Financial Markets in Review
April 2008

Global equity markets rebounded strongly in April as signs continue to suggest that we may be nearing a bottom in the financial crisis. Global economic growth continues to slow, but the unprecedented speed and magnitude of the Federal Reserve’s actions and other central banks should begin to take hold. These actions along with the U.S. tax rebates being sent this quarter should help stabilize economies.

Preliminary estimated first quarter real U.S. GDP growth was +0.6%. We expect a similar rate of growth to persist into the second quarter of 2008, with moderately stronger growth expected to return in the second half of this year. The spending boost from U.S. tax rebate checks should push real GDP into positive territory in the second quarter of 2008. The ISI Group estimates this stimulus will add +1.8% and +3.2% to second and third quarter real GDP growth, respectively.

U.S. consumer spending, which accounts for 70 percent of GDP, slowed significantly in the first quarter as the effects of high energy prices and the ongoing correction in residential real estate gained further traction. Evidence continues to suggest that consumer spending is likely to be soft at least through the first half of this year. Employment, a key component of recession measurement because of its link to consumer spending, declined in April, but the non-farm payrolls 20,000 decline was a deceleration from the first three months of 2008 when payrolls averaged a monthly decline of 80,000. This compares favorably to the 2001 recession, when the monthly decline in non-farm payrolls averaged 250,000. These indicators send mixed signals with respect to the prospects for growth in upcoming quarters.

The market currently expects the Federal Reserve to leave rates unchanged at the June 24-25 meeting, after it’s -25 basis point cut to 2.00% at the April 28-29 FOMC meeting. We think that the Federal Reserve believes they have taken sufficient actions with respect to both interest rates and liquidity measures to stay in front of the financial crisis and will now allow their policy actions time to work through the economy.

Equity Markets
Regardless of the label that economists eventually ascribe to the current period, there is no question that we are experiencing a significant economic slowdown. We continue to believe that the recovery from this economic downturn will be slow and drawn out, largely as a result of the correction in residential real estate that we believe will persist well into 2009. Such periods make earnings growth more difficult for companies to achieve and for investors to find. At the moment, the discrepancy between bottom-up and top-down current year S&P 500 earnings forecasts is unusually large. The bottom-up forecast is +11 percent, while the top-down forecast is +3 percent. This is clearly a risk to some companies’ stock prices as rather optimistic forecasts appear to be built into current year earnings estimates, although part of this will likely be offset by the fact that some stocks already reflect this risk. This underscores our belief that, in the current environment, superior stock selection will be even more important.

Fixed Income Markets
The bond market experienced more volatility in April, as the U.S. Treasury yield curve flattened some, with rates rising approximately 50 basis points on the short end, 35 basis points for intermediate maturities, and 15 basis points on the long end during the month. Corporates tightened, but asset-backed securities were considerably weaker due to credit concerns and downgrades regarding the bond insurers and sub prime mortgages. Tax-exempt bonds, particularly long municipals, were quite strong during the month, as the market continued to recover from the de-leveraging by hedge funds that occurred in late February. Tax-exempt yields fell sharply for the long end of the curve during April, but rose somewhat on the short end. Issuance of tax-exempt bonds increased significantly in March and April, as many auction-rate securities are being remarketed as long-term bonds. Retail demand remained strong, but credit spreads remained wide across most sectors. We expect inflation in the 3.0% to 3.5% range for the year, with interest rates higher across the curve by year-end.