Capital Markets

Domestic markets suffered further declines in February, as most indicators pointed to further economic softening. Declines in non-farm payrolls, multiple housing metrics, consumer confidence, and services and manufacturing sector activity all contributed to investor jitters. Meanwhile, rising inflation indices contributed to concerns about the Federal Reserve’s ability to calm credit markets and stimulate the economy without stoking inflation.

International equities, as measured by the MSCI EAFE Index, reported a nominal recovery of 1.4% during the month. Year to date, international developed markets are faring just slightly better than domestic equities.


Source: PMFA

As illustrated below, market volatility remains elevated as a result of investor fears about the economic outlook. The daily drumbeat of credit market instability and the lack of an apparent bottom in the housing market have added fuel to the fire.

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

Source: Yahoo Finance

The span of credit uncertainties spread more deeply into the municipal markets in February. This played a major role in the negative returns reported for the month. Taxable bond returns showed relatively flat performance, although short-term issues rallied as the Fed cut rates and the market anticipated further easing.


Source: PMFA

Commodities gained momentum, fueled by weakness in the Dollar and investors seeking alternatives to stocks. Precious metals also benefited as gold continued to climb toward $1,000 per ounce. Conversely, REITS extended their slide; the Wilshire REIT Index has lost nearly 30% over the last twelve months.

Economy

GDP

The preliminary estimate for Q4 GDP growth was unchanged from the advance estimate at a sluggish 0.6% annualized rate. The primary factors contributing to the slower growth were the decline in residential housing and a deceleration in consumer spending and exports. Residential investment plunged at a 25% annualized pace in the fourth quarter, the largest quarterly decline in over 26 years. Business inventories were trimmed during the quarter, while the pace of export growth also slowed considerably.

Real GDP & Personal Consumption – Quarterly % Change

Source: PMFA, Bureau of Economic Analysis (BEA)

The Federal Reserve Board recently announced a downward revision for projected GDP growth for 2008 to a rate of 1.3% to 2.0%, considerably lower than their October estimate of 1.8% to 2.5%. Further, their forecast for the core Personal Consumption Expenditures (PCE) inflation was revised upward to a range of 2.1% to 2.4%, nearly a half percent higher than the Fed’s last estimate released in October.

Employment

The pace of job creation declined for the fourth consecutive month and indicated a net monthly loss in non-farm payrolls for the second straight month in February. An estimated 63,000 net jobs were eliminated during the month, the worst single month result since March 2003. Moreover, this result was substantially weaker than the consensus estimate of a net creation of 25,000 jobs.

Nonfarm Payrolls & Unemployment Rate – Monthly

Source: PMFA, Bureau of Labor Statistics

The unemployment rate for February was 4.8%, a fractional decline from January. However, the net loss of actual jobs during the month suggests that the decline in the rate is not a result of a strengthening job market, but individuals leaving the labor force. During February, the civilian labor force declined by nearly a half million workers.

Inflation

Inflation crept higher again in January. The Consumer Price Index rose 0.5% and is now up 4.3% in the past 12 months.


Source: PMFA, BEA, BLS

Inflation Indices – 12-Month % Change

Source: PMFA, BLS, BEA

Interest Rates

While the FOMC took a break from their easing cycle in February, inflationary concerns persisted, spurring the nation’s central bankers to increase their anti-inflationary rhetoric, even while providing further stimulus. Many of their recent comments have stressed the need to closely monitor indicators of future inflation.

The Fed is faced with a significant challenge in the short term: restore a sense of stability to the credit markets and stem the tide of declining economic growth while not allowing inflationary pressures to take root further. Setting the rhetoric aside, the Fed has clearly determined to address the credit markets first through both interest rate cuts and their other innovative efforts to inject some liquidity into the banking system.

The market is currently anticipating a 75 basis point cut at their March 18^th meeting, following further evidence of continued slackening in manufacturing, construction, payrolls, and consumer spending. At this point, some further reduction in the Fed Funds rate below its current 3.0% appears to be a foregone conclusion.

Current Probabilities for 3/18/08 FOMC Meeting

Source: PMFA, Bloomberg

The yield curve generally trended downward again in February. The ten-year treasury yield ended the month at 3.53%, declining by 14 basis points. Short-term yields also fell, with the three-month Treasury ending the month at a yield of 1.85%. In the early days of March, the three-month Treasury yield has dropped even further, trimming nearly another half percent to a three-year low of 1.39%.

Treasury Yield Curve History

Source: PMFA, U.S. Treasury

The Fed’s last easing cycle ended with a final cut to bring the Funds rate down to just 1.0% in June 2003. While the short end of the current yield curve remains higher than at that cyclical nadir, longer term rates are very similar to the lows reached over four years ago.

Dollar Depreciation

The Dollar has now declined over 20% relative to a handful of other currencies. This has helped U.S. exports, but is likely also a cause of higher inflation and oil costs.

Broad Dollar Index & WTI Crude Oil – History

Source: PMFA, Bloomberg

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 (PMFA) 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 PMFA for investment advice regarding your own situation.