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July 2008

Dear Client:

The first half of the year ended just as it began—with significant stock market losses. The S&P 500 Index fell 8.4%, its second worst month since September 2002 (January 2008 being the worst). Overseas the MSCI EAFE Index dropped 8.2%, its worst performing month since September 2002. Recall that September 2002 marked the beginning of the end of the 2000•2002 bear market. The lows of September 2002 were retested in March 2003 after which point the global stock market entered a 5-plus year bull market.

Both at home and abroad, there was very little difference in performance between large-, mid-, and small-caps in June; however, growth clearly outperformed value at each level of market capitalization. Of course, even the best-performing growth categories still sustained significant losses for a one-month period.

There was one area of the market that held up well in June on a relative and an absolute basis—commodities and commodity producers (i.e. natural resource companies)—and fortunately, that is an area that is a part of our current trend allocation. The Dow Jones AIG Commodity Index gained a whopping 8.9% as energy, food, and metal prices continued to surge. The S&P North American Natural Resources Sector Index—a proxy for the stocks of commodity producers—also managed a positive return to the tune of 2.5%.

Rising Unemployment
The month’s first major piece of negative economic news came on June 6 when the Labor Department reported that the unemployment rate jumped from 5.0% in April to 5.5% in May. It represented the largest month-over-month increase in the unemployment rate in over 22 years. In response, the S&P 500 Index fell 3.1% that day.

A 5.5% unemployment rate is not bad in and of itself, as the average unemployment rate since 1948 is 5.6%; however, it is clear that unemployment is clearly on the upswing, which is what spooked investors and led to the sell-off on June 6.

As we have noted many times before, we do not incorporate economic analysis into ACTIVE PORTFOLIO ENHANCEMENT^® because economic data is not all that useful in predicting future stock market performance. According to JP Morgan, there have been 19 prior instances since World War II when the unemployment rate increased at least 0.5% over a one-month period. The average stock market return one year after the jump in unemployment is 28.2%. The “worst” subsequent one-year return was a gain of 17.6%, which occurred in 1960.

Declining Consumer Confidence
The other piece of negative economic news of note last month was released on June 24. The Conference Board indicated that consumer confidence fell to a 16-year low in June. Consumer confidence surveys are notoriously backward looking though. While we do not have access to the historical results of the Conference Board’s survey, we do have access to data since 1978 from a similar survey of consumers compiled by the University of Michigan. Looking at that data, we found essentially no correlation between monthly changes in consumer sentiment and the subsequent performance of the S&P 500 Index over one-, two-, three-, or five-year periods. Instead, we confirmed that the month-to-month change in consumer sentiment is much better at predicting the previous month’s return. Unfortunately, we do not need much help predicting the past.

As you can see in the chart to the right, the S&P 500 Index tends to perform very well in subsequent one-year periods after significant, multi-year lows in consumer confidence are reached.

Sincerely,

Matthew P. King, CFA Chief Investment Officer

©2008 Bell Investment Advisors, Inc.