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SECOND QUARTER 2008 REVIEW

Market Summary

• Stocks:  S&P 500 declined 3.2% in volatile second quarter (Q2).
• Treasuries:  lost ground as yields rose; 10 Year Yield:  3.98%, up 55 bps from 3.43% at end of Q1.
• Corporate Bonds:  modest losses – narrowly outperformed Treasuries.
• High-Yield Bonds:  modest gains, following late quarter slippage with stocks.
• Crude Oil:  $140.00 per barrel, up from $100.10 at end of Q1.
• Natural Gas:  $13.53, up from $10.30.
• GDP grew 1.0% in Q1:  tepid growth expected through year-end.

 

			Average Annual %
Historical Results	Q2	YTD	1 Yr	3 Yrs	5 Yrs	10 Yrs
Short-Term Treasury Fd (Vanguard –VFISX)	-1.1	2.2	8.3	4.9	3.4	5.0
Intermediate Treasury Fd (Vanguard –VFITX)	-2.7	2.7	12.0	5.1	4.0	6.1
High-Yield Bond Fd (Vanguard –VWEHX)	0.4	-2.0	-1.8	3.3	5.1	4.6
S&P 500 Stock Index Fd  (Vanguard-VFINX)	-2.8	-12.0	-13.2	4.3	7.5	4.1
Small Cap Stock Index Fd (Vanguard-NAESX)	1.1	-8.2	-15.0	4.6	11.5	7.3
Balanced Composite (50% Treasury Fd / 50% S&P 500 Fd)	-2.7	-4.6	-0.6	4.7	5.7	5.1
Data includes reinvested income

 

Review of Markets

Stocks lost ground in a volatile second quarter (Q2).  The large-cap S&P 500 fell 3.2% in Q2 and is down 12.8% year-to-date.   Returns on other indices ranged from –21.7% (Bank Index) to +23.9% (Natural Gas Index).  In the broad market, mid and small-cap indices were generally positive, while large-caps were negative.  Energy and commodity stocks performed best, while financial stocks performed worst.  Q2 was the third-straight down quarter for the broad market.   

Stock market sentiment has been negative since early June and the worry meter red-lined at quarter-end.  Prices have retraced most of the rebound from March lows.  Investors remain concerned about the quality of bank assets (loans) and most financial sector stocks are trading at multi-year lows.  Continuing housing sector weakness and the stalled U.S. economy raise the likelihood that mortgage defaults, especially the sub-prime variety, will continue to increase and then remain high for an extended period of time.  Commodity inflation continues to threaten global growth.  Credit markets have partially recovered from first quarter lows, but remain challenging.  The Fed has cut rates eight times since September, from a start of 5.25% to 2.0% today.   While we'll hear jawboning about inflation, the Fed's highest priority is to stimulate U.S. economic growth.  That means short-term rates should remain low until there are clear signs of a sustainable economic upturn.  

In the near term, we expect continuing volatility.  Longer-term, GPM is bullish.   After declining substantially from October highs, the stock market is valued quite reasonably.  Many individual companies and some sectors represent truly compelling values.  While inflation is a continuing worry, investors are growing more confident in the Fed’s leadership in restoring liquidity to credit markets.  We believe interest rates will remain low and that the resilient U.S. economy will show tepid growth in the second half of '08 before accelerating in '09.  Well-positioned companies, however, can still find ways to grow, especially in global markets. 

Bond market performance was mixed in Q2.  Treasuries and high quality corporates lost ground as yields rose across all maturities.  Corporate bonds outperformed Treasuries by a margin that narrowed late in the quarter as still fragile credit markets weakened with stocks.  Low bond yields seem to indicate little worry about inflation.  High-yield bonds posted modest gains, which also narrowed in June due to the same worries and risk aversion that has pressured stocks.  

 

GPM Portfolios

GPM stock portfolios fared relatively well in Q2, compared to most broad-based indices, which lost substantial ground.   During the quarter, we sold or reduced five stocks and added two, resulting in a higher than normal cash position.  Of our four stock mutual funds, two posted slight gains in Q2, one equaled the S&P 500 loss and the fourth was disappointing.  All four have out-performed the S&P 500 over the past year, and by wide margins in three and five years.  At quarter-end, our model GPM stock portfolio market-cap weighting was about 55% large-caps, 25% mid-caps and 20% small-caps; with non-U.S. stocks at about 11% (approximate percentages include mutual funds held).   

Bond portfolios were slightly positive in Q2.  Results benefited from the slight improvement in credit market function.  Performance was most positively impacted by our closed-end high-yield bond (HYB) funds.  We continue to believe these securities represent good value and expect very attractive returns over the next twelve to eighteen months.  Offsetting slightly negative performance was attributable to high quality short and intermediate maturity bonds and bond funds.

Our balanced portfolios also fared relatively well, compared to large losses in broad stock and bond market indices.  Performance is covered in the stock and bond portfolio discussions above.  In short, gains in our stock and HYB holdings were offset by modest losses in other fixed income holdings.

Accounts that invest exclusively in mutual funds lost ground in Q2.  While down for the quarter, three of our five stock mutual funds held outperformed the S&P 500 during the quarter.  Normally these accounts are under $100,000 in value and invest exclusively in mutual funds and ETF’s.

 

Ten-year Treasury Yield: 3.98%, +55  bps in Q2

 

Historically, periods of heightened uncertainty have been followed by recovery and the opportunity for longer-term investors to realize highly satisfactory returns.  We believe that our stock portfolios are comprised of solid businesses that are trading at attractive valuations, and likely to perform well as some of the present uncertainty is resolved.  Over the years, our value-oriented strategy has served our clients well and should continue to do so.  Thank you for allowing GPM to serve as your investment manager and advisor. 

As always, feel free to call us for any reason.

The GPM Team