer Price Index (CPI) remained flat in July, while Core CPI was up 0.1%. The more volatile Producer Price Index (PPI) increased by 0.6% for the month. The 12-month trailing core PCE Deflator was unchanged at 1.9% in July, within the Fed’s implied target range.

Inflation Indices – 12 Month % Change

Source: PMFA, Bureau of Labor Statistics (BLS)

Source: PMFA, BLS, BEA

INTEREST RATES

Most market observers now expect the Fed to announce a cut in the Fed Funds rate when they meet on September 18. In their August 17th statement, the FOMC stated that “the downside risks to growth have increased appreciably.” While the specifics surrounding the Fed’s next move remain unclear, a cut in the Fed Funds rate in the near term appears increasingly likely.


Source: Federal Reserve

The market for Fed Funds futures is now pricing in an implied probability of a reduction of the Fed Funds rate has increased to 85%.

Longer term yields decreased throughout August as investors took shelter from increased equity market volatility and pushed dollars into Treasuries.

Ten-Year Treasury Yield - as of September 5, 2007

Source: Yahoo Finance

Shorter term rates declined significantly throughout August. The one-month Treasury yield decreased 1.11% over the month, to 4.03%. The 10-year Treasury closed the month of August at 4.54%, decreasing 0.24%. The yield curve shifted from a partial inversion in July to a more normalized curve by the end of August.

Treasury Yield Curve History

Source: PMFA, U.S. Treasury

HOUSING MARKET

The already struggling housing market is becoming increasingly concerning in light of the sub-prime mortgage market troubles. Existing home sales decreased in July by 0.2% and are 22% lower than their peak in June 2005. Pending home sales decreased in July by a dramatic 12.2%, now down 16.6% from a year ago. Meanwhile rising foreclosure rates continue to add to existing home inventories which are already at a cyclical high.

There is very little evidence to suggest that the housing market is likely to materially improve until well into 2008.

Existing Home Sales History

Source: NAR Research

Gratuitously Unnecessary Statistic of the Month

“Dad, I’m dropping out of school…”

According to the soon to be released Statistical Abstract of the United States: 2008, approximately 203,000 individuals are employed as “musicians, singers, and related workers” in the United States. This compares relatively favorably to the estimated 98,000 tax preparers, suggesting that there may be more career opportunities if you can play a guitar than operate an adding machine.

Nobody pays $60 a seat to watch anyone add or subtract, anyway.

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.